EURIBOR swap yields

We consider three-or-six-month EURIBOR swap yields with maturities ranging from one year to 10 years and find recursively equivalent zero-coupon rates. Swap yields are par yields so the zero-coupon rate with maturity two years R(0,2) is obtained as the solution to the following equation ... 

That said, there are two reasons why the performance of German swap spreads are related to Euro peripheral spreads. The first one is that, flows apart, the bond-swap spread reflects the yield difference between a government rate and the composition of a string of EURI-BOR rates (i.e., a swap fixed rate). As the average credit quality of the banks in the EURIBOR panel is A-AA, any increase in the investors preference for credit quality will make both swap and peripheral spreads widen versus the core Euro government rate, thus increasing the correlation between both differentials. Yet this increase in the correlation will be mainly due to the outperformance of the benchmark asset... 

The terms spread or credit spread refer to the yield differential, usually expressed in basis points, between a corporate bond and an equivalent maturity government security or point on the government curve. It can also be expressed as a spread over the swap curve. In the former case, we refer to the fixed-rate spread. In the latter, we use the term spread over EURIBOR, or over the swap curve. 

Suppose an investor has purchased a 5-year note paying 6-month EURIBOR plus 50 bp, with 6-month EURIBOR initially set at 2%. Interest rates are currently very low, so the investor is thinking about using a 5-year swap to boost the return. With 5-year swaps quoted at 3%, against EURIBOR flat, the investor could switch from 6-month EURIBOR plus 50 bp to an effective yield of 3.5%, enjoying an immediate 100 bp improvement in yield. This structure is pictured in Exhibit 17.30. 

The only problem with this strategy is that the investor cannot gain from any subsequent increase in EURIBOR. The swap freezes the yield to 3.5% for five years, regardless of what happens to EURIBOR in the future. 

The fixed rate is some spread above the benchmark yield curve with the same term to maturity as the swap. In our illustration, suppose that the 10-year benchmark yield is 8.35%. Then the offer price that the dealer would quote to the fixed-rate payer is the 10-year benchmark rate plus 50 basis points versus receiving EURIBOR flat. For the floating-rate payer, the bid price quoted would be EURIBOR flat versus the 10-year benchmark rate plus 40 basis points. The dealer would quote such a swap as 40-50, meaning that the dealer is willing to enter into a swap to receive EURIBOR and pay a fixed rate equal to the 10-year benchmark rate plus 40 basis points and it would be willing to enter into a swap to pay EURIBOR and receive a fixed rate equal to the 10-year benchmark rate plus 50 basis points. 

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