DEFINITION of 'Bond Market Association (BMA) Swap'

A Bond Market Association (BMA) Swap is a type of swap arrangement in which two parties agree to exchange interest rates on debt obligations, where the floating rate is based on the U.S. SIFMA Municipal Swap Index. One of the parties involved will swap a fixed interest rate for a floating rate, while the other party will swap a floating rate for a fixed rate.

The BMA Swap is also referred to as the municipal interest rate swap.

BREAKING DOWN 'Bond Market Association (BMA) Swap'

The Bond Market Association (BMA) is a defunct trade association that consisted of brokers, dealers, underwriters, and banks that dealt with debt securities. In 2006, the BMA merged with the Securities Industry Association to form the Securities Industry and Financial Markets Association (SIFMA). SIFMA is a securities trading group in the U.S. that represents the shared interests of securities firms, banks, and asset management companies. The association created The Securities Industry and Financial Markets Association Municipal Swap Index (formerly called The Bond Market Association/PSA Municipal Swap Index), which is a high-grade market index comprised of hundreds of tax-exempt variable-rate demand obligations (VRDOs). VRDOs are municipal bonds with floating interest rates. The index is calculated on a weekly basis as the non-weighted average of the weekly rates of various VRDO issues included in the index. The U.S. SIFMA Municipal Swap Index serves as a benchmark floating rate in municipal swap transactions.

When an interest rate swap is entered into by an issuer and a counterparty, such as a dealer, bank, insurance company, or other financial institution, both parties agree to exchange payment streams according to a notional principal amount which is never exchanged but only used to calculate the cash flow payments. In an interest rate swap, two counterparties “swap” fixed interest rate payments for floating rate payments. A Bond Market Association (BMA) Swap is a municipal interest rate swap which has its floating rate payments based on the SIFMA Index. Because the interest received from VRDOs qualifies for certain exemptions from income tax, the SIFMA rate tends to trend towards a rate that makes the after-tax position of a VRDO holder roughly equivalent to the after-tax position of a holder of non-tax-exempt obligations.

Just as the London InterBank Offered Rate (LIBOR) is the most common measure of short-term taxable rates, SIFMA is the most common measure of short-term tax-exempt rates. The SIFMA rate generally trades as a fraction of LIBOR, reflecting the income tax benefits associated with municipal bonds. The SIFMA Index is usually 64% - 70% of its taxable equivalent 3-month LIBOR. For example, assume the 3-month LIBOR, as of March 28, 2017, is 2.29%, and the SIFMA rate is approximately 67.5% of 3-month LIBOR, the SIFMA rate can be calculated to be .675 x 2.29% = 1.55%.

In a municipal interest rate swap, the issuer enters into a swap agreement to convert existing fixed rate debt synthetically into floating rate debt, or vice versa. An issuer that has fixed rate debt but expects prevailing interest rates in the market to decrease and does not want to refinance or refund its existing debt issue, may choose to add variable exposure by entering into a BMA swap. In this case, the issuer will pay the counterparty the current SIFMA rate, and the counterparty pays the issuer an agreed upon fixed interest rate. However, the issuer will continue paying its bondholders the regular fixed interest associated with the existing bond issue. If the floating rate is less than the fixed rate, then the issuer receives a surplus from the counterparty which can be used to make its interest payments. In effect, the variable rate exposure which the issuer now has, reduces its overall interest costs or debt service payments.

The benefits of two parties entering into an interest rate swap arrangement can be significant. Often, each of the two firms involved has a comparative advantage in its fixed or variable interest rate obligation. Consequently, for budgeting or forecasting reasons, a company may wish to enter into a loan with a fixed or variable interest rate in which it does not have a comparative advantage.

The BMA swap can be used to either bet on the direction of interest rates in the municipal market or hedge exposure to U.S. state and local government debt.

RELATED TERMS
  1. Delayed Rate Setting Swap

    A delayed rate setting swap is an exchange of cash flows, one ...
  2. Asset Swap

    An asset swap is a derivative contract through which fixed and ...
  3. Currency Swap

    A swap that involves the exchange of principal and interest in ...
  4. Fixed Price

    The fixed price leg of a swap is one that is based on an unchanging ...
  5. Inflation Swap

    An inflation swap is a transaction in which two parties exchange ...
  6. Basis Rate Swap

    A basis rate swap is a type of swap in which two parties swap ...
Related Articles
  1. Trading

    How To Value Interest Rate Swaps

    An interest rate swap is a contractual agreement between two parties agreeing to exchange cash flows of an underlying asset for a fixed period of time.
  2. Managing Wealth

    An In-Depth Look at the Swap Market

    The swap market plays an important role in the global financial marketplace; find out what you need to know about it.
  3. Investing

    What's an Interest Rate Swap?

    An interest rate swap is an exchange of future interest receipts. Essentially, one stream of future interest payments is exchanged for another, based on a specified principal amount.
  4. Trading

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  5. Investing

    How To Read Interest Rate Swap Quotes

    Puzzled by interest rate swap quotes terminology? Investopedia explains how to read the interest rate swap quotes
  6. Trading

    Different Types of Swaps

    Identify and explore the most common types of swap contracts. Swaps are derivative instruments that represent an agreement between two parties to exchange a series of cash flows over a specific ...
  7. Investing

    The Advantages Of Bond Swapping

    This technique can add diversity to your portfolio and lower your taxes. Find out how.
  8. Investing

    CFTC Probes Banks' Use of Interest Rate Swaps

    U.S. regulators are probing banks' trading and clearing of interest rate swaps, which played a central role in the 2008 financial crisis
  9. Investing

    The Fast-Paced World of Libor & Fixed Income Arbitrage

    LIBOR is an essential part of implementing the swap spread arbitrage strategy for fixed income arbitrage. Here is a step-by-step explanation of how it works.
  10. Investing

    The Basics Of Municipal Bonds

    Investing in municipal bonds may offer a tax-free income stream, but such bonds are not without risks. Check out types of bonds and the risk factors of muni-bond.
RELATED FAQS
  1. How do companies benefit from interest rate and currency swaps?

    Interest rate and currency swaps help companies manage exposure to rate fluctuations and acquire a lower rate than they would ... Read Answer >>
  2. How do currency swaps work?

    Learn how a currency swap works, including who uses these transactions, and the mechanics and purpose of the different cash ... Read Answer >>
  3. What is the difference between derivatives and options?

    A derivative is a financial contract that gets its value from an underlying asset. Options offer one type of common derivative. Read Answer >>
  4. What are some examples of risks associated with financial markets?

    Find out about the different types of risks for different classes of assets including volatility, counterparty risk and default ... Read Answer >>
  5. How do companies benefit from interest rate swaps?

    Learn how companies can swap interest rate payments and mutually benefit. Find out how these swaps arbitrage differences ... Read Answer >>
Trading Center