What is 'Intermarket Spread Swap'

An Intermarket spread swap is the exchange of two bonds within different parts of the same market that can help produce a more favorable yield spread. A yield spread is a difference between yields on various debt securities with varying maturities, credit rating, and risk. One bond is sold to purchase, or swap, for another security seen as superior in some aspect.

An Intermarket spread swap is a transaction meant to capitalize on a yield discrepancy between bond market sectors

BREAKING DOWN 'Intermarket Spread Swap'

Intermarket spread swaps have a basis on the yield spreads between different bond sectors. By entering a swap, parties gain exposure to the underlying bonds, without having to hold the securities directly. An Intermarket spread swap is also a strategy to attempt to improve an investor’s position through diversification.

Opportunities for Intermarket spread swaps exist when there are credit quality, or feature differences, between bonds. For example, investors would swap government securities for corporate securities if there is a wide credit spread between the two investments and the spread is expected to narrow. One party would pay the yield on corporate bonds while the other will pay the treasury rate plus the initial range. As the spread widens or narrows, the parties will begin to gain or lose on the swap.

An example of an Intermarket Spread Swap could occur in a situation when the investment rate of return on a bond changes, so the investor “swaps” it out for the better-performing kind. For example, if a one type bond has historically seen a 2 percent return rate, but the yield spread reveals a 3 percent difference, the investor might consider “swapping,” or essentially selling, the bond to try to narrow the difference and yield a higher profit.

Limitations of an Intermarket Spread Swap

One important consideration of an intermarket spread swap is for the investor to consider what is the driving the difference in the yield spread. Typically, bonds yields tend to rise when their prices fall, but a smart investor will also take into consideration just what is driving those dropping prices. For example, during times of recession, a wide yield spread could actually represent the perceived higher risk of that bond instead of just some bargain pricing. Purchasing what actually boils down to high risk bonds is a decision that should not be taken lightly by investors.  

RELATED TERMS
  1. Intermarket Sector Spread

    Intermarket sector spread is the yield spread between two fixed-income ...
  2. Asset Swap

    An asset swap is a derivative contract through which fixed and ...
  3. High-Yield Bond Spread

    A high yield bond spread is the percentage difference in current ...
  4. Substitution Swap

    A substitution swap is a bond exchange that trades one security ...
  5. Basis Rate Swap

    A basis rate swap is a type of swap in which two parties swap ...
  6. Delayed Rate Setting Swap

    A delayed rate setting swap is an exchange of cash flows, one ...
Related Articles
  1. Investing

    The Advantages Of Bond Swapping

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

    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.
  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

    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.
  7. 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 ...
  8. Trading

    Intermarket relationships: Following the cycle

    Learn more about the interactions between commodity, bond, stock and currency markets.
  9. 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.
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 types of stocks have a large difference between bid and ask prices?

    Find out which factors influence bid-ask spread width. Learn why some stocks have large spreads between bid and ask prices, ... Read Answer >>
Trading Center