What is Tenor
Tenor in finance can have multiple usages, but it most commonly refers to the amount of time left for the repayment of a loan or until a financial contract expires. It is most commonly used for nonstandardized contracts, such as foreign exchange and interest rate swaps, while the term "maturity" is usually used to express the same concept for government bonds and corporate bonds. Tenor can also refer to the payment frequency on an interest rate swap.
BREAKING DOWN Tenor
The tenor of most financial instruments declines over time, while the maturity remains constant. The risk associated with a given asset tends to decline with the reduction of the time remaining to maturity. The tenor of an interest rate swap can also refer to the frequency with which coupon payments are exchanged.
In general, the risk associated with a given instrument decreases as the time to maturity, the tenor, declines. This is because the longer the period of time to maturity, the greater the chance that something will go wrong, which could cost the investor all or part of their principal. This is why, in general, an interest rate swap with a longer tenor will require a bigger spread.
Some investors will not buy financial instruments or enter contracts with a tenor longer than a certain period because of the associated risk; the tenor limit can also vary depending on the credit rating of the counterparty. For example, a bank might enter into a five-year interest rate swap with a AA-rated company but only a three-year swap with an A-rated company.
An interest rate swap is the exchange of one type of interest rate payment, usually a fixed rate, for another type of payment, which is usually a floating rate. The interest coupons are exchanged between the two parties at stipulated intervals. The interval is sometimes referred to as the tenor of the swap.
For example, one of the most common swaps involves the exchange of a fixed rate for payments at the U.S. three-month LIBOR rate, paid semiannually. This means that while the floating rate is reset quarterly, the payments are compounded and paid semiannually. This would be considered a six-month tenor.
Basis swaps are the exchange of one floating rate index for another, such as the one-month U.S. dollar LIBOR for the three-month U.S. dollar LIBOR. The swaps are often structured so that interest rate payments are only exchanged on the longer of the two periods. In this example, payments would be exchanged every three months, which is the tenor of the swap. Matching the coupon payments reduces the credit risk for the counterparty paying one-month LIBOR, who otherwise would make three payments for every one received.