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Advaita
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Joined: April 20th, 2005, 1:54 pm

How to hedge the swap spread (or a spreadlock)

April 21st, 2005, 1:30 pm

How would one hedge a "forward"swap spread (Par swap rate - Tsy yield.) Essentially I need to *delta hedge* a 5 yr spreadlock starting in 2 yr using ONLY one swap and maybe 2-3 gov. bonds. (i.e. the deltas for the hedge = delta for the spreadlock)i.e. Delta (Swap + 2 bonds) = Delta (Spreadlock)For this I am using a 7 yr swap (with the same payment times and frequencies as the spreadlock) with the fixed rate as the 2 yr forward par swap rate. This would hopefully hedge my "forward swap" part of the swap spread.How about the bonds?? Because there are only a given number of bonds in the market, with payment dates that do not align with the spreadlock, I am not sure how to incorporate bonds.(I was thinking of using 2 bonds. one for the initial 2 yr period and another for the 3yr-7yr period.) Any help is appreciated. Any alternate method of hedging (with swaps and gov bonds only) or analytical/math insight will be very helpful.
 
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donyoshi
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Joined: February 18th, 2004, 8:26 am

How to hedge the swap spread (or a spreadlock)

April 23rd, 2005, 6:31 am

never traded a 2y forward on the spread, we usually did 3 to 6mth forwards on the 10y TED spread, which we hedged via a forward starting swap and the treasury future.
 
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Stochastix
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Joined: May 28th, 2002, 11:21 am

How to hedge the swap spread (or a spreadlock)

April 25th, 2005, 2:20 pm

The problem is not so simple. We don't know what will be the 5Y Benchmark in two years (not its exact maturity and coupon). The only thing you could rationally set up is a forward swap spread on current Treasuries (a 7 year one). Hedging such a trade is straightforward.
 
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rambo900
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Joined: January 24th, 2006, 4:15 pm

How to hedge the swap spread (or a spreadlock)

July 26th, 2007, 9:58 pm

Sorry, could anyone please explain to me what TED spread is? Thank you!
 
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u418936
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Joined: October 28th, 2003, 9:31 pm

How to hedge the swap spread (or a spreadlock)

July 27th, 2007, 12:28 pm

You're trying to replicate the 5yr swap rate 2yrs fwd. Say you're receiving on spreads. Ideally, if there were a 2yr term market on repo, you could borrow a few different 7yr bonds (spread out your risk) for 2yrs, sell the bonds in cash, and receive on matched-maturity fwd starting swaps. Then the main source of risk in two years (I think) would be that the bonds might be rich to CT5.Since there's no term repo market, you can't exactly do that. Off the top of my head, I'd say that you could roll the bonds overnight (or roll term) and hedge out the funding risk by buying Eurodollars. Fed funds would be better than Eurodollars (less basis risk), but there isn't much liquidity past 6 months. The thing that sucks about this idea is that you're now exposed to the LIBOR-Funds basis widenting, the Funds-GC basis widening, or the bonds' getting really special. You can hedge out the LIBOR-Funds basis with basis swaps (I would), but there's nothing you can really do about the other two.