What Is a Spreadlock?

A spreadlock is a credit derivative contract that establishes a predetermined spread for future 澳洲幸运5官方开奖结果体彩网:interest rate swaps. The two main types of spreadlocks that can be used are forward-based spreadlocks and option-based spreadlocks. ꧙

With a spreadlock, an interest rate swap user may lock in a current spread between a swap and an underlying government bond yield. This strategy allows for the transfer of 澳洲幸运5官方开奖结果体彩网:basis points forward to the time when the swap is written.

Spreadlocks🦩 are potentially useful for investors contemplating the use of an interest rate swap at some point in the future. However, they are not available in all markets.

Understanding a Spreadlock

Spreadlocks have been an option for investors since the late 1980s, and they quickly joined swaps, caps, floors, and swaptions as 澳洲幸运5官方开奖结果体彩网:plain vanilla derivative structures.

A forward spreadlock allows 🐓for a definitive inc🌌rease of a set number of basis points on top of the current spread in the underlying swap. With a spreadlock through an option contract, the buyer of the contract can decide whether or not to make the swap useful.

An example of a forward-based spreadlock would be a two-way contract in which the parties agree that in one year’s time they will enter into a five-year swap. In this hypothetical swap, one party will pay a floating rate, such as the 澳洲幸运5官方开奖结果体彩网:London Interbank Offered Rate (LIBOR), and the other party will pay the five-year Treasury yield as of the start date, plus 30 basis points. In the case of an option-based spreadlock, one of the parties would have the right to decide whether or🐷 not the swap will go into effect before the date of maturity.

Spreadlocks can be regarded as credit derivatives si🐷nce one of the factors driving the underlying swap spread is ♚the general level of credit spreads.

Some advantages of using a spreadlock are that they allow for more precise interest rate management, plus increased flexibility and customization. The main goal of a spreadlock is to hedge against adverse moves in ꧟the spread between swaps and the underlying government bond yield.

Some disadvantages are that spreadlocks require documentation from the 澳洲幸运5官方开奖结果体彩ꦕ𓆉网:International Swaps and Derivatives Association (ISDA), have unlimited loss 🧜potential,𓃲 and because implied forwards can sometimes be unattractive.

Spreadlocks and Swap Spread Curves

A spreadlock’s price is equivalent to the difference between the implied forward swap rate and the implied forward bond yield. The 澳洲幸运5官方开奖结果体彩网:swap spread curve can be viewed independently from the overall swap 澳洲幸运5官方开奖结果体彩网:yield curve. 

As is the case with all implied forwards, a positively sloped spread curve suggests that swap spreads will rise over time because swap spreads for shorter 澳洲幸运5官方开奖结果体彩网:maturities are lower than longer maturities. A negatively sloped spread curve means that swap spr🤡eads will fall over time because swap spreads for shorter maturities are higher than longer maturities.

Spreadlocks and Hedging Bond Issuances

Spreadlocks are primarily used to hedge bond issuances. When a company issues a bond the 澳洲幸运5官方开奖结果体彩网:fixed rate is usually ൩above that of the Treasuri𒊎es. When a company is issuing a bond, the interest rates can change between the time of the decision to issue a bond and the time of funding.

It can be difficult to hedge the changes in th♑e spread between the offered fixed-rate and the yield on the Treasury. Using a spreadlock locks in a swap rate for a specific period of time at a specific amount in adꦉvance, regardless of what the rates are at the time the swap begins.