What Is a LIBOR-in-Arrears Swap?

A LIBOR-in-arrears swap is similar to a regular or vanilla swap but the floating rate sid𝓡e is set at the end𝔉 of the reset period instead of the beginning. That rate is then applied retroactively.

The quick definition is that a vanilla swap sets the rate in advance and pays later (in arrears) while an arrears swa༒p setsᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚ and pays later (in arrears).

This swap has several other names, including 澳洲幸运5官方开奖结果体彩网:arrears swap, reset swap♔, back-set swap, and delayed reset swap.꧑

Understanding a LIBOR-in-Arrears Swap

The LIBOR-in-arrears structure was introduced in the mid-1980s to enable investors to take advantage of potentially falling 澳洲幸运5官方开奖结果体彩网:interest rates. It is a strategy used by investors and borro🎀wers who are directiꦡonal on the interest rates and who believe they will fall.

Swap transactions exchange the cash flows of fixed-rate investments for those of floating-rate investments. The floating rate is usually based on an index, such as the 澳洲幸运5官方开奖结果体彩网:London Interbank Offered Rate (LIBOR), plus a predetermined amount. Typica𓄧lly, all rates set at the start of🐬 the swap, and, if applicable, at the start of subsequent reset periods until the swap matures.

The definition of "arrears" is money that is owed and should have been paid earlier. In the case of a LIBOR-in-arrears swap, the definition tilts more toward the calculation of the payment, rather than the payment itself.

In a regular or 澳洲幸运5官方开奖结果体彩网:plain vanilla swap, the floating rate is set at the start of the reset period and paid at the end of that period. For an arrears swap, the ma♛jor difference is when the swap contract samples the LIBOR rate and determines what the payment should be. In a vanilla swap, the LIBOR rate at the beginning of the ꩲreset period is the base rate. In an arrears swap, the LIBOR rate at the end of the reset period is the base rate.

Using a LIBOR-in-Arrears Swap

The floating rate side of a vanilla swap, in this case, LIBOR, resets on each reset date. If the three-month LIBOR is the base rate, the floating rate paym🦋ent under the swap occurs in three months, and then the then-current three-month LIBOR will determine the rate for the next period. For an arrears swap, the current period's rate sets in three-months to cover the period just ended. The rate for the second three-month period sets six months into the contract, and so forth.

If an investor believes that LIBOR will fall over the next few years and only wants to exploit this possibility then they expect it to be lower at the end of each reset period instead of at the beginning. The investor could ente༺r a swap agreement to receive LIBOR and pay LIBOR-in-arrears over the life of theꩵ contract. Note, both rates are floating, in this case.