What Is Quality Spread Differential (QSD)?

Quality spread differential (QSD) is used to calculate the difference between market interest rates that two parties potentially entering into an 澳洲幸运5官方开奖结果体彩网:interest rate swap are able to achieve. It is a measurement that companies can use to gauge 澳洲幸运5官方开奖结果体彩网:counterparty risk in an interest rate swap.

Understanding Quality Spread Differential (QSD)

QSD is a measure used by companies of different creditworthiness in interest rate swap analysis. They use a QSD to gauge 澳洲幸运5官方开奖结果体彩网:default risk. When the QSD is positive, the swap is considered to 🀅benefit both parties involved.

A quality spread provides a 澳洲幸运5官方开奖结果体彩网:credit quality measure for both parties involved in an intღerest rate swap. The quality differential is calculated by subtracting the contracted 🔯market rate by the rate available to the counter-party on similar rate instruments.

The difference between the two quality spreads can be calculated🎃 as follows:

• QSD = Fixed-rate debt premium differential - Floating-rate debt premium differential

The fixed-rate de🐻bt differentia💛l is typically larger than that of the floating-rate debt.

Interest Rate Swaps

Interest rate swaps trade on institutional market exchanges or through direct agreements between counterparties. They allow one entity to swap their 澳洲幸运5官方开奖结果体彩网:credit risk with anotꦓher using different types of credit instruments.

A typical interest rate swap will include a 澳洲幸运5官方开奖结果体彩网:fixed rate and a 澳洲幸运5官方开奖结果体彩网:floating rate. A company that seeks to hedge against paying higher rates on its floating-rate⛎ bonds in a rising rate environment would swap the floating-rate debt for fixed-rate debt. The counterparty takes the opposite view of the market and believes rates will fall, so it wants the floating-rate debt to pay off its obligations and obtain a profit.

For example, a bank may swap its floating-rate bond debt currently at 6% for a fixed-rate bond debt of 6%. C༒ompanies can match debt with varying maturity lengths depending on the swap contract length. Each company💛 agrees to the swap using the instruments it has issued.

Quality Spread Differential (QSD) Example

Here's an example of how QSDs work. Company A, swapping its floating-rate debt, will receive a fixed rate. Company B, swapping its fixed-rate debt, will receive a floating rate. The QSD is usually not calculated based on the rates of the instruments used. The creditworthiness of both companies is different.

If Company A (AAA-rated) uses a two-year term floating-rate debt at 6% and Company B (BBB-rated) uses a five-year fixed-rate debt at 6%, then the QSD 🃏would need to be calculated based on the rates versus the market rates.

Company A’s 6% rate on the two-year floating-rate debt compares to a 7% rate obtained for Company B on a two-year floating-🍎rate debt, so this quality spread is 1%. For a five-year fixed-rate debt, Company A pays 4% where Company B pays 6%, so the quality spread is 2%. The key is to use similar products in the quality spread calculation in order to compare rates of simil♈ar issues.

In the example above, this would be 2% minus 1%, resulting in a QSD of 1%. Remember, a positive QSD indicates a swap is in the interest of both parties because there is a favorable default risk. If the AAA-rated company had a significantly higher floating-rate premium to the lower credit quality company, it🔯 would result in a negative QSD. This would likely cause the higher-rated company to seek a higher-rated counterpart.