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Basis Swaps

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Published: 11th August 2014 by William Webster

A basis is swap is an interest rate or currency swap where both the payment of interest and receipt of interest are on a variable or floating rate basis.

Let’s see three examples:

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Basis risk - an update It's a salutary fact that the regulator has identified that firms that run relatively large basis risks are more prone to margin compression. That's because excessive basis risk reduces your control over the balance sheet and calls into question your risk management and governance. Ask a trader about basis risk and they will tell you it is to do with ineffective hedging. You may think of it as the risk between Libor and Bank rate. The fact is basis risk means different things to different people. So let's define it. In the following article basis risk is "the degree of control you have over the margins in your balance sheet". This may seem an unusual definition but all will become apparent.

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This risk is still very much alive, so how do we form judgement on what our risk appetite should be? I’ll try and answer this by considering three things.