Swap curve: meaning and how it differs from the bond yield curve

Most people know the government bond yield curve. Banks and big companies also watch another curve built from interest rate swaps. This page explains what a swap curve is, how it is used and how it differs from the bond yield curve.

Quick answer

A swap curve is a line that shows the fixed interest rates on interest rate swaps for different time periods, such as one year, three years and five years. Each point is the fixed rate that market players agree to exchange for a floating rate over that period. Banks and companies use the swap curve to price loans, hedge interest rate risk and read market expectations about future rates.

Key takeaways

• It plots fixed swap rates across maturities.
• In India, most swaps are linked to overnight MIBOR.
• It reflects expected future rates and bank credit conditions.
• The gap between swap rates and bond yields is the swap spread.
• Banks use it to price loans and hedge rate risk.

What is a swap curve?

An interest rate swap is a deal where two parties exchange interest payments. One pays a fixed rate and the other pays a floating rate, on the same notional amount, for an agreed period. No principal changes hands.

The fixed rate agreed for each period is called the swap rate. When you plot swap rates for one year, two years, five years and so on, you get the curve. It shows how the market prices interest rates over time.

Which swaps make up the curve in India?

In India, the most traded swaps are overnight index swaps linked to FBIL's overnight MIBOR, the benchmark for the interbank call money market. Most of these trades are cleared through CCIL.

There are also swaps linked to Modified MIFOR, which combine rupee and dollar rates and are used by firms with foreign currency exposure. Each type has its own curve.

How is the swap curve different from the bond yield curve?

The difference between a swap rate and a government bond yield of the same maturity is called the swap spread. It can change with liquidity, demand for bonds, bank funding conditions and expectations about RBI policy.

How is the swap curve used?

Banks use it to set the fixed rate on loans and to hedge their own interest rate risk. A company with a floating rate loan can use a swap to lock in a fixed rate, and the curve tells it roughly what that fixed rate would be.

Traders also read the curve as a guide to market expectations. If short-term swap rates fall below the overnight rate, the market may be pricing in rate cuts. If they rise, it may be expecting hikes.

Why it matters for investors

Changes in this curve often move before or along with changes in bond yields and lending rates. Following it can help you understand why loan rates, debt fund returns and bank shares react to RBI decisions.

In short, the swap curve is the market's price list for future interest rates in the swap market. It is a key tool for banks and companies, and a useful signal for anyone tracking interest rates.

Frequently Asked Questions