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D/SWAP (DIFFERENTIAL TO SWAP)


An essential measure in bond management is the premium associated with the debtor’s default risk.

A company with a high default risk needs to offer higher yields to attract investors. Generally speaking, the term risk premium is used to denote the surplus yield an issuer must offer to attract investors.
Three components go into the figure that represents a bond’s yield:
  1. The yield equivalent to swaps
  2. The risk premium attributed by the market to each debtor
  3. A variable portion that depends on issue-specific factors (liquidity, maturity, currency, call option, etc.)

Points 2 and 3 constitute the issue’s risk premium, known as the D/Swap (Differential to Swap).

D/Swap = (Issue Yield – Interpolated Swap Yield) x 100

La différence de rendement est multiplié par 100 afin d’obtenir le résultat en point de base (bp ou bps). Un point de base est équivalent à 0.01%.







Widening D/Swap
A widening D/Swap (increasing differential to swap) is synonymous with a deterioration of credit or underperformance of the issue versus swaps.

If one considers that the swap curve remains unchanged, a widening of the D/Swap is due to the increased yield of the bond resulting from a deterioration in the issuer’s credit standing. A higher yield is equal to a deterioration in price. The bond depreciates while the swaps remain constant, and therefore the issue is underperforming vis-à-vis the swaps


Narrowing D/Swap
A narrowing D/Swap (decreasing differential to swap) is synonymous with improved credit or overperformance of the issue versus swaps.

If one considers that the swap curve remains unchanged, a narrowing of the D/Swap is due to the lower yield of the bond resulting from an improvement in the issuer’s credit standing. A lower yield is equal to an increase in price. The bond appreciates while the swaps remain constant, and therefore the issue is overperforming vis-à-vis the swaps.


D/Swap is a Relative Value
If an AAA rated bond has a D/Swap of –2 bp, it does not necessarily mean that it is expensive. Indeed, if the AAA bond market average is –15 bp, a bond with a D/Swap of –2 bp is attractively priced. On the other hand, if the AAA bond average is +10 bp, then the bond is expensive.

If a BBB rated bond has a D/Swap of +50bp but the average for BBB bonds is +60bp, then the bond is expensive, while the bond is relatively cheap if the BBB average is +40 bp.

The graph below shows the average D/Swap evolution for different sectors:



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