A Constant Maturity Swap is a variation of the regular interest rate swap. In a constant maturity swap, the floating interest portion is reset periodically according to a fixed maturity market rate of a product with a duration extending beyond that of the swap’s reset period.
A constant maturity swap, also known as a CMS, is a swap that allows the purchaser to fix the duration of received flows on a swap.
Constant maturity swaps are exposed to changes in long-term interest rate movements. They are initially priced to reflect fixed-rate products with maturities between two and five years in duration, but adjust with each reset period.
The floating leg of an interest rate swap typically resets against a published index. The floating leg of a constant maturity swap fixes against a point on the swap curve on a periodic basis.
A constant maturity swap is an interest rate swap where the interest rate on one leg is reset periodically, but with reference to a market swap rate rather than LIBOR. The other leg of the swap is generally LIBOR, but may be a fixed rate or potentially another constant maturity rate. Constant maturity swaps can either be single currency or cross currency swaps. Therefore, the prime factor for a constant maturity swap is the shape of the forward implied yield curves.
A standard fixed-for-floating interest rate swap is priced to reflect the arbitrage- enforced relationship between a fixed rate and the combined spot and forward rates implied by the yield curve. In contrast, the CMS is priced to reflect the relative values of either fixed or floating rates on one side and an intermediate- term fixed rate instrument that covers a segment of the forward curve and moves out along the forward curve at each reset date. The CMS arbitrage relationship is more complex than the fixed-for-floating rate swap, but the principles that determine the pricing of other swaps apply to CMS. In general, a flattening or an inversion of the curve after the swap is in place will improve the constant maturity rate payer’s position relative to a floating rate payer. The relative positions of a constant maturity rate payer and a fixed rate payer are more complex, but the fixed rate payer in any swap will benefit primarily from an upward shift of the yield curve.