-51-
spread is 4 basis points,23 and the midmarket rate is 6.52
percent. If the dealer’s bid price is accepted and the dealer
enters into a swap under which it is paying a fixed interest rate
of 6.5 percent, then the spread from midmarket is 2 basis points.
4. Significance of Spreads
The spread from midmarket that a dealer is able to obtain
when it negotiates a swap provides it with the revenue necessary
to cover its costs connected with the swap and, it hopes,
generate a profit. When a dealer buys a swap, the dealer
captures the difference between its bid on the transaction and
the midmarket rate. When a dealer sells a swap, the dealer
captures the difference between its ask on the transaction and
the midmarket rate.
In general, a dealer did not enter into a swap unless it
expected to make a profit. As two exceptions to this rule,
dealers entered into swaps without profit to develop a
relationship with a particular customer or to hedge their
portfolio.
Dealers typically charged smaller spreads to other
dealer/counterparties than to end users. A dealer that entered
into an interdealer swap usually contemporaneously entered into a
similar swap with an end user. The dealer typically earned a
profit on the end-user swap by negotiating a bid or ask rate that
23 A basis point is 0.01 percent.
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