Constant Maturity Swap (CMS)

A variation of the fixed rate-for-floating rate interest rate swap. The rate on one side of the constant maturity swap is either fixed or reset periodically at or relative to LIBOR (or another floating reference index rate). The constant maturity side, which gives the swap its name, is reset each period relative to a regularly available fixed maturity market rate. This constant maturity rate is the yield on an instrument with a longer life than the length of the reset period, so the parties to a constant maturity swap have exposure to changes in a longer- term market rate. Although published swap rates are often used as constant maturity rates, the most popular constant maturity rates are yields on two-year to five-year sovereign debt. In the United States, swaps based on sovereign rates are often called constant maturity Treasury (CMT) swaps.
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. See also Constant Maturity Treasury (CMT) Rate (diagram), Swap (1).

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