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A highly generic term often used to describe one or more of the following instruments or arrangements: (1) a put or a call with a payoff dependent on the interest rate spread between a specific corporate debt instrument and sovereign debt denominated in the same currency. The most common example is the Treasury-EuroDollar or TED spread. Alternately, an option with a payoff dependent on the spread between indexes of similar maturity debt instruments such as the five-year swap rate and a five-year government bond rate; (2) A swap or embedded swap with the payments on one side mirroring the interest and principal payments of a basket of bonds rated below investment grade. The payer of the bond return is the nominal holder of the low rated bonds but the receiver actually takes the credit risk. The payment on the other side can be a fixed or floating rate as the parties agree; (3) An asset swap in the form of a stand-alone swap or structured note where one party holds a below-investment grade issue and pays the interest called for under the bond indenture, in exchange for a traditional fixed or floating rate. The fixed or floating rate will be greater than usual in compensation for the acceptance of any losses from default by the holder of the below-investment grade issue. See also Credit Derivative Bond; (4) A total return swap with the 'fixed' rate based on the total return of a corporate bond because the bond's issuer is over-represented in the fixed rate payer's credit portfolio.
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