Is the difference between ASW and I spread just the rate we use to calculate the spread?
I Spread= YTM of the bond- swap rate
ASW= Coupon of the bond- swap rate
What exactly are we trying to measure with the ASW?
This chapter is terribly written. Try this out : http://www.sfu.ca/~rjones/bus864/readings/OKane_2004_CreditSpreadsExplained.pdf
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I find also. Thanks for sharing 
An asset swap is equivalent to a synthetic floating rate note by swapping a fixed rate bond cash flow to floating rate cash flows. The fixed rate payer pays the coupon rate and receives MRR + a spread. At initiation, the swap payer pays par and receives the bond whose face value is equivalent to par.
Then entering the swap is valuable to an investor who just bought a coupon paying bond and wants to hedge the interest risk. But this investor wants also to be compensated for taking the remaining credit risk which is not hedged because if the bond defaults the swap buyer loses the coupons and the principal but the swap payments still hold.
As a consequence the swap enables to hedge out the interest risk while the credit remains and the swap spread is the added return earned by being long the remaining credit risk.
Since the price of the bond change is only due to the credit quality of the bond, if the price of the bond increase, the asset swap spread will decrease and if the price of the bond decrease the price asset swap spread will increase.
Then the asset swap spread is a « good » measure of the credit risk.
Hope this helps.
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Hi,
Can you please elaborate on – “If price of the bond increases, the asset swap spread decreases and If price of the bond decreases the assets swap spread increases”.
We know, ASW = Coupon - swap rate. How will change in price affect ASW, When the coupon of the bond is fixed.
I think I am missing a point. I would be glad if you can point it out.
Thanks in advance!
Suppose I hold a risky coupon paying bond. I want to hedge out the credit risk of this bond. I then pay the coupon to the counterparty (the bank) which in returns pays me MRR± a spread.
Basically the bank will continue to pay the floating rate ±spread if the bond defaults. So the bank asks for a compensation to bear the credit risk and this the spread which can be positive or negative depending both on the coupon paid relative to the swap rate and the discount or premium vs par of the bond at initiation.
Than the ASW like you mention it is the coupon of a risky bond less the swap rate or said differently the spread required to bear the credit risk of a risky coupon-paying bond vs a risk free bond.
The protection buyer pays COUPON and the protection seller pays MRR±spread so the net payment is COUPON-MRR-+spread.
Since in the asset swap interest risk is muted the only remaining risk is the credit risk.
As a consequence, the only reason why the bond price should increase or decrease is due to the credit risk. If credit risk decreases than the credit spread narrows and the bond price increases and conversely.
Hope this helps.
As per my knowledge the spread remains constant. And MRR increase/decrease is because of govt rate. So how does he hedged his credit risk?
If the bond price increases the spread which you could think as a discount rate that prices the bond or/and the credit risk needs not to be as high as before.
Think that the price of the bond is inversely correlated with the credit risk, aka the added spread needed to bear the risk of holding it.
The ASW reflects the credit risk at any given point in time and is not a credit risk hedging tool per se.
My only issue is how are we identifying whole spread as credit spread alone. There can be other components.