A general swap is a Vanilla Swap with one main difference: for the general swap’s floating leg (or floating legs in a floating to floating swap), there is no dependency between the reference rate, the frequency of the fixing dates and the frequency of the payment dates, as there is in a vanilla swap.
In a vanilla swap, there is direct dependency between the reference rate and the frequency of the fixing and payment dates. So, for example, if the vanilla swap’s reference rate is based on 3m LIBOR, its fixing and payment frequency must be quarterly; similarly, if the reference rate is based on 1m LIBOR, the fixing and payment frequency must be monthly. However, in a general swap, the reference rate, fixing frequency and payment frequency are all independent of one another. You can therefore choose, for example, a reference rate of 3m LIBOR, a semi-annual fixing frequency and a monthly payment frequency.
When pricing a general swap, because the reference rate, fixing frequency and payment frequency are all independent of one another the pricing model applies convexity adjustment when necessary for mismatches between the floating rate and the period over which it is accrued.
Advantages of a General Swap over a Vanilla Swap
The main advantage of the general swap is the flexibility and control it gives you over the fixing and payment frequencies.
As such, there are two main uses for general swaps:
To reduce credit exposure in corporates. See An Example of Using a General Swap to Reduce Credit Exposure in Corporates.
To increase your leverage. For an example, see An Example of Using a General Swap to Increase Leverage.
An Example of Using a General Swap to Reduce Credit Exposure in Corporates
In a vanilla swap, you can set different frequencies for the fixed and floating legs. This is useful if, for example, you have exposure to 6m LIBOR and you want to swap that floating rate payment to a fixed rate which you will pay annually. However, in such an instance, because you are receiving 6m LIBOR semi-annually and paying the fixed rate annually, your counterparty incurs a credit risk. The credit risk incurred is that after the counterparty has made the first 6m LIBOR payment, you subsequently cannot make the first annual fixed leg payment.
Precisely because of this credit concern, a bank may prefer to “roll-up” the floating rate and net out the payments annually. This is possible using a general swap. Using a general swap, you can create a swap where you pay the fixed leg annually, and where the 6m LIBOR floating rate that you receive is fixed semi-annually but only paid annually. In this case, the counterparty would fix 6m LIBOR semi-annually and add the first 6m LIBOR fixing to the second 6m LIBOR fixing rate to pay them both on the annual payment date.
As such, the second 6m fixing would be paid as normal at the end of the period since this would be its normal pay date; in addition, the first 6m LIBOR would also be paid on this date.
An Example of Using a General Swap to Increase Leverage
General swaps can be used to increase your leverage, for example, in comparison to a vanilla swap.
This is because in an upward sloping yield curve, longer term interest rates are higher than shorter term interest rates. For example, in an upward sloping yield curve, 12M LIBOR is typically much higher than 3M LIBOR. In a vanilla swap, if you want to receive a fixed rate and pay a floating rate on a quarterly basis, you must base the floating rate on the 3M LIBOR because the reference rate has to match the fixing frequency. Using a general swap, you can enter into a 5 year swap where you receive the fixed rate and pay the floating rate quarterly based on 12m LIBOR. Because you are paying a higher rate (as the 12m LIBOR is higher than 3m LIBOR), this will effectively give you an enhanced fixed rate relative to the 5 year fixed rate for a vanilla swap.
Pricing a General Swap in SDX Interest Rates
When pricing a general swap, the system uses the fixed leg’s frequency setting (as defined in the Payment Freq. dropdown list) to calculate this leg’s payment periods. Subsequently, in the Swap Cash Flow Dates window you can then edit the payment date for each of this leg's coupons individually in the Payment Date column.
By default each time you manually enter a payment date for a coupon in the Swap Cash Flow Dates window, the system automatically verifies that this date is valid in the context of the overall instrument definition. However, for a general swap’s fixed leg you can then optionally choose to allow yourself increased flexibility when defining the payment dates for the individual coupons. This lets you, for example, set the payment dates for multiple coupons to the same date.
For more information on this functionality see Configuring Payments for a General Swap’s Fixed Leg.