Let's take a look at how prices for fixed to floating interest rate swaps are quoted in the market.

There are two main approaches.

The first approach is to quote the fixed rate of the swap, commonly referred to as the swap rate.

For example, if a market maker quotes five year swap rates versus IBOR as 2.37% to 2.39%, this means that a client can enter into a payer swap at a fixed rate of 2.39%, or a receiver swap at a fixed rate of 2.37%.

In this context, payer and receiver are viewed from the client's perspective, so the client would pay the fixed rate of 2.39% in a payer swap, or receive the fixed rate of 2.37% in a receiver swap.

Another common method is to quote swaps as a spread over government bond yields.

This is because in many markets, fixed income cash products such as bonds and derivatives are priced, quoted and traded relative to government bonds yields.

Quoting swaps in terms of spreads to government bonds provides a consistent benchmark, making it easier for market participants to compare the relative cost of entering into a swap.

It's also important to note the similarities between swaps and bonds.

Imagine an investor buying a five year Euro government bond with a 2.25% coupon, which is priced at par.

This means that the bonds yield would also be 2.25%.

If the investor funds the bond through the repo market, the combination of transactions starts to resemble or receiver swap.

The investor receives a fixed 2.25% yield for five years and pays a floating repo rate.

Given these similarities, it's natural to compare swap rates to bond yields, which again, is simplified when swaps are quoted in spread terms.

But how does a quote look when the swap is quoted as a spread? Well, let's assume the previous example.

Five year Euro government bond with its 2.5% yield.

This is the current five year benchmark Treasury bond.

Swap quotes might be quoted as T plus 12 on the bid and T plus 14 on the offer.

Here, T refers to the yield on the five year Euro government bond yield.

The 2.25%.

This means a client can enter into a five year payer swap at a fixed rate that is 14 basis points higher than the five year government bond yield.

Effectively 2.25% plus 0.14% equals 2.39%.

Similarly, a client could enter into a five year receiver swap at t plus 12, which is 2.25% plus 0.12% equals 2.37%.

In other words, the effective swap rates 2.39% for a payer, and 2.37% for a receiver remain the same.

They're just quoted in two different ways, either as a fixed rate or as a spread to government bonds.

The difference between the fixed rate of a swap and the corresponding government bond yield is called the swap spread.

Swap spreads are calculated as the swap rate minus the bond yield.

In our example, on the bid side, the spread is the difference between the five year swap rates of 2.37% and the five year government bond yield of 2.25%, giving us the swap spread of 12 basis points.

When swap spreads are positive, it means the fixed rates on the swap is higher than the government bond yield.

Conversely, when swap spreads are negative, the fixed rate on the swap is lower than the bond yield.