Constant Maturity Swaps

Constant Maturity Swaps (CMS) are interest rate derivatives where the floating leg resets periodically to a constant maturity rate like 10-year swap rates rather than short-term rates like LIBOR, providing exposure to specific yield curve points. For example, a 10-year CMS swap might pay the 10-year swap rate quarterly versus receiving fixed 3%, benefiting if long-term rates rise. CMS enables curve positioning without buying/selling bonds – investors can express steepening/flattening views or hedge specific curve exposures. Banks use CMS to hedge mortgage portfolios sensitive to long-term rates. Structure includes CMS caps/floors providing optionality on forward rates. Valuation requires convexity adjustments accounting for correlation between rates and volatility. The market expanded as yield curve shape became crucial post-QE with central banks controlling short rates while long rates floated. CMS spreads (e.g., 30Y-10Y CMS) trade curve steepness directly. Risks include model dependence for convexity adjustments and potential illiquidity during stress. CMS represents sophisticated interest rate engineering, allowing precise curve exposure beyond simple duration management.