Interest-rate swaps and arbitrage

Three approaches toward the determination of fixed swap rates are presented in this article: a swap as a portfolio of bonds with a fixed and floating coupon, a swap as a portfolio of forwards, and a swap as the difference bet ween the cap and the floor (zero-collar). Later in the paper, credit risk i s taken in consideration. The credit risk of interest-rate swaps is much lo wer than that of loans or corporate bonds. Empirical research is presented to support the analysis. One of the most important determinants of credit r isk in a swap spread is the yield curve slope.