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Oakland University Interest Rate Swap Restructuring Opportunity – Constant Maturity Swap (CMS) CDR Financial Products,

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Oakland University Interest Rate Swap Restructuring Opportunity – Constant Maturity Swap (CMS) CDR Financial Products, Inc. April 4, 2007. Constant Maturity Swap (CMS) - Overview.

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Oakland University

Interest Rate Swap Restructuring Opportunity –

Constant Maturity Swap (CMS)

CDR Financial Products, Inc.

April 4, 2007


Constant Maturity Swap (CMS) - Overview

Take advantage of the current interest rate environment and historically flat yield curve by converting the variable rate index received on the swap from the short-term index to the longer tenor 10-year BMA swap rate index.


Experience significant cost savings in the event the BMA swap curve reverts to its historical average, and the spread between BMA and the 10-year BMA swap rate widens.


Convert at a minimal cost while the BMA swap curve remains relatively flat. An overlay basis swap to the existing deal will complete the transaction with minimal documentation.




  • Based on historical averages, the BMA swap curve typically displays a steep and positive slope, whereby longer-term yields are higher than short-term yields.
  • Current market conditions have resulted in a significant “flattening” of the BMA swap curve such that the current spread (differential) between the weekly BMA index and the 10-year BMA swap rate is narrow:


  • The CMS structure/basis swap replaces the floating leg of the swap with a lower % of 10-year BMA.
  • As the existing swap is based on the actual bond rate with alternative index conditions, CDR recommends an overlay basis swap instead of an amendment to the existing confirmation. This simplifies the process and provides transparency to the new transaction.
  • The proposed structure is a basis swap whereby the University pays the BMA Index and receives a lower % of 10-year BMA.

Actual Bond Rate1

BMA Index

Swap Counterparty





Fixed Rate

% 10 yr BMA


Bond Rate

CMS Basis Swap

Bond Holders


(1) Index converts to the BMA Index upon certain conditions including a rating downgrade of the bonds or default. Furthermore, the index converts to 65% of 1-Month LIBOR upon certain conditions including an event of taxability as described in the confirmation, including if the actual bond rate average exceeds 77% of the 1-Month LIBOR average for a period of more than 180 days


Economic Summary

  • Potential cost savings exist for the University if the curve returns to its normal positive sloping shape and steepness.


(1) Assumes a forward-start date of 03/01/08 and a dealer spread of 2 ratios. Indicative pricing is as of 03/16/07 and is not a guarantee of future pricing.


Economic Summary (cont.) - Potential benefit/(loss) based on yield curve spreads

  • ________________________________
  • Based on an analysis of data over the past 10 years, the spread between 89.36% of 10 yr-BMA swap rates and the weekly BMA index has averaged 107 basis points, with a low of (108) bps and a high of 294 bps
  • Based on 2 standard deviations (a 95% confidence interval), the worst/best case spread income falls within a range of (70) bps and 285 bps. These ranges serve as the endpoints to the scenarios shown above. Current spread is (27) bps

Executed Transactions

  • Many issuers throughout the country have similarly taken advantage of this market opportunity and have entered into CMS transactions -
    • Large Municipalities
    • Specialized Authorities (e.g., water & sewer, transportation issuers)
    • School Districts
    • Hospitals and Healthcare Facilities
    • Universities
  • CMS Transactions executed by Universities include the following:

University Approx. Notional Amount

University of Texas $500,000,000

Louisiana State University $22,940,000

University of New Mexico $125,000,000

American University $21,000,000

Boston University (in process) $29,000,000 - $56,000,000



Potential Cost Savings

  • Borrowing costs can be reduced significantly if the yield curve returns to its historically positive sloping shape in the long term.
    • For example, from a cash flow perspective, the potential exists to capture significant value and unwind the CMS at a future date in the event the swap curve steepens to a normal level.


  • Relatively easy to implement and the structure is flexible, allowing the swap to be executed in a number of different ways depending on the needs of the University. If executed with the existing swap counterparty, a new trade confirmation would be governed by the ISDA Master currently in place.

Risks: Mark-to-Market Risk

The Primary Risk is Curve Flatness/Inversion

  • The market value will move against the University if long-term BMA swap rates fall below short-term BMA resets.
  • Historically, the longest periods of inversion occurred over 20 years ago before the Fed applied rigorous monitoring and management of interest rates.

Additional Risks

Higher Execution/Termination Costs

  • Using a 10-year BMA swap rate provides for a less efficient market than executing a traditional fixed payer swap based on the short-term BMA index; higher counterparty hedging costs may result in increased termination costs for the University.

Higher Risk/Reward for CMS

  • Historically, the current index shows a higher correlation to the underlying bonds versus an equivalent % of the 10-year BMA swap rate. Converting the variable rate swap index to a % of the 10-year BMA swap rate results in increased volatility versus the underlying bonds, reducing cash flows in some periods.
    • However, historical averages show a significantly higher spread over BMA (greater upside) for 10-Year BMA swaps, thereby mitigating this risk in the long run.