Zero Basis Risk Swap - ZEBRA
Quick: what do Brits call crosswalks? Get on your safari hat, because they call them zebra stripes.
What else is called zebra? Zero basis risk swap, which is ZBRS, which is kinda, sorta ZEBRA if you squint and mumble at the same time.
A zero basis risk swap, or ZEBRA, is when a municipality (usually a city or town that’s got its act together, i.e. a government) makes an agreement with a financial middleman to do an interest rate swap.
What are interest rate swaps? Well, they’re pretty complicated, but once you figure out what they’re for and why parties...do them...it makes a bit more sense.
Basically, an interest rate swap is when two parties agree to pay certain amounts of interest rates in the future. One party pays a fixed rate, and one party pays the floating rate. The party paying the fixed rate always pays the same amount, even though the interest rate in the market economy is going up and down. The party paying the floating rate pays the difference. If interest rates go up, that means the party who has to pay the floating rate has to pay more. If interest rates go down, where the floating rate is less than the fixed rate, then the tables are turned. The fixed interest party still pays that same fixed amount, even if interest rates on the market are lower. The difference goes to the floating rate party, which is why they risked getting into this business in the first place.
Why do this swap? Mostly for stability. The party paying out the fixed interest rate can manage their finances much better, since they know exactly what they’ll owe in the future.
Back to the zero basis risk swap. The municipality is the party that pays the fixed interest rate, so they can better manage their finances. This kind of interest rate swap is zero basis risk, because the municipality gets a floating rate from the financial intermediary that’s the same as the floating rate on the debt they owe. Which means that, if interest on their debt goes up, they get more from the ZEBRA swap to cover it. If interest rates go down, well, the town is still stuck paying that fixed interest rate, and the financial intermediary collects the floating difference. Business is business.