In a basis swap counterparties exchange 2 different floating rates instead of regular fixed v/s floating. This means that one of the counterparty in the swap will pay a regular floating rate in exchange for a compounded floating rate as specified in the contract.
While calculating the coupon for compounded floating rate, each monthly accrual will be added to the principal amt/original notional for calculating the next accrual.
We can take a hypothetical example of a basis swap traded over the notional of 100,000,000 with USD 3 month Libor exchanged for USD 1 month Libor. The calculations for compounded floating rate coupon would be as follows:
| Fixing Date | Start Date | End Date | Principal Amount | Rate | No. Days | Accrual |
| 1/22/2008 | 1/24/2008 | 2/25/2008 | 100,000,000.00 | 3.77375 | 32 | 335,444.44 |
| 2/21/2008 | 2/25/2008 | 3/25/2008 | 100,335,444.44 | 3.135 | 29 | 253,388.80 |
| 3/19/2008 | 3/25/2008 | 4/24/2008 | 100,588,833.25 | 2.59875 | 30 | 217,837.69 |
| 806,670.94 |
In this, the first accrual of 345,222.22 has been added to the principal amt of 100,000,000 to calculate the next accrual and so on. The final amt of 806,670.94 will be exchanged with a regular USD 3 month libor coupon.
However, if spread/bps has been specified in a basis swap, then we need to calculate the accrual to be added over the notional with or without spread as the case may be.
In some basis swap we need to add the accrual interest to the notional without the spread. This is specified in the trade confirmation.
Example
| Fixing Date | Start Date | End Date | Principal Amount | Rate | Accrual to be added over the notional | Rate + Spread of 0.11 | No. Days | Accrual |
| 1/22/2008 | 1/24/2008 | 2/25/2008 | 100,000,000.00 | 3.77375 | 335,444.44 | 3.88375 | 32 | 345,222.22 |
| 2/21/2008 | 2/25/2008 | 3/25/2008 | 100,335,444.44 | 3.135 | 253,388.80 | 3.245 | 29 | 262,279.64 |
| 3/19/2008 | 3/25/2008 | 4/24/2008 | 100,588,833.25 | 2.59875 | 2.70875 | 30 | 227,058.34 | |
| 834,560.20 |
OTCWIRE 