An interest rate swap (fixed for floating rate swap) in which the floating rate is calculated by raising the LIBOR (or any benchmark floating rate) to the second power. For example, if LIBOR is 3.5%, then the floating rate leg of a turbo swap is the square of 3.5%, or 12.25%. The turbo swap, which is also called a LIBOR-squared swap, is particularly instrumental for companies keen to hedge exposures to changes in interest rate volatility without being confined to a particular rate. A firm willing to enter into a turbo swap as a fixed rate receiver would do so on expectations that interest rates would be low. The firm is said, in this case, to be selling convexity of interest rate. Likewise, a firm would like to receive LIBOR squared in order to hedge its positions in short options.
The turbo swap is mainly used to hedge exposure to withdrawal of demand deposits at banks. Variants include LIBOR-squared caps and floors, LIBOR-cubed swaps, among others.
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