What is an accreting swap and why use one?

Question

AcadiFi · Accepted Answer

An accreting swap has a notional that increases over time according to a pre-agreed schedule — the opposite of amortizing. Cash flows scale with the growing notional.

Principal use cases:

1. Project finance: construction loans draw down in tranches as building phases complete. Initial debt is $30M, rising to $150M over three years as draws occur. An accreting swap fixed-rate payer locks in rates matching this draw schedule.

2. Inflation-linked funding: some indexed products have growing nominal principal (e.g., TIPS, CPI-linked notes). An accreting swap can hedge the growing exposure.

3. Pension funding: future contributions grow, creating expanding liability exposure. Accreting swaps match this.

Example: 5Y accreting swap. Year 1 notional $50M, Year 2 $80M, Year 3 $110M, Year 4 $130M, Year 5 $150M. Fixed rate pays 4.10% on each period's current notional against SOFR.

Pricing: par rate is a weighted average of forward zero rates weighted by notional × discount factor — because later periods have larger notional, the par rate sits closer to the long-end forward zero than the short-end. If the curve is upward-sloping, accreting par rates exceed vanilla par rates of equal final maturity.

```mermaid
flowchart LR
    A[Year 1: $50M] --> B[Year 3: $110M]
    B --> C[Year 5: $150M]
```

Credit risk grows too: as notional expands, so does the potential exposure. Dealers require collateral schedules that increase in lockstep.

Watch out for exotic variations: step-up swaps (discrete jumps in notional rather than smooth accretion) trade with liquidity premium.

What is an accreting swap and why use one?

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