spreads are also affected by the hedging costs faced by swap dealers. Dealers hedge the interest rate risk of long (short) swap positions by taking a long (short) position in a Treasury security with the same maturity as the swaps tenor and borrowing funds (lending funds) in the repo market. As a result, the spread between LIBOR and the appropriate repo rate will be a critical determinant of the hedging costs. For example, with the burgeoning U.S. government budget surpluses starting in the late 1990s, the supply of Treasury securities has diminished. One impact of the decreased supply is an increase in the spread between the yields of on- the-run and off-the-run Treasuries. As this spread widens, investors must pay up for the relatively more liquid on-the-run issues. This chain reac- tion continues and results in on-the-run Treasuries going "on special" in repo markets. When on-the-run Treasuries go "on special," it is corre- spondingly more expensive to use these Treasuries as a hedge. This increase in hedging costs results in wider swap spreads.8 Another influence on the level of swap spreads is the volume of asset- based swap transactions. An asset-based swap transaction involves the creation of a synthetic security via the purchase of an existing security and the simultaneous execution of a swap. For example, after the Russian debt default and ruble devaluation in August 1998, risk-averse investors sold corporate bonds and fled to the relative safety of U.S. Treasuries. Credit spreads widened considerably and liquidity diminished. A con- trary-minded floating-rate investor (like a financial institution) could have taken advantage of these circumstances by buying newly issued invest-     8Traders often use the repo market to obtain specific securities to cover short posi- tions. If a security is in short supply relative to demand, the repo rate on a specific security used as collateral in repo transaction will be below the general (i.e., generic) collateral repo rate. When a particular securitys repo rate falls markedly, that secu- rity is said to be "on special." Investors who own these securities are able to lend them out as collateral and borrow at bargain basement rates.     ment grade corporate bonds with relatively attractive coupon rates and simultaneously taking a long position in an interest rate swap (pay fixed/ receive floating). Because of the higher credit spreads, the coupon rate that the financial institution receives is higher than the fixed-rate paid in the swap. Accordingly, the financial institution ends up with a synthetic floating-rate asset with a sizeable spread above LIBOR. By similar reasoning, investors can use swaps to create a synthetic fixed-rate security. For example, during the mid-1980s, many banks issued perpetual floating-rate notes in the Eurobond market. A perpetual floating-rate note is a security that delivers floating-rate cash flows for- ever. The coupon is reset and paid usually every three months with a cou-