How do dealers make money on a swap?
Revenue on a swap can result from a number of different sources, including fees. However, the standard way is through mark-up. This is simply charging the hedger a higher rate (if paying fixed), or a lower rate (if receiving fixed) than where the dealer can hedge itself in the market. Mark-ups should be based on credit risk, and not on what the market can bear.
The higher the credit risk, the longer the deal, and/or the more complicated the deal, the more the mark-up. This mark-up varies from market to market, but in liquid markets of normal economic circumstance, these mark-ups can range from a fraction of a basis point on a highly rated, competitive transaction, to north of 30-40 bps for a lower rated (or more likely, unrated) captive transaction.
In the example, the swap bank dealer is making a 40 bps mark-up on the swap transaction by receiving fixed from the hedging client and offsetting the market risk through a variety of possible trading techniques.