Currency swaps are often combined with interest rate swaps. For example, one company would seek to swap a cash flow for their fixed rate debt denominated in US dollars for a floating-rate debt denominated in Euro. This is especially common in Europe where companies shop for the cheapest debt regardless of its denomination and then seek to exchange it for the debt in desired currency.
For example, suppose a U.S.-based company needs to acquire Swiss francs and a Swiss-based company needs to acquire U.S. dollars. These two companies could arrange to swap currencies by establishing an interest rate, an agreed upon amount and a common maturity date for the exchange. Currency swap maturities are negotiable for at least ten years, making them a very flexible method of foreign exchange.
Currency swaps were originally done to get around exchange controls.
During the global financial crisis of 2008 currency swaps were offered to other central banks by the Federal Reserve System including stable emerging economies such as South Korea, Singapore, Brazil, and Mexico.
Currency Swap
A currency swap (or cross currency swap) is a foreign exchange agreement between two parties to exchange a given amount of one currency for another and, after a specified period of time, to give back the original amounts swapped.
Structure
Currency swaps can be negotiated for a variety of maturities of up to 30 years. Unlike a back-to-back loan, a currency swap is not considered to be a loan by United States accounting laws and thus it is not reflected on a company's balance sheet. A swap is considered to be a foreign exchange transaction (short leg) plus an obligation to close the swap (far leg) being a forward contract.
Unlike interest rate swaps, currency swaps involve the exchange of the principal amount. Interest payments are not netted (as they are in interest rate swaps) because they are denominated in different currencies. Further, many currency swaps are traded on organized exchanges - lowering counter-party risk, as evidenced by the bid-ask spread on most listings.
Structure
Currency swaps can be negotiated for a variety of maturities of up to 30 years. Unlike a back-to-back loan, a currency swap is not considered to be a loan by United States accounting laws and thus it is not reflected on a company's balance sheet. A swap is considered to be a foreign exchange transaction (short leg) plus an obligation to close the swap (far leg) being a forward contract.
Unlike interest rate swaps, currency swaps involve the exchange of the principal amount. Interest payments are not netted (as they are in interest rate swaps) because they are denominated in different currencies. Further, many currency swaps are traded on organized exchanges - lowering counter-party risk, as evidenced by the bid-ask spread on most listings.
Forex Swap Pricing
The relationship between spot and forward is as follows:
where:
* F = forward
* S = spot
* rT = simple interest rate of the term currency
* rB = simple interest rate of the base currency
* T = tenor (calculated according to the appropriate day count convention)
The forward points or swap points are quoted as the difference between forward and spot, F - S, and is expressed as the following:
where rT and rB are small. Thus, the absolute value of the swap points increases when the interest rate differential gets larger, and vice versa.
where:
* F = forward
* S = spot
* rT = simple interest rate of the term currency
* rB = simple interest rate of the base currency
* T = tenor (calculated according to the appropriate day count convention)
The forward points or swap points are quoted as the difference between forward and spot, F - S, and is expressed as the following:
where rT and rB are small. Thus, the absolute value of the swap points increases when the interest rate differential gets larger, and vice versa.
Forex Swap Usage
By far and away the most common use of FX swaps is for institutions to fund their foreign exchange balances.
Once a foreign exchange transaction settles, the holder is left with a positive (or long) position in one currency, and a negative (or short) position in another. In order to collect or pay any overnight interest due on these foreign balances, at the end of every day institutions will close out any foreign balances and re-institute them for the following day. To do this they typically use tom-next swaps, buying (selling) a foreign amount settling tomorrow, and selling (buying) it back settling the day after.
The interest collected or paid every night is referred to as the cost of carry. As currency traders know roughly how much holding a currency position will make or cost on a daily basis, specific trades are put on based on this; these are referred to as carry trades.
Once a foreign exchange transaction settles, the holder is left with a positive (or long) position in one currency, and a negative (or short) position in another. In order to collect or pay any overnight interest due on these foreign balances, at the end of every day institutions will close out any foreign balances and re-institute them for the following day. To do this they typically use tom-next swaps, buying (selling) a foreign amount settling tomorrow, and selling (buying) it back settling the day after.
The interest collected or paid every night is referred to as the cost of carry. As currency traders know roughly how much holding a currency position will make or cost on a daily basis, specific trades are put on based on this; these are referred to as carry trades.
Forex swap
In finance, a forex swap (or FX swap) is a simultaneous purchase and sale, or vice versa, of identical amounts of one currency for another with two different value dates (normally spot to forward).
Structure
A forex swap consists of two legs:
* a spot foreign exchange transaction, and
* a forward foreign exchange transaction.
These two legs are executed simultaneously for the same quantity, and therefore offset each other.
It is also common to trade forward-forward, where both transactions are for (different) forward dates.
Structure
A forex swap consists of two legs:
* a spot foreign exchange transaction, and
* a forward foreign exchange transaction.
These two legs are executed simultaneously for the same quantity, and therefore offset each other.
It is also common to trade forward-forward, where both transactions are for (different) forward dates.
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