World Library  
Flag as Inappropriate
Email this Article

Foreign exchange swap

Article Id: WHEBN0002893299
Reproduction Date:

Title: Foreign exchange swap  
Author: World Heritage Encyclopedia
Language: English
Subject: Foreign exchange market, Foreign exchange derivative, Derivatives market, Exchange-rate flexibility, Linked exchange rate
Collection: Derivatives (Finance), Foreign Exchange Market, Interest Rates
Publisher: World Heritage Encyclopedia

Foreign exchange swap

In finance, a foreign exchange swap, forex swap, or FX swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward).[1] see Foreign exchange derivative. Foreign Exchange Swap allows sums of a certain currency to be used to fund charges designated in another currency without acquiring foreign exchange risk. It permits companies that have funds in different currencies to manage them efficiently.[2] swap contract: swap contract is an agreement between two parties to exchange a cash flow in one currency against a cash flow in another currency according to predetermined terms and conditions.


  • Structure 1
  • Uses 2
  • Pricing 3
  • Related instruments 4
  • See also 5
  • References 6


A foreign exchange swap has two legs—a spot transaction and a forward transaction—that are executed simultaneously for the same quantity, and therefore offset each other. Forward foreign exchange transactions occur if both companies have a currency the other needs. It prevents negative foreign exchange risk for either party.[3] Foreign exchange spot transactions are similar to forward foreign exchange transactions in terms of how they are agreed upon; however, they are planned for a specific date in the very near future, usually within the same week.

It is also common to trade "forward-forward", where both transactions are for (different) forward dates.


The most common use of foreign exchange 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 (or selling) a foreign amount settling tomorrow, and then doing the opposite, selling (or 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.

Companies may also use them to avoid foreign exchange risk.


A British Company may be long EUR from sales in Europe but operate primarily in Britain using GBP. However, they know that they need to pay their manufacturers in Europe in 1 months time.
They could of course SPOT Sell their EUR and buy GBP to cover their expenses in Britain, and then in one month SPOT Buy EUR and sell GBP to pay their business partners in Europe.
However, this exposes them to FX risk. If Britain has financial trouble and the EURGBP exchange rate goes against them, they may have to spend a lot more GBP to get the same amount of EUR.
Therefore they create a 1M Swap, where they Sell EUR and Buy GBP on SPOT and simultaneously Buy EUR and Sell GBP on a 1 Month (1M) forward. This significantly reduces their risk as they know that they will be able to purchase EUR reliably, while still being able to use the money for their domestic transactions in the meantime.


The relationship between spot and forward is known as the interest rate parity, which states that

F = S \left( \frac{1+r_d T}{1+r_f T}\right) ,


The forward points or swap points are quoted as the difference between forward and spot, F - S, and is expressed as the following:

F - S = S \left( \frac{1+r_d T}{1+r_f T} -1 \right) = \frac{S (r_d - r_f) T}{1+r_f T} \approx S \left( r_d - r_f \right) T ,

if r_f T is small. Thus, the value of the swap points is roughly proportional to the interest rate differential.

Related instruments

A foreign exchange swap should not be confused with a currency swap, which is a rarer long-term transaction governed by different rules.

See also


  1. ^ Reuters Glossary, "FX Swap"
  2. ^ “Foreign Exchange Swap Transaction”
  3. ^ "Forward Currency Contract"
This article was sourced from Creative Commons Attribution-ShareAlike License; additional terms may apply. World Heritage Encyclopedia content is assembled from numerous content providers, Open Access Publishing, and in compliance with The Fair Access to Science and Technology Research Act (FASTR), Wikimedia Foundation, Inc., Public Library of Science, The Encyclopedia of Life, Open Book Publishers (OBP), PubMed, U.S. National Library of Medicine, National Center for Biotechnology Information, U.S. National Library of Medicine, National Institutes of Health (NIH), U.S. Department of Health & Human Services, and, which sources content from all federal, state, local, tribal, and territorial government publication portals (.gov, .mil, .edu). Funding for and content contributors is made possible from the U.S. Congress, E-Government Act of 2002.
Crowd sourced content that is contributed to World Heritage Encyclopedia is peer reviewed and edited by our editorial staff to ensure quality scholarly research articles.
By using this site, you agree to the Terms of Use and Privacy Policy. World Heritage Encyclopedia™ is a registered trademark of the World Public Library Association, a non-profit organization.

Copyright © World Library Foundation. All rights reserved. eBooks from Project Gutenberg are sponsored by the World Library Foundation,
a 501c(4) Member's Support Non-Profit Organization, and is NOT affiliated with any governmental agency or department.