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Forex Swaps, refers to a two-part currency transaction system used to “swap” or shift the value date of a position to another date. Furthermore, Forex swaps may refer to the swap points or the amount of pips traders add or subtract from the spot rate to calculate the forward exchange rate while pricing a forex swap transaction.
How Forex Swaps Works.
In the first phase of a Forex swap, a currency is bought or sold in exchange of another currency. It’s done in a mutually agreed rate on an initial date, popularly referred to as the near date. In the second phase, the exactly same quantity of currency is sold or bought in exchange of the previously held currency. It’s also done in a rate, which was agreed upon earlier, on another date known as the far date.
Thus, the first phase opens up spot market risk, while the second phase closes the risk down. Therefore, the Forex swap deal essentially results in very little or no net exposure to the existing spot rate.
Swaps in Forex – Cost.
The forex swap points or the cost of carry to a particular value date is determined from the overall cost involved in lending one currency and borrowing another one. The carry (see also – The Carry Trade Strategy) is calculated from the total number of days from the spot date to the forward date and the existing inter-bank interest rates for those two currencies to the forward date. Typically, the carry will be negative for the trader who sells the currency with lower interest rate forward.
The Use Of Forex Swaps.
A foreign exchange swap is often used to roll an open forex position forward to a future date in order to delay or avoid the delivery required on the contract. Furthermore, it can also be utilized to bring the delivery date near. Meanwhile, a corporation may want to use a Forex swap deal to hedge a certain position by rolling its forward outright contract hedge for some time.