In finance, a forex swap (or FX swap) is an over-the-counter short term interest rate derivative instrument. In Finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how The currency band is a system of Exchange rates by which a Floating currency is backed by Hard money. In Finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how The exchange rate regime is the way a country manages its Currency in respect to foreign currencies and the Foreign exchange market. A fixed exchange rate, sometimes called a pegged exchange rate, is a type of Exchange rate regime wherein a Currency 's value is matched to the value of Floating rate may also refer to a Floating interest rate applied to a Loan or other lending product A linked exchange rate system is a type of Exchange rate regime to link the exchange rate of a Currency to another The foreign exchange ( currency or forex or FX) market refers to the market for currencies. A futures exchange is a central financial exchange where people can trade standardized Futures contracts; that is a contract to buy specific quantities of a Commodity In financial markets the retail forex ( retail currency trading or retail FX) market is a subset of the larger Foreign exchange market. A currency is a unit of exchange, facilitating the transfer of Goods and/or services It is one form of Money, where money is A currency future, also FX future or foreign exchange future, is a Futures contract to exchange one Currency for another at a specified date In Finance, a non-deliverable forward ( NDF) is an outright forward or Futures contract in which counterparties settle the difference between 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 In finance a foreign exchange option (commonly shortened to just FX option or currency option) is a derivative financial instrument where the owner has A bureau de change is an organisation or facility which allows customers to exchange one Currency for another The field of finance refers to the concepts of Time, Money and Risk and how they are interrelated Over-the-counter ( OTC) trading is to Trade Financial instruments such as Stocks bonds, commodities or derivatives Interest is a fee paid on borrowed capital Assets lent include Money, Shares, Consumer goods through Hire purchase, major assets Derivatives are Financial instruments whose values depend on the value of other underlying financial instruments In emerging money markets, forex swaps are usually the first derivative instrument to be traded, ahead of forward rate agreements. In finance a forward rate agreement ( FRA) is a Forward contract in which one party pays a fixed interest rate and receives a floating interest rate equal to a
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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.
Uses
Forex swaps are used for hedging currency positions and for speculation. In Finance, a hedge is an investment that is taken out specifically to reduce or cancel out the Risk in another investment
Hedging
Investors use forex swaps to hedge their existing forex exposures by swapping temporary surplus funds in one currency into another currency for better use of liquidity. Doing so protects against adverse movements in the forex rate, but favourable moves are renounced.
Speculation
Investors use forex swaps to speculate on changes in the interest rate differentials between two currencies.
The relationship between spot and forward is as follows:
where:
- F = forward
- S = spot
- rT = interest rate of the term currency
- rB = 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. In Foreign exchange markets the base currency is the first Currency in a Currency pair. In finance a day count convention determines how interest accrues over time for a variety of investments including bonds notes loans medium-term notes swaps and FRAs Thus, the absolute value of the swap points increases when the interest rate differential gets larger, and vice versa.
Related instruments
A forex swap should not be confused with a currency swap, which is a much rarer, long term transaction, governed by a slightly different set of rules. 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
See also
- Currency swap
- Overnight index swap
- Foreign exchange market
- Interest rate swap
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