FX Swap
An FX swap is a contract in which two parties exchange two currencies today and agree to reverse the exchange on a set future date at a rate fixed now. In economic terms it is a loan of one currency secured by another.
Also called: foreign exchange swap · forex swap · currency swap · FX swaps
The swap has two legs. In the near leg, one party delivers, say, euros and receives dollars at the spot rate. In the far leg, days or months later, the dollars go back and the euros return at the agreed forward rate. The gap between the two rates reflects the interest-rate difference between the currencies, plus any premium for scarcity.
FX swaps are the most heavily traded instrument in the foreign exchange market. Banks, insurers, pension funds and companies use them to obtain a currency they need without selling the one they hold: a European bank funds its dollar lending, a treasury covers a payout in a currency it will receive later. The far leg is the same promise as a forward contract.
Accounting rules record FX swaps as derivatives, so the obligation to repay the borrowed currency does not appear as debt on the balance sheet. BIS researchers have estimated this hidden dollar debt in the tens of trillions. Most of it is short term and must be rolled over, which is why stress in dollar funding shows up first in swap prices. See cross-currency basis.
In practice
The term 'currency swap' is also used for the longer-dated cross-currency swap, which exchanges interest payments as well as principal. Check which instrument a counterparty means.
Example
A payments firm holds €10 million but needs dollars for one week of US payouts. It swaps the euros for US$10.8 million today and agrees to reverse the trade in seven days at a slightly different rate. It has borrowed dollars for a week without selling its euros.
Commonly confused with
| Term | How it differs |
|---|---|
| Forward contract | A forward is a single exchange at a future date. An FX swap pairs an exchange now with the reverse exchange later. |
See also
- Cross-Currency BasisThe cross-currency basis is the extra cost, or saving, of borrowing one currency through the FX swap market compared with borrowing it directly. A negative dollar basis means dollars are scarcer and dearer offshore than interest rates alone imply.
- Central Bank Swap LineA central bank swap line is a standing agreement under which one central bank lends its currency to another in exchange for the borrower's currency, so the borrower can supply foreign-currency funding to banks in its own jurisdiction.
- Forward ContractA forward contract is an agreement to exchange one currency for another on a future date at a rate fixed today. It creates a binding obligation on both sides — which is what makes it useful for certainty and dangerous if the underlying payment never happens.
- Spot RateThe spot rate is the price for exchanging one currency for another for near-immediate settlement. "Immediate" is a convention rather than a fact: standard spot settlement in most currency pairs is two business days after the trade.
- EurodollarA Eurodollar is a US dollar deposit held at a bank outside the United States, or at an offshore unit of a US bank. Eurodollars are created by bank lending abroad and sit largely beyond US banking regulation; they have nothing to do with the euro.
- Herstatt RiskHerstatt risk is the risk in a foreign exchange trade that one party pays the currency it sold but never receives the currency it bought, because the counterparty fails in between. The full principal amount is at stake.