Chapter 5

FX Swap market

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 Global foreign exchange market turnover by
instrument
4 Options etc.
Average daily turnover,
trillion US$ at April 2010 exchange rate

Foreign
3 exchange
swaps
2
Forwards

1 Spot
transactions

0
2004
1992

1998

2010
2007
1989

2001
1995

Source: Bank of International Settlements (http://www.bis.org/)

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 Outline
1. Definition
Foreign Exchange, Currency Swap
2. FX Swap Rate Interest rate Swap
3. Types of FX Swap
4. Pure/ Engineered Swap
5. Forward-Forward Swap
6. Short dated Swap
7. Application of FX Swap

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 Example 1
 Suppose the following rates prevail in the interbank market.

a. If a customer wants to buy 6 months forward, at what forward

rate will we (bank) offer that customer?
b. If we have sold USD1 million to a customer 6 months' forward,
how did we say we can cover ourselves? How many ways can
help us cover a forward and avoid the risk of future movements?
And which do you think would be the simplest way?
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 Example 1
(1) Buy an equal/opposite Forward
 From another bank

 From broker

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 Example 1
(2) Cover Interest Arbitrage
 Sell USD1,000,000 to customer 6 months' forward.
 Buy sufficient USD which, if invested, would
produce USD1,000,000 in 6 months' time.
How?
 Borrow yyyDEM
 Sell DEM, buy xxxUSD spot
 Lend xxx USD for 6 months to produce
1,000,000USD
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 Example 1
Pros Cons
 Possibility of buying USD  As we are lending USD, there
at a cheaper spot rate is a risk that the borrower
 Possibility of investing USD might not repay
at higher interest rate  As we are borrowing DEM,
 Possibility of borrowing we may be using our valuable
DEM at lower interest rate credit limits
 Add margin  As both loans and deposits
are “on balance sheet”, the
expansion of our balance
sheet in this way may impact
unfavourably on the “Return
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 Example 1
(3) Foreign Exchange Swap
(A) - Sell USD1 million Forward 6 months at 1.9760
(B) - Buy USD1 million Spot at 1.9950
(C) - Sell USD1 million Spot at 1.9925
(D) - Buy USD1 million Forward 6 months at 1.9735

Swap points
= 1.9925 - 1.9735
= 0.0190
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 Example 1
 Why would Foreign Exchange Swap method be
preferable to the other two ways of covering?

Swap CIA
Greater profit opportunity Off balance sheet
Fewer Transactions
Usage of less credit lines

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 1. Definition
 A FX swap is the  A foreign exchange swap
simultaneous purchase is the simultaneous
and sale of one currency borrowing and lending of
against another for two one currency for another
different value dates with two different value
dates.

Shani Shamah A foreign exchange primer –

Willey finance - 2003
Reuters Glossary

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 1. Definition
 In the foreign exchange market, a swap means:
(a) Buying a currency spot and simultaneously selling it
forward; or
(b) Selling a currency spot and simultaneously buying it
forward.
 Foreign exchange swaps are used by banks to cover
their own foreign exchange commitments.
 Swaps are often used by banks as a technique for
balancing their position and avoiding foreign exchange
exposure.
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 1. Definition
 Swap contract:
 Trade date,
 Type of swap,
 Counterparties,
 Direction of deal,
 Currencies,
 Spot rate,
 Forward point (swap rate),
 Amounts,
 Maturity date, value date, charges.
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 2. FX Swap Rate
 Swap rate/pips (forward margins) reflect the difference
between spot rates and forward rates.

Swap rate = forward rate - spot rate

Example: Bid Offer

Spot rate USD/SGD = 1.4010 1.4015
Three-month swap rate 190 180
What do Swap Bid/Offer Rate mean?

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 2. FX Swap Rate
 Swap Rate: Premium or Discount?
 Swap Rate 190 - 180
 Buy forward at 190 points below spot
 Sell forward at 180 points below spot
 Swap Rate 180 - 190
 Buy forward at 180 points above spot
 Sell forward at 190 points above spot

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 2. FX Swap Rate

Swap rate = forward rate - spot rate

 Spot rate: mutually acceptable spot rate.

 The quoting bank usually suggests which spot rate
should be used.
 This is commonly/ usually the mid rate at the time.

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 3. Types of FX Swap
 Pure/Standard swap
Pure swap is a swap in which both the spot and forward
transactions are done simultaneously with the same
counterparty.
 Engineered swap
An engineered swap is a swap in which the spot and
forward transactions are done with different
counterparties.

Foreign exchange in practice, Steve Anthony, Galgrave Macmillan (2003)

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 3. Types of FX Swap
 Long (forward) swap
A forward/forward swap is an FX swap that starts in the
future with both forward transactions.
 Short swaps
A forward/forward swap is an FX swap that one or both
of the transactions are value today or tomorrow

Foreign exchange in practice, Steve Anthony, Galgrave Macmillan (2003)

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 Points of note
 Firstly, as the swap pips determine the price of the
swap, the spot rate used is less important. In practice,
market makers tend to use the middle rate when
actually processing the swap transaction. The key
point to note is that whichever spot rate is chosen, the
forward rate is determined by adjusting that spot rate
by the swap pips.
 Secondly, the amount of one currency in a swap is
kept constant. Typically, this is the dollar, thus the
same amount of dollars is sold and bought in the
transaction.
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 4. Pure/Engineered Swaps
 Example
Bid Offer
 Spot rates AUD/USD= 0.7200 0.7205
 3 month swap rates 24 21

Required:
A customer wants to buy A$1,000,000 spot and sell
A$1,000,000 three months forward. How much will the
pure/engineerd swaps cost?

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 4. Pure/Engineered Swaps
 Spot USD/CAD = 1.4560-65
 1 month 13-20
 3 months 69-99
1. At what swap rate if a market taker make a transaction
in which he/she buy spot USD100,000 and sell forward
1 month ?
2. At what swap rate if a market taker make a transaction
in which he/she buy spot USD100,000 and sell forward
3 months ?

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 5. Forward / Forward Swap
 A forward/forward swap is an FX swap that starts in the
future with both forward transactions.
Example
 Spot USD/CAD = 1.4560-65
 1 month 13-20
 3 months 69-99
Required:
At what swap rate if a market taker make a transaction in
which he/she buy USD100,000 forward 1 month and sell
100,000 forward 3 months ?
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 6. Short – dated Swaps
 Short dated swaps: one or both of the
transactions are value today or tomorrow.
Overnight swap: from today until the next
business day.
Tom/Next swap: from tomorrow until the next
business day (spot value)

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 6. Short – dated Swaps
What /How is Swap rate from today until spot offered?

T T+1 T+2 T+3

Contract & Obtain funds Return funds

ON SWAP

Obtain funds Return funds

Contract
TN SWAP
Return funds
Contract & Obtain funds
TODAY SPOT SWAP

Contract Return funds

Obtain funds
SN SWAP

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 7. Application of FX Swap
 Swaps are undertaken together with a money
market operation to take advantage of imperfect
exchange rate and interest rate differentials. This
is particularly of use to companies, which have a
borrowing advantage in one currency or type of
facility over another.
 Swaps are also used where the domestic money
market may not offer the necessary investment
possibilities
 Swaps can be used to hedge exposure
 A client can use a swap to roll a hedge forward
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 7. Application of FX Swap
7.1. Covering outright forward exchange
positions
7.2. Rolling foreign exchange positions
(including historic rate rollovers)
7.3. Simulated foreign currency loans
7.4. Simulated foreign currency investments
7.5. Covered interest arbitrage
7.6. Managing bank system liquidity
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