FX swap may involve both the exchange of interest payments and the exchange of principal. The situation on the international capital market may develop in such a way that a bank may be quoted lower interest rates on loans in one currency, and higher - on loans in another (for example, an American bank quotes more attractive interest rates in US dollars compared to interest rates on loans in British pounds sterling). It is then possible for the bank to borrow in the market where it has an advantage and make a currency swap. Such a swap would include:
Exchange of principal amounts at the beginning of the agreement;
Exchange of interest payments during the term of the agreement;
Reverse exchange of amounts owed at the end of the agreement. It is also possible that banks make only interest payments, without
exchange of principal amounts.
Example :
As you can see, Bank A is more profitable to attract US dollars, and Bank B - British pounds. If, on the other hand, bank needs to have British pounds at its disposal, and bank B needs dollar resources, then they can make a swap.
If the exchange rate at the date of the transaction is 1.6000, then Bank A lends $16 million, Bank B lends £10 million. Art., banks exchange debt amounts (Fig. 13.3), and then, during the term of the agreement, service each other's interest payments (in this case, each of the banks is liable for its obligations in the international capital market, regardless of the quality of the other bank's performance of its obligations under the swap). At the end of the agreement, banks carry out a reverse exchange of debt amounts and each of them settles with its creditor.
Rice. 13.3. v
But exchanging principal amounts involves credit risk, because the exchange rate at the closing date of the transaction may differ significantly from the exchange rate that was on the date of conclusion. However, the banks exchanged fixed amounts, and at the end of the swap, they must return to each other precisely these amounts.
It is also possible to carry out cross-currency interest rate swaps without exchanging principal amounts. That is, banks exchange only interest payments on obligations in different currencies. Such swaps are carried out when the bank does not need to raise funds in one currency or another, but only to fix income and expenses in one currency, that is, when the bank has interest income from an asset in one currency and interest expenses in another. For example, a British bank issues debt in US dollars with a maturity of five years, paying interest annually. This assumes that during these five years the bank must pay interest on the US dollar bonds. At the same time, the bank has income from assets in British pounds sterling. Therefore, the bank has receipts in one currency and payment obligations in another, which implies currency risk for the bank. The swap allows the bank to calculate income and expenses in one currency. In this case, swaps with an exchange are possible:
Interest payments at fixed rates;
Interest payments at floating rates;
Fixed rate payments to floating rate payments.
As a rule, such swaps are concluded with the participation of a third party - a dealer. Depending on the terms of the swap, the currency risk may be assumed by the dealer or one of the parties. The mechanism for implementing a currency swap based on Swiss francs and US dollars is shown in Fig. 13.4.
Rice. 13.4. v
swaption
swaption - marching a financial instrument, a swap option, a contract that gives its buyer the right to enter into a swap deal at a certain date in the future.
Swaption call- a swaption that provides the buyer with the right to be a payer at a fixed rate (fixed rate), while he will be paid at a floating rate.
Swaption Put- a swaption that ensures the right of the buyer to be a payer at a floating rate (floating rate), while he will be paid at a fixed rate.
If the buyer of a swaption has a need in the future to act as a buyer of an asset (or currency) with a fixed rate, while at the same time counterselling a similar asset at a floating rate, then he can enter into a put swaption, thereby completely transferring all risks to the seller of the swaption. If, for any reason, the current floating rate is lower than the previously agreed fixed buying rate, the trader will incur losses. Using the swaption, he will receive a fixed fee, which he will pay for his obligations, and he will give the resulting floating rate to the seller of the swaption. If the floating rate is higher than the fixed purchase price, then the trader will simply refuse the swaption, because such conditions will bring him profit.
Typically, the buyer and seller of a swaption stipulate:
Swaption premium (penalty) (fee for deferring a swap operation);
Rate (fixed rate of the underlying swap);
Duration (usually ends two business days before the start date of the main swap) ("term" - the amount of the swap deferral);
Main swap date;
Additional commissions and deductions;
Settlement frequency for payments on the underlying swap.
Like others options, A swaption grants the right to conclude a contract in the future with the terms stipulated now, but does not oblige to do so. The fee reflects the volatility of compliance with the agreed characteristics of the swap in the future.
Fluctuations in exchange rates force market participants to develop and implement various methods of hedging the risk of foreign exchange transactions in search of the most reliable one.
Thus, in recent years, the use of currency swaps has increased significantly in global financial markets.
Currency swaps are a way to avoid financial losses due to exchange rate fluctuations.
In this case, a transaction is concluded, which actually consists of two operations - the purchase and sale of currency - on a specified date in the future and at a fixed rate.
It is most beneficial to use swaps to reduce economic risks for long-term obligations in foreign currency.
What are the types of currency swaps, features and purposes of their application in practice - read the article.
Currency swaps are a currency market instrument
This group of foreign exchange market instruments includes the majority of forward transactions, which are mostly interbank and over-the-counter. A currency swap is a currency transaction that involves the simultaneous purchase and sale of a certain amount of one currency in exchange for another with two different value dates.
The dealer executes the swap as a single transaction with a single counterparty. Y currency swap has two value dates on which the currency exchange takes place.
- Spot forward (spot against forward).
In this case, the first exchange (the first leg) falls on the spot date, that is, on the second business day after the transaction is concluded, and the reverse exchange (the second leg) falls on the forward date, for example, 3 months after the first date - Forward-forward (forward against forward).
Here, the first exchange (leg one) occurs on the first forward date, and the reverse exchange (leg two) occurs on a later forward date, called the forward-forward date.For example, a forward-forward swap may start 3 months after the trade is entered into and end 6 months after the trade is entered into. This is called a 3x6 forward-forward swap.
- Short (short dates).
These are swaps with a maturity of less than one month. For example, the first leg can be executed on a spot basis, and the second leg after 7 days (1 week). Some short swaps are executed even before the spot value date, for example, the first leg is today and the second leg is tomorrow.
Summing up, we note that in the framework of a currency swap:
- a single OTC transaction with two value dates is carried out;
- there are two legs, while the second assumes the opposite of the first action;
- the exchange operation is performed twice;
- value terms can vary from one day to 12 months;
- usually the amounts of the base currency are identical for both legs;
- quotation is carried out in forward points.
Who uses
As already mentioned, currency swaps represent a single transaction with one counterparty. Since the bank usually buys and sells the same amount of currency at the set rates, there is no obvious foreign exchange risk.
- speculation on the interest rate differential;
- cash flow management in the dealing room;
- servicing internal and external clients;
- carrying out arbitrage operations to profit from the difference in prices for two financial instruments.
While the spot market trader speculates on exchange rates, the forward trader speculates on the interest rate differential.
Source: "fx-fin.net"
Currency swaps
A currency swap is two currency transactions - buying and selling with two different value dates, one of which is the spot date. Currency swap is one of the most common currency market instruments; their share in turnover is significantly higher than the share of both spot and forward transactions.
A currency swap is executed as a single transaction with a single counterparty. However, for profit and loss purposes, the swap is treated as two separate but related transactions, each corresponding to a specific side (or leg) of the swap.
Please note that currency swaps are not the same as currency interest rate or interest rate swaps. Cross-currency interest rate swaps involve an exchange of principal, followed by an exchange of interest payments over the life of the swap.In currency swaps, only principal is exchanged on value dates without any interest payments. Interest rate swaps are associated with only one currency, while currency and currency interest rate swaps are always associated with two.
The following three types of swaps are most widely used:
- Spot forward (spot against forward). In this case, the first exchange (the first leg) falls on the spot date, that is, on the second business day after the conclusion of the transaction, and the reverse exchange (the second leg) on the forward date (for example, 1 month after the first date).
- Forward-forward (forward against forward). Here, the first exchange (leg one) occurs on the first forward date, and the reverse exchange (leg two) occurs on a later forward date. For example, a forward-forward swap could start 3 months (leg one) after the spot date and end 6 months (leg two) after the spot date. This is called a 3x6 forward-forward swap.
- Short swaps (short dates). These are swaps with a maturity of less than one month. For example, the first leg can be executed today, and the second one - tomorrow or overnight (O / N - overnight).
In a currency swap, the base currency determines how much of the counter currency will be delivered on the value date. The forward delivery quote is quoted in forward points, which in this case are called swap points.
Example. On July 10, Bank A enters a three-month USD/DEM currency swap for $10 million. The amount of the base currency on both legs of the trade is the same. Bank A needs to buy USD at the spot rate and sell dollars for marks at the forward rate.
The sequence of events is shown in the diagram below:
Forward value dates in currency swaps
Forward value dates in currency swaps are set in the same way as in forward outright transactions with fixed, short and non-standard terms. There are four main groups of value dates that you need to know to understand the essence of currency swaps:
- Fixed periods
- Short dates
- Non-standard dates
- forward forward dates
Fixed periods
The terms of currency swaps coincide with the terms of interbank money market deposits. For currency swaps with fixed periods, the first value date is the spot date, and the second one is one of the forward dates, which is counted from the spot date and is called the "term from the spot date".
The standard duration of such terms is 1, 2, 3, 6 and 12 months, the full set of terms also includes 4, 5, 7, 8, 9, 10 and 11 months. Fixed periods are also called standard dates.
Short dates
Short value dates are used in currency swaps, the validity of which does not exceed one month. The most common short dates and their designations are shown in the table below:
Non-standard dates
In practice, many clients require currency swaps with intermediate maturities. Such terms are called non-standard, atypical.
Example. Today is July 9th, so the spot date is July 11th. Let the second value date be September 25th. It falls on the interval between the second and third months, the value dates for which are September 11 and October 13.
The swap is traded on the OTC market, so banks can quote on almost any non-standard day; the necessary calculations can be performed by the Money 3000 trading system.
Quotes are determined based on linear interpolation. Thus, the price for a two-and-a-half-month swap can be calculated based on the prices for two- and three-month swaps.
Example. Consider the swap spot - September, IMM:
- value date - Spot date as usual.
- value date - Any date that coincides with the term of currency derivatives traded on the International Monetary Market (IMM) (a division of the Chicago Mercantile Exchange). These dates are the third Wednesday of March, June, September and December. To use the IMM value dates, you need to know what dates are on the third Wednesday in March, June, September, and December.
forward forward dates
In the fixed-period examples discussed so far, the first currency swap value date is the spot date, but forward-forward contracts also exist. The diagram below shows the sequence of events for a 2×5 forward-forward swap with a July 3 spot date. Both forward dates are calculated from the spot date:
The procedure for determining the value date for each leg of the swap is exactly the same as for fixed periods, with the only difference that in this case the first value date is also forward.
Source: "sergioforex.com"
Currency Swap
Currency swap - eng. Currency Swap is a combination of two opposite currency exchange transactions for the same amount with different value dates.
Dates applicable to swap:
- the execution date of the closer transaction is called the value date,
- the date of execution of the more distant reverse transaction - the date of the end of the swap (Eng. Maturity).
Swap types:
- If the nearest currency exchange transaction is a purchase of a currency, and a more distant one is a sale of a currency, such a swap is called a “buy/sell” (eng. Buy and Sell Swap).
- If at first a transaction is made to sell a currency, and the reverse transaction is a purchase of a currency, this swap will be called “sold / bought” (eng. Sell and Buy Swap).
By the number of counterparties:
- As a rule, a currency swap is carried out with one counterparty, that is, both currency exchange operations are carried out with the same bank. This is the so-called pure swap.
- However, it is allowed to call a swap a combination of two opposite currency exchange transactions with different value dates for the same amount, concluded with different banks - this is an engineered swap.
By maturity, currency swaps can be divided into three types:
- standard swaps (from spot) - here the nearest value date is spot, the farthest one is on forward terms;
- short one-day swaps (before spot) - here both trade dates included in the swap fall on the dates from spot. For example, one deal goes in the spot-tom format, and the second on the second business day after the deal is closed (spot);
- forward swaps (after spot) - they are characterized by combinations of two outright transactions, when a transaction that is closer in term is concluded on forward terms (the value date is later than spot), and the reverse transaction is concluded on the terms of a later forward.
Currency swaps, despite the fact that in form they are currency exchange transactions, in terms of their content they are related to money market transactions.
Currency Swap Example
Consider an example of a currency swap. The American company has a subsidiary in Germany. To implement a 5-year investment project, she needs 30 million euros. The exchange rate on the spot market is EUR/USD 1.3350. The company has the option to issue US$40.05 million worth of bonds in the US at a fixed interest rate of 8%.
An alternative would be to issue euro-denominated bonds with a fixed rate of 6% +1% (risk premium). Suppose there is a company in Germany with a subsidiary in the US that needs a similar amount of investment. It can either issue €30m bonds at a fixed rate of 6% or $40.05m at 8%+1% (risk premium) in the US.
In any case, both companies face significant foreign exchange risk, which will affect interest payments throughout the life of the bonds, as well as the principal amount of the loan after 5 years.In this case, the bank can arrange a currency swap for these two companies, receiving a commission for this. The bank closes long currency buying positions for both companies and reduces interest costs for both parties. This is due to the fact that each company borrows in local currency at a lower interest rate (no risk premium).
Thus, each company gains a relative advantage. The principal amount of the loan will be transferred through the bank:
- $40.05 million by an American subsidiary of a German company;
- 30 million euros by a German company - a subsidiary of an American company.
Interest payments will be repaid as follows:
- The subsidiary structure of the American company annually transfers 30 * 0.06 = 1.8 million euros to the parent company, which transfers these funds to the bank, which, in turn, transfers them to the German company to repay the loan in euros.
- A subsidiary of a German company annually transfers 40.05 * 0.08 = 3.204 million US dollars to the parent company, which transfers these funds to the bank, which transfers them to the American company to repay the loan in US dollars.
Thus, a currency swap fixes the exchange rate three times:
- The principal amounts of loans are exchanged at a spot rate of EUR/USD 1.3350.
- The exchange rate for annual interest payments (years 1 to 4) will be fixed at EUR/USD 1.7800 (USD 3.204 million/EUR 1.8 million).
- The exchange rate for repayment of the interest payment for the fifth year and repayment of the principal amount of the loan will be EUR/USD 1.3602:
During the transaction "currency swap" the parties fixed the exchange rate, which allowed to avoid currency risks.
Source: allfi.biz
Currency swap and its types
A currency swap is a combination of two opposite conversion transactions for the same amount with different value dates. In relation to a swap, the date of execution of a closer transaction is called the value date, and the date of execution of a more distant reverse transaction is the swap end date (maturity). Usually swaps are concluded for a period of up to 1 year.
The first currency swap operation (exchange of USD for CHF) was carried out in August 1981 between the American company IBM and the International Bank for Reconstruction and Development.
- If the nearest conversion transaction is a purchase of a currency (usually the base one), and a more distant one is a sale of a currency, such a swap is called a buy and sell swap (buy/sell, b + s).
- If, however, a transaction is first carried out to sell the currency, and the reverse transaction is the purchase of the currency, this swap will be called a sell/bought - sell and buy swap (sell/buy or s + b).
As a rule, a swap transaction is carried out with one counterparty, i.e. both conversions are made with the same bank.
However, it is allowed to call a swap a combination of two opposite conversion transactions with different value dates for the same amount, concluded with different banks.
For example, if a bank bought CHF 250,000 against Japanese Yen (JPY) with a spot value date and simultaneously sold that CHF 250,000 against JPY on a 3-month forward (outright) - this would be referred to as a 3-month Swiss franc swap to Japanese yen (3 month CHF/JPY buy/sell swap).
By maturity, currency swaps can be classified into 3 types:
- Standard Swaps
- Short One Day Swaps
- Forward swaps (after spot)
Standard Swaps
If the bank executes the first transaction on the spot, and the reverse one on the terms of a weekly forward, such a swap is called a spot week (spot-week swap or s/w swap). Since a standard swap deal contains 2 deals: the first is on the spot, and the second is an outright, which are concluded simultaneously with one counterparty bank, they have a common spot rate in their rates.
One rate is used in the first conversion transaction with the spot value date, the second one is used to obtain the outright rate for the reverse conversion.
Thus, the difference in rates for these two transactions is only in forward points for a specific period. These forward points will be the swap quote for this period (hence their second name: swap points - swap points, swap rates).When quoting a swap, it is enough to quote only forward (swap) points for the corresponding period in the form of a two-way quote:
USD / FRF 6 month swap =125132
This quote means that on the Bid side, the quoting bank buys the base currency on a forward basis (as of the swap end date); on the Offer side, the quoting bank sells the base currency on the swap end date.
Thus, on the bid side, the quoting bank performs a sell and buy currency swap (sell spot, buy forward). In this case, his counterparty makes a buy and sell swap.
On the offer side, the quoting bank conducts a buy and sell currency swap (buy spot, sell forward), its counterparty is a sell and buy swap.
Therefore, the same parties are used - bid to buy the base currency, offer to sell the base currency, as for current spot transactions, only on the swap end date.
Short One Day Swaps
If the first transaction is carried out with the value date tomorrow (tomorrow), and the reverse transaction is on the spot, such a swap is called a tom-next swap (tomorrow - next swap or t/n swap).
Short swaps are quoted similarly to standard swaps in the form of forward punts for the respective periods (overnight - o/n, next tom - t/n).In this case, the transaction rates are calculated in accordance with the rules for calculating the outright rate for the value date before the spot:
- If forward points increase from left to right (the base currency is quoted at a premium), the exchange rate for the first swap transaction (pre-spot) must be lower than the exchange rate for the second transaction (spot).
- In the case of decreasing forward points from left to right (the base currency is quoted at a discount), the exchange rate for the first transaction must be higher than for the second.
At the same time, the current spot exchange rate can be used both for the value date (before the spot) and for the swap end date (directly at the spot).
The main thing is that the difference between the two rates should be the value of forward points for the corresponding period. The spot date here will always represent the forward (more distant) date.
Forward swaps (after spot)
This is a combination of two outright transactions, when a transaction that is closer in terms of time is concluded on forward terms (the value date is later than spot), and the reverse transaction is concluded on the terms of a later forward.
Forecasting is the backbone of any trading system, so well done Forex forecasting can make you extremely wealthy.
For example, a bank dealer entered into 2 transactions at the same time: a 3-month forward outright transaction to sell 1 million USD against EUR and a 6-month forward transaction to buy 1 million USD against EUR - 3 month against 6 month EUR/USD sell and buy swap or 3 x 6 mth EUR/USD s/b swap.
For a currency swap, one transaction ticket is generated, which reflects the following information:
- transaction date;
- deal type: swap;
- amounts;
- counterparty;
- transaction direction: buy + sell, sell + buy;
- names of currencies;
- exchange rates/forward points;
- value dates;
- payment instructions;
- through whom the transaction was made (in case of working through a broker)
Since a standard swap transaction contains two transactions - one on the spot and the other outright, which are concluded simultaneously with one counterparty bank, they have a common spot rate in their rates.
One spot rate is used in the first conversion trade with a spot value date, the second is used to get the outright rate for the reverse conversion.
Therefore, the difference in rates for these two transactions is only in forward points for a particular period. These forward points will be the swap quote for that period.Therefore, when quoting a swap, it is enough to quote only forward (swap) points for the corresponding period in the form of a two-way quote, for example:
Thus, the rule for choosing the side of the swap is as follows: the same sides are used - bid to buy the base currency, offer to sell the base currency, as for current spot transactions, only on the swap end date.
In practice, many clients require currency swaps with intermediate maturities. Such terms are called non-standard.
Since the swap is traded on the OTC market, banks can quote on almost any non-standard day; necessary calculations help to perform automated systems.
Quotes are determined based on linear interpolation. Thus, the price of a two-and-a-half-month swap can be calculated based on the prices of two- and three-month swaps. In Russia, the most common and liquid market is the short swap market. In fact, this operation is a hidden deposit.When making a decision on what kind of transaction it is more profitable for the bank to make - direct attraction of interbank loans, or a short swap - the dealer is guided by the following indicators.
Let's assume that the ruble overnight rate on the market is 10%, and the dollar overnight rate is 1.5%. The dealer requests swap rate quotes (in practice, these are current market rates for TOD and TOM trades), which look like this:
A swap transaction (selling dollars to buy rubles with the TOD value date followed by a reverse exchange of the TOM value date) will make sense if the rate is less than 10%, i.e. the swap price will be cheaper than attracting ruble interbank loans in the money market.
(31.8760 / 31.8665 - 1) x 365 = 10.88%
At the same time, it should be taken into account that when concluding a swap deal, the dealer will miss the opportunity to place a dollar deposit at the current overnight rate of 1.5% on the money market. Thus, 1.5% is nothing but the cost of a missed opportunity, which also needs to be taken into account.
10,88%+ 1,5% = 12,38%
From the calculation, it turns out that the conclusion of a swap transaction at these current market quotations is unprofitable for the bank compared to the alternative possibility of transactions in the money market. However, if as a result of calculations the price would be less than 11.5%, then the dealer would enter into a swap.
A similar algorithm applies to a situation where a dealer is trying to find an opportunity to raise dollars on more favorable terms at current money and currency market rates.
As already noted, currency swaps represent a single transaction with one counterparty. Since the bank usually buys and sells the same amount of currency at the set rates, there is no obvious foreign exchange risk.
Purpose of using currency swaps
Forward traders use swaps primarily for the following purposes:
- speculation on the interest rate differential;
- managing the flow of funds in the dealing room in order to manage liquidity;
- servicing internal and external clients; carrying out arbitrage operations to make a profit due to the difference in prices for two financial instruments.
If the spot market trader speculates on exchange rates, then the forward trader speculates on the interest rate differential.
For example, a forward trader believes that US dollar interest rates will remain stable over the next 3 months. At the same time, in his opinion, interest rates on EURO will rise. In other words, according to the trader's assumption, the interest rate differential between the EURO and the dollar will narrow. Based on this forecast, the forward trader decides to open a position.
A trader can go two ways:
- Attract a loan in EURO for 3 months and hold a position, monitoring the situation daily in the hope of an early rise in rates and the possibility of providing a loan at a higher interest rate.
- Take advantage of a currency swap, that is, buy and sell EURO (sell and buy US dollars) and hold a position, monitoring the situation daily.
The forward raider manages the flow of short-term funds in order to maintain liquidity.
For example, in areas that specialize in spot transactions, money market transactions and forward transactions, this can be done using short-term swaps. A forward trader may be contacted by a corporate site dealer to quote a swap for one of the clients.
A corporate client enters into a forward outright transaction to buy US dollars for EURO at a fixed rate for delivery in 3 months. The corporate client thus covered its currency risk, but the bank had to accept the risk associated with the delivery of dollars for EURO in 3 months at the established rate.
If after 3 months the dollar rises, the bank will have to pay more for their purchase. To cover this risk, the bank can take the following actions:
- attract a loan in EURO for 3 months
- buy US dollars for EURO at the spot rate
- place US dollars on a 3-month deposit. Let's say the bank has already bought dollars, which it must sell to the client in 3 months.
In principle, if a bank wants to take risks and hopes for a favorable change in the exchange rate, it can hold this position until the value date and close it on spot. However, usually banks do not take risks for such a long period and try to close positions.
To cover the forward outright, the bank conducts operations on the money market - it borrows EURO and provides a loan in US dollars. A cheaper option is to cover outright forwards by making an opposite outright transaction on the same value date.However, there is a risk of exchange rate fluctuations. The size of forward points may not change (because it depends on the difference in interest rates), but the spot rate, which is an integral part of the forward rate, may change.
Another way of hedging the currency risk in this case is that, simultaneously with the conclusion of the outright transaction, conclude a reverse transaction on the spot, that is, turn the outright into a swap. The bank, first of all, needs to cover the spot risk. When selling a dollar forward to a client, he buys dollars in the spot market. The bank is now long the spot dollar dollar position and short the three-month forward.
To close the time gap between two cash flows, the following swap can be executed:
- sell USD / buy EUR spot;
- buy USD / sell EUR 3-month forward.
The first leg of the swap provides financing for the spot trade, while the second leg provides the forward outright. This example shows how a bank can manage a forward outright position using a currency swap. Swaps also allow you to take advantage of the interest rate differential between the two currencies. The swap rate is determined by the spot rates of the respective currencies, interest rates and the swap period.
Source: "market-pages.ru"
Forex Currency Swap
A currency swap is a combination of two opposite conversion transactions that fall on the same volume of the base currency, but differ in value dates. A currency swap is also called overnight (transfer of a trading position through the night) or rollover.
If two conversion transactions with different value dates are carried out by different counterparties, such a swap is called structured. However, this type of operations is not typical for trading on the international Forex currency market.
Let's take this situation as an example. The counterparty (a bank or a brokerage company) purchased $1 million against the Japanese yen with a value date on the spot, and sold this million on a 2-month forward. Then this transaction will be called a two-month US dollar to Japanese yen swap.
All currency swaps are divided into three types, depending on the timing of implementation. So allocate:
- overnight or short swaps
- standard
- forward
The latter are characterized by such combinations of transactions when the closest transaction is concluded on the terms if the value date is later than the swap, and the reverse transaction is concluded on the terms of a later forward. For standard transactions, the closest value date is spot, and the farthest one is forward. Spot is the second working day after the conclusion of the transaction.
Source: "fxclub.org"
Economic meaning and profitability of a currency swap
A currency swap, like an interest rate swap, is an exchange of cash flows denominated in different currencies. This operation is used as a means of attracting one currency for another currency in the money market, and in the foreign exchange market it is used to transfer positions.
Currency swap (eng - currency swap), as mentioned above, is an exchange of cash flows in different currencies on a certain date in the future at a pre-fixed rate.
In fact, a currency swap is a simultaneous purchase and sale (buy/sell) or sale and purchase (sell/buy) of one currency for another.
That is, we buy currency A and sell currency B. However, the transaction does not end there - on the swap end date, a reverse operation is performed and final settlements are made for the swap, depending on the side of the transaction and fixed rates.
A regular currency swap (overnight) for the USD/RUB currency pair is as follows:
This is a real currency swap concluded on the MICEX on one of the trading days. Let's consider it in more detail:
- The first part of the deal (the first leg of the swap) is the purchase of $2 million for rubles at the rate of 34.7116 with a settlement date of today.
- The second part of the deal (the second leg of the swap) is the sale of $2 million for rubles at the rate of 34.7193 with a settlement date on the next business day.
- The first line in the transaction is indicative and shows the swap - the difference in points that we receive / pay for such an operation.
As a result of this transaction, we received 2 million dollars this day, and on the next business day we have an obligation to return 2 million dollars and receive rubles back. The difference in ruble equivalent is our profit or loss from the swap.
The currency swap is quoted in basis points. Basis points are calculated based on the difference in interest rates for currency A and currency B:
Current Market Price * ((1+Currency A Rate * Days Until Swap End/Days In Year)/(1+Currency B Rate * Days Until Swap End/Days In Year)-1)
For example, for a one-day USD/RUB swap, the USD rate is 0.25% (Currency B), the RUB rate is 8.50% (Currency A), the time bases for USD are 360, for RUB 365, the current market rate is 34.7116, swap - Buy/Sell (Buy/Sell):Swap Rate = 34.7116 * ((1+0.085*1/365)/(1+0.0025*1/360)-1) = 0.0078
Important in a currency swap is the direction of the transaction. I considered a Buy/Sell swap, where we get a premium in swap points for buying dollars for rubles.
During the reverse Sell/Buy operation, the formula will take a different form, where dollars will act as currency A, and rubles as currency B. Accordingly, we will pay the same premium in swap points for selling dollars for rubles.
The economic meaning of a currency swap is as follows: in the presence of one currency and a shortage of the second currency, we can conclude a swap for a certain period of time and make up for this shortage. In this case, we will either receive or pay a premium due to the difference in interest rates across currencies.A currency swap is used by banks and financial institutions just to finance their obligations in one currency (for example, in dollars) at the expense of other currencies (for example, Rubles or Euros), that is, to manage liquidity.
It can be concluded both on the exchange (for example, the MICEX), and on the over-the-counter market, that is, between banks and financial institutions. It is worth noting that this is one of the main instruments of the money and currency markets, so you should not neglect it.
The yield on currency swaps is comparable to the yield on other money market instruments, such as interbank deposits. However, if demand for a certain currency grows, the yield of this instrument may grow, exceeding the average yield of money market instruments, or decrease and have a lower yield.
From the point of view of a private investor, a currency swap can be used as a tool for carrying over positions in foreign currencies, as well as a carry-trade tool, which I will talk about in my next posts on my blog about finance and financial markets.
If we describe the concept of "currency swap" in more strict terms, then they say that this is a combination of conversion transactions that are opposite in essence, with an equivalent amount, but valued. They say that the value date is the date when the first trade was made, and the date of the swap or the swap realization is the time of the reverse trade. As a rule, a transaction such as a currency swap is very rarely concluded for a period of more than one year.
There are two types of swap transactions. In the first case, the currency is bought first, and then it is sold, in the second, it is vice versa. So, the swap of the first kind is called “bought/sold”, and the swap of the second kind is called “sold/bought”.
In most cases, the swap is carried out with the same counterparty - a foreign bank. This is a "clean" swap. But there is also a “constructed” swap, when the first currency transaction is performed with one counterparty, and the second with another. The value amount remains the same, even with a constructed swap.
Swap transactions serve as a tool for refinancing or regulating bank liquidity. As a rule, Central banks, which have a significant flow of funds in foreign currency, are more willing to lean towards this instrument. For example, swaps are constantly used by Brazil and Australia.
Despite the fact that currency swaps, in form, are currency conversion operations, in fact, they relate to money market operations.
Swap line
A swap line is an agreement between the Central Banks of different countries regarding the exchange of currencies at fixed rates. For example, one Central Bank buys euros for dollars from another, and sells them at a cost increased by the swap difference. This method, in fact, allows you to issue funds.
Swap lines were first used during the 2008 credit crunch to stabilize the situation. The agreement on the use of the swap line significantly affects the exchange rates. It may be concluded for a fixed term or amount of funds, but may not have any restrictions.
The Bank of Russia also uses transactions such as currency swaps to provide liquidity to credit institutions or to ensure the liquidity of banking institutions, if other funds are insufficient to achieve this goal. The Bank of Russia has been using currency swap operations since autumn 2002. At first, transactions were made using the ruble-dollar instrument, in 2005 the ruble-euro instrument was added.
A foreign exchange swap is a spot currency exchange (the first part of a currency swap) with an obligation to make a subsequent forward reverse exchange of the same currencies on a certain date (the second part of a currency swap). In this case, the rate at which the exchange is made for the first part, and the rate at which the exchange is made for the second part, are agreed by the parties when concluding a currency swap. The rate for the first part (base rate) and the rate for the second part differ by the swap difference.
The currency swap mechanism implies that there is a transfer of ownership of foreign currency, which reduces the credit risk for this type of transaction compared to a deposit or secured loan and makes it easier to resolve situations in the event of default by one of the parties.
Currency swap as an instrument of monetary policy mainly used by central banks when providing liquidity in local currency. In this case, foreign currency acts as collateral.
Freely convertible foreign currency, of course, is a reliable security in any transaction. At the same time, it is usually irrational for the central bank to provide liquidity to credit institutions only or mainly against the backing of foreign currency. First of all, credit institutions may not have so much foreign currency. In addition, foreign currency is needed by credit organizations to make payments. But as an auxiliary tool, many central banks include currency swaps in their arsenal. Moreover, since currency swaps are widely used in transactions between credit institutions, then central banks use these transactions, and not secured loans.
The active use of this instrument to provide liquidity for monetary policy purposes is typical for central banks of countries with a high degree of economic openness (significant flows of funds in foreign currency) and a low capacity of the domestic market for quality securities (which limits the potential for using instruments to provide liquidity against collateral). securities). Examples of countries where central banks have ever actually provided domestic currency liquidity through currency swaps are Australia and New Zealand.
Currency swap operations of the Bank of Russia as an instrument of monetary policy represent the purchase by the Bank of Russia of foreign currency from a credit institution for rubles (spot) with the subsequent sale by the Bank of Russia of foreign currency to a credit institution for rubles on a certain date (forward). The Bank of Russia uses the currency swap as a permanent instrument. The Bank of Russia may also conduct "fine-tuning" currency swap auctions.
Currency swap can be used by central banks as a tool to maintain financial stability, including the provision of funds to credit institutions in foreign currency. Such operations were carried out, for example, by the Eurosystem (ECB) and the Swiss National Bank.
Currency swap operations of the Bank of Russia as an instrument of maintaining financial stability represent the sale by the Bank of Russia of US dollars to a credit institution for rubles (spot) with the subsequent purchase by the Bank of Russia of US dollars from a credit institution for rubles on a certain date (forward). The Bank of Russia enters into these transactions in accordance with standard market practice.
Main characteristics of operations
The Bank of Russia establishes the following conditions for concluding currency swap transactions: the date of conclusion of transactions, the dates of exchange for the first and second parts, the base rate, the interest rate on rubles, the interest rate on cash in foreign currency, and also, in accordance with general market practice, announces a swap difference. The base rate is the central rate for the relevant currency pair, calculated by NBCO "National Clearing Center" (JSC) on the date of trading of the Public Joint Stock Company "Moscow Exchange MICEX-RTS" (hereinafter referred to as the Moscow Exchange). Interest rates are set by a decision of the Board of Directors of the Bank of Russia. The swap difference is calculated as follows.
- SR— the value of the swap difference, expressed in rubles, rounded to 4 decimal places;
- BC CUR— the base rate, which is the central rate for the relevant currency pair, calculated by NBCO National Clearing Center (JSC) on the date of trading on the Moscow Exchange;
- PS RUB— interest rate on rubles set by the Board of Directors of the Bank of Russia, in percent per annum;
- PS CUR— interest rate on funds in foreign currency set by the Board of Directors of the Bank of Russia, in percent per annum;
- D— the number of calendar days from the day of settlement of the first part of the currency swap (excluding the day of settlement of the first part of the transaction) to the day of settlement of the second part of the currency swap (including the day of settlement of the second part of the transaction);
- DG RUB— the number of calendar days in a calendar year (365 or 366). If parts of the currency swap fall on calendar years with different numbers of days, then the ratio D / DG RUB calculated from the actual number of days in each year.
FX standing swap
The currency swap as a permanent instrument was introduced in September 2002. As a result, credit institutions were able to raise liquidity from the Bank of Russia on a daily basis for a period of 1 day in exchange for US dollars (the ruble-US dollar instrument). Since October 2005, a similar ruble-euro instrument has appeared.
In accordance with the general purpose of standing liquidity instruments, the Bank of Russia currency swap serves two purposes. First, it contributes to the formation of the upper limit of the interest rate corridor, since the interest rate paid by credit institutions for ruble liquidity on these transactions is set at a level corresponding to the upper limit of the interest rate corridor of the Bank of Russia. Secondly, it allows credit institutions, which for some reason could not find funds in the money market, to attract liquidity from the Bank of Russia for a period of 1 day secured by foreign currency.
For standing currency swaps, the ruble interest rate is set at the key rate plus one percentage point, and interest rates for cash in foreign currencies are equal to market LIBOR rates for loans in the respective currency for a period of 1 day.
Currency swap transactions are concluded at organized trading on the Moscow Exchange with financial market participants who have access to exchange trading. The Bank of Russia participates in exchange trading only in a non-address mode, that is, when concluding transactions, participants in organized trading do not know their counterparty.
Transactions on the instrument "ruble-US dollar" are carried out daily from 10:00 to 18:00 Moscow time, on the instrument "ruble-euro" - from 10:00 to 15:15 Moscow time.
Information on the conditions of operations "currency swap" standing
Fine-Tuning Currency Swap Auctions
In June 2015, the system of monetary policy instruments was supplemented by “fine-tuning” currency swap auctions. The Bank of Russia may hold auctions for the conclusion of currency swap transactions for a period of 1 or 2 days with US dollars or euros.
The Bank of Russia may decide to hold a “fine-tuning” currency swap auction if it is necessary to significantly and quickly increase the supply of bank liquidity. A "fine-tuning" currency swap auction for a period of 1-2 days can only be held simultaneously with a "fine-tuning" repo auction for a similar period (single auction). Such an auction is held only if credit institutions experience a shortage (shortage) of market collateral, which may adversely affect the ability of the Bank of Russia to manage money market rates.
The simultaneous holding of auctions, first of all, means the same time schedule. In addition, the Bank of Russia sets the total supply volume (limit), draws up a unified register of orders and determines one cut-off rate, below which it will not enter into repo and currency swap transactions. The minimum interest rate for rubles, which may be specified by auction participants in bids, is equivalent to the key rate. Interest rates on cash in foreign currencies are equal to the market LIBOR rates on loans in the relevant currency for a period of 1 day. Fine-tuning currency swap auctions are held on the Moscow Exchange.
Currency swap as a tool to maintain financial stability
The currency swap, as a tool to support Russian credit institutions with dollar liquidity, was introduced in September 2014, as a result of which credit institutions were able to raise US dollars daily from the Bank of Russia for a period of 1 day in exchange for rubles. Such transactions are offered by the Bank of Russia with “today/tomorrow” and “tomorrow/the day after tomorrow” settlements.
Currency swaps to provide US dollars from the Bank of Russia are aimed at helping banks with dollar liquidity when access to it is difficult for reasons beyond their control, as well as at preventing sharp changes in quotations in the currency swap market in the event of a short-term increase in market participants' demand for foreign currency.
The US dollar interest rate on these currency swaps corresponds to the market rate of LIBOR on loans in US dollars for a period of 1 day, increased by 1.5 percentage points. At the same time, the interest rate on rubles is set at the level of the key rate minus one percentage point.
The Bank of Russia every day sets aggregate limits on the maximum volume of FX swap transactions separately for an instrument with “today/tomorrow” settlements and for an instrument with “tomorrow/the day after tomorrow” settlements.
Currency swap transactions to provide US dollars are concluded on the organized trading of the Moscow Exchange in the addressless mode. Transactions are concluded daily from 10:00 to 18:00 Moscow time.
Information on the terms of "currency swap" transactions for the sale of US dollars for rubles is published daily on the website of the Bank of Russia.
A currency stop is a special financial instrument used by both banks and international companies. Despite the fact that all types of swaps - currency, stock and interest - work in approximately the same way, the former have certain features.
Such an operation as a currency swap always involves the participation of two market participants who want to make an exchange in order to obtain the desired currency with the maximum benefit. To illustrate the essence of a currency swap, consider the following conditional example.
Let a certain English firm (company A) wish to enter the US market, and an American corporation (B) wish to expand the geography of its sales in the UK. Typically, loans and credits issued by banks to non-resident companies have higher interest rates than those issued to local firms. For example, company A can be given a loan in US dollars at 10% per annum, and company B can be given a loan in GBP at 9%. At the same time, the rates for local companies are much lower - 5% and 4% respectively. Firms A and B could enter into a mutually beneficial agreement under which each entity would receive a loan in its national currency from a local bank at better rates, and then the loans would be "swapped" through a mechanism known as a currency swap.
Let's say that the dollar is exchanged on the Forex market at the rate of 1.60 USD for 1.00 GBP, and each firm needs the same amount. In this case, US Firm B will receive £100 million and Company A $160 million. Of course, they have to compensate their partner, but the swap technology allows both firms to reduce their loan repayment costs by almost half.
For the sake of simplicity, the role of the swap dealer, which acts as an intermediary between the participants in the transaction, was excluded from the example. The involvement of the dealer will slightly increase the cost of the loan for both partners, but the costs will still be much higher if the parties do not use the swap technology. The amount of interest that the dealer adds to the cost of the loan, as a rule, is not too large and is in the range of ten basis points.
It should also be noted that such a type of such operation as a currency-interest swap. In this case, the parties exchange interest payments aimed at repaying foreign currency loans.
There are a few key points that make swaps different from other types of similar transactions.
Unlike an income-based swap and an interest-bearing simple swap, a currency swap involves a preliminary and then a final exchange of a predetermined amount of credit obligations. In our example, the companies made an exchange of $160 million for £100 million at the start of the transaction, and at the end of the contract they have to make the final exchange - the amounts are returned to the relevant parties. At this point, both partners are at risk, because the original exchange rate of the dollar and the pound (1.60:1) has probably already changed.
In addition, most swap transactions are characterized by netting. This term means the netting of amounts of money. In a swap transaction, for example, the return on an index can be exchanged for the return on a particular security. The income of one participant in the transaction is netted in relation to the income of the other participant on a prearranged specific date, and only one payment is made. At the same time, those associated with currency swaps are not subject to netting. Both partners undertake to make the respective payments on the agreed dates.
Thus, a currency swap is a tool that achieves two main goals. On the one hand, they reduce the cost of obtaining loans in (as in the example above), and on the other hand, they allow you to hedge the risks associated with sharp changes in the exchange rate in the Forex market.
