Currency swaps are transactions designed to protect participants from currency risk. What are swap transactions in the stock and currency 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 price 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.

Success in financial terms implies education and knowledge in this area. In order not to lose your opportunities to earn money, you need to know how exactly you can do it. In this article, we will look at what swap (swap) transactions with foreign currency are and in what situations they can be used.

What is a swap deal?

A swap transaction is a financial transaction based on the exchange of one currency for another. In this case, the exchange agreement is concluded in both parties. On a certain date, a currency is bought, and on another, its reverse exchange is a sale. Moreover, this transaction usually implies pre-known conditions for buying and selling currency, they can be either the same or different.

However, it is not always very easy to understand what a swap transaction means. In order to understand this and better understand how it works, examples are needed. A few of them will be presented below.

Let's look at a few examples where this concept can come in handy. So you can better understand how it works, and in what cases it can help you.

FX Swap: Deal Example

There is an investor who has the opportunity to make a profitable transaction by buying bonds in the amount of 1 million dollars. According to the terms of this deal, he will be able to make a profit of 5% in one year, that is, 50 thousand dollars. However, the problem is that bonds are sold for dollars, while the investor's money is kept in euros.

In this case, he has several options for the development of the situation.

Consider the simplest and, perhaps, the first one that comes to mind - currency exchange. The bank offers the investor to buy currency from him at the rate, for example, 1.350. At the same time, in a year, he will be able to sell this currency back to the bank at a different rate. At the time of the sale, he could have sold the same currency at 1.345.

Calculate the amount of investment in euros by dividing by the current exchange rate. We get 741 thousand euros for 1 million dollars. In this case, one year after receiving a profit from the transaction, namely 50 thousand dollars, it is necessary to convert the money back into euros.

By simple calculations, we get that if the rate rises above 1.417, then you will already receive small losses during the reverse transaction. This is bad, because initially everything was planned only in order to make a profit. Depending on the exchange rate in this case is very impractical.

This means that it is necessary to look for other ways to solve this problem. To do this, you can use the swap deal.

For such a transaction, the bank offers the following conditions:

• Purchase of 1 million dollars now at the rate of 1.350, that is, for 741 thousand euros.
• Sale of 1 million dollars in a year at the rate of 1.355, that is, for 738 thousand euros.

At the same time, you still have your 50 thousand dollars of profit from the deal with the purchase of bonds. Their conversion into euros will already depend on the market rate, but you, as an investor, still remain in the black.

If during this time the rate has grown in favor of the investor, then the net profit will be more than 37 thousand euros. And at the same time, there are no risks and dependence on the course.

Yes, of course, if the rate changes to a more profitable one for you, this will mean that you could earn more. However, the risks you would have to take are not justified.

As you can see, a swap transaction with foreign currency gives the investor confidence that his investment will be justified and will not cause losses when exchanging currencies. In this situation, both parties remain in the black, both the investor, who insures himself against the risks of losing money, and the bank, which receives a specific profit from the transaction.

The bank knows that it will now give $1 million at one rate, and then buy it back at an already known rate and make a profit of 3,000 euros. And at the same time, he will remain with his money, lose nothing and risk nothing.

There is also such a thing as an interest rate swap.

This is an agreement between two parties, which is concluded with the condition of making payments both on the one hand and on the other with a certain percentage.

Interest is calculated depending on the terms of the transaction and is different for both parties. To make it clearer what it is, let's look at the example of an interest rate swap.

For example, the World Bank needs a long-term loan in francs. At the same time, the interest rate for such lending from a Swiss bank is too high. But at the same time, the bank has the opportunity to attract, for example, a long-term loan in rubles from the Russian Bank, which, for example, can borrow francs at a better interest rate and needs to replenish ruble capital.

To solve this problem, banks can begin to cooperate through an interest rate swap.

In this case, banks take the loans described above and exchange currencies, while paying a certain percentage. After the expiration of the term of the concluded agreement, banks make a reverse transaction.

As a result, both parties are in the black, as they received the desired amounts at a lower interest rate and did not lose a lot of money.

As you can see, swap deals are very useful in many cases. Their application can be found in many areas and for different purposes. It is very important to understand all the intricacies and nuances of transactions in order not to miss anything important.

Summing up

A swap transaction is a process of exchange between two parties of different, or rather opposite, currency conversion transactions.

In this case, one party receives confidence in receiving a fixed profit, and the other - a guarantee of a constant exchange rate during a reverse currency exchange. Moreover, this rate (both buying and selling) is determined in advance, at the conclusion of the transaction, and may even contain the same purchase and sale costs.

Swap transactions are a good solution for saving money. A currency swap allows you to know a specific rate before the actual exchange. You know in advance how much you will give for a certain amount, and how much you will receive for it later. The bank, in turn, knows in advance how much profit it will receive. Both sides do not take risks and do not depend on exchange rate fluctuations.

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 British 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. Dealer involvement 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 against 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.

The term "swap" can be found quite often both in the lexicon of a trader, and an economist, mathematician, and even a programmer. This is due primarily to the English meaning of the word, which means a very general concept of "transfer". However, the most widely used term "swap" is in the financial markets. Below we will consider its meaning in this vein.

Initially swap transactions were accepted only in an interbank environment where both participants traded different currencies and both required a fair exchange. A simple conversion through buying and selling was inconvenient because, firstly, not everyone needs a currency here and now, and secondly, not everyone has the amount of cash that can be spent on transactions.

The so-called this is the exchange of rubles, dollars, euros, yen, any other currency, carried out in two stages. The first transaction is called the value date, the second - the end of the swap.

Swap (from the English swap) - this, as mentioned above, means transfer. In exchange trading, it means conducting two conversion transactions for a specific amount with different delivery dates.

The main subject of interest of the buyer and seller is money, therefore, over time, a new category emerged from currency swaps - . It can be divided into two sub-categories relating to the deferred delivery of funds at interest ( most often determined by LIBOR - London Interbank Offered Rate), or for the supply of purchased money in equal shares during the term of the contract.

conversion deal represents the transactions of traders in the foreign exchange market, aimed at the exchange of currencies. The operation takes place at a predetermined rate and date.

Features of swap transactions

1. Extended over time for up to several years.
2. Put the buyer and seller at equal risk.
3. They allow you to refinance or get rid of an unnecessary asset for a while.
4. They allow you to conduct simultaneous transactions with dozens of counterparties.
5. Can be measured in both financial and in-kind form.

If we move away from complex terms and analyze the swap using a specific example, its simple principle of operation will become clear.

There are three main swaps in stock trading: short swaps, short one-day and forward. The first should not cause difficulties - here both stages of the transaction took place within one day. The second ones are executed within two working days - today and tomorrow, for the third ones, the value date is earlier than the conclusion of the contract.

There are three types of contracts on the Moscow Exchange currency market:

• TOD (T+0)- today, today
• TOM (T+1)- today plus one day - tomorrow
• SPT (T+2)- from the English spot - plus two days - the day after tomorrow

If a trader wants to make a delivery, he simply acquires the contract he needs and waits for its execution today, tomorrow and the day after tomorrow, respectively. However, if we are talking about the transfer of funds without delivery, then the broker is obliged to conduct a swap transaction by selling the client's current contract and buying another one in return, but with a different life.

In more detail it looks like this. The client purchased 1 lot of USDTOM (1000$). But he has only 40,000 rubles in his account. At a rate of 80 rubles per dollar, the remaining 40,000 are the broker's credit funds, the position is open with leverage. Since the delivery takes place only at its own expense (the client cannotpay the counterparty half the cost of $1,000 with borrowed money), the next day the client will not see 1 lot of the USDTOD contract on his account. He had USDTOM as he had, and so he will remain. The broker will automatically sell today's TOM and buy tomorrow's TOM at the end of the trading session.

The client may have such a question. At what rate will the broker conduct a swap transaction?

When transferring from one position to another, a spread will inexorably arise, which will result in a direct loss for the trader. However, this spread in the market is also formed by supply and demand, but at a narrower and more isolated level from the open market.

After the end of trading, a special auction begins, at which brokers and large players form their own glass of swap operations, trying to carry out the transfer procedure in the most profitable way. Responsibility for the rollover of the position lies entirely with the broker. The difference in the swap is at least equal to the key rate in the country divided by 365 days, but at the time of the swap rollover variance may be higher.

Good brokerage companies provide large clients with the opportunity to trade with ETS Swaps contracts. These instruments are the same swap trades that carry over. In fact, the client gets the opportunity to independently choose the difference betweentransferable contracts, but private investors with limited capital cannot use this option as the USD_TODTOM swap trades in $100,000 lots. Thus, in order to make a swap deal and transfer 100 lots of the USDTOD instrument, you need to buy 1 lot of the USD_TODTOM swap.

There is a so-called “swap line” between the US Fed and the European ECB, which is a special system of tranche conversions of euros and dollars between them. The currency exchange procedure itself takes place at a pre-agreed rate and allows the ECB regulator to issue eurodollars, issuing loans to European banks in US dollars. This line has existed since the beginning of the 2008 crisis.

Swap trading refers to non-exchange methods, since it is not regulated by the rules of the trading platform and depends on the desire and capabilities of counterparties. With this in mind, there can be an extremely large number of opportunities for the implementation of contracts, conditions, cost, number of participants in a constructed swap. There is no single scheme, as you understand.

Instead, an order is created on the exchange:

an issuer such and such is ready to take a swap from any other issuer for 1 year under your conditions. Propositions are electronic in nature, calculated by exchange robots and require only one thing from the trader: to agree or refuse. At the end of the term, a reverse step will be taken, and from the outside it may seem that all the work is to agree or refuse.

Swap transactions require a lot of coordination, an understanding of market processes and the possession of a lot of information. In the Russian exchange segment, they have replaced loans and lending to market participants, you can also find the abbreviation ( English REPO-repurchase agreement). By the way, the Bank of Russia regularly places orders for REPO as part of the stabilization of the ruble exchange rate.

Long and short currency positions

Swap short and long positions the forex market is accompanied by some changes in price. In fact, a trader loses a little bit of value each time a position is rolled over to the next day or weekend. In general, the foreign exchange market is significantly different from the stock market. Dividend cutoffs do not pass for currency pairs and, in general, the potential value of a particular monetary unit can only be assessed in relation to another monetary unit. A trader should analyze the economy of the whole state, and not the financial condition of an individual enterprise.

Forex shorts and longs can be used in the concept of any short-term and medium-term strategy. A trader must clearly understand what positions are open in his portfolio, and what operations he must perform in order not to accidentally form unwanted positions on the account.

The investor can separately form short and long lists depo accounts , to evaluate the structure of your own portfolio. Moreover, short and long lists individual shares and financial instruments are created by the broker himself. They contain those assets that can be used in margin trading. For example, a broker cannot afford to provide the opportunity to short low-liquid stocks.

Financial SWAP arithmetic

The swap cost is the difference between the quotes of the so-called " legs» swap ( swap legs) - quotes of conversion transactions that create a spread.

Simply put, a swap is presented in the form of 2 opposite transactions, which are exchanged by traders on a transaction at certain interest rates. Since these rates on deposits and loans are not always equal, then - if the proportions of the amounts on the first leg of the swap are equal and the terms of the conditional depo transactions are equal - the interest payments will not be equivalent. It is this difference between these parties that determines the price of the swap itself.

Derivative impact on financial instruments

In 2004, the first combined derivative financial instruments were introduced - swaps EDS (Equity Default Swaps). Due to their non-standard, they received the name " exotic».

EDS Swaps is a kind of asset that allows one party to carry over the risks of another market participant associated with the entry into force of certain events (equity event). We are talking primarily about the fall in the price of shares for a certain price level. Thus, EDS is able to protect the client if the price of a share or contract falls by 20% of its value at the time of the conclusion of such an agreement.

Exotic Swaps is a contract between two counterparties in which the buyer of the swap pays the seller small payments during the life of the EDS, until the moment when a conditional event occurs and the seller of the EDS pays permanently the full price, after which the swap contract is considered to be fulfilled. These exotic swaps are similar to CDS contracts, but in the case of CDS, the seller pays the money when a particular issuer goes bankrupt.

Such swaps also have much in common with, since one of the parties risks everything at once, at the same time, the periodic nature of payments distinguishes this instrument and allows you to create interesting and non-trivial strategies based on it.

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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.

1. 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
2. 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.

3. 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.

1. speculation on the interest rate differential;
2. cash flow management in the dealing room;
3. servicing internal and external clients;
4. 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, a swap is accounted for 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 transaction is concluded, and the reverse exchange (the second leg) falls 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:

1. Fixed periods
2. Short dates
3. Non-standard dates
4. 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:

1. the execution date of the closer transaction is called the value date,
2. 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, however, a transaction to sell a currency is carried out first, 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:

1. 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.
2. 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 (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 represent foreign exchange transactions, in terms of their content, they relate 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:

1. $40.05 million by an American subsidiary of a German company;
2. 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:

1. The principal amounts of loans are exchanged at a spot rate of EUR/USD 1.3350.
2. 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).
3. 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:

1. Standard Swaps
2. Short One Day Swaps
3. 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 particular 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:

1. transaction date;
2. deal type: swap;
3. amounts;
4. counterparty;
5. transaction direction: buy + sell, sell + buy;
6. names of currencies;
7. exchange rates/forward points;
8. value dates;
9. payment instructions;
10. through whom the transaction was made (in case of working through a broker)

Since a standard swap deal contains two deals - 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:

1. 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.
2. 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 to hedge the currency risk in this case is to conclude the reverse transaction on the spot simultaneously with the conclusion of the outright transaction, that is, to 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:

1. sell USD / buy EUR spot;
2. 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 (bank or 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 (English - 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.

An ordinary 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:

1. 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.
2. 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 the settlement date on the next business day.
3. 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 have 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.