Currency interest rate swaps. Currency swap

23.06.2023

Currency interest rate swap may involve both an exchange of interest payments and an exchange of the principal amount. The situation on international market capital may develop in such a way that the bank may be quoted lower interest rates on loans in one currency, and higher interest rates on loans in another (for example, American bank offer more attractive interest rates in US dollars compared to rates for loans in British pounds sterling). It is then possible for the bank to obtain a loan in the market where it has an advantage and carry out currency swap. Such a swap will provide:

Exchange of principal amounts at the beginning of the agreement;

Exchange of interest payments during the term of the agreement;

Reverse exchange of debt amounts 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, it is more profitable for Bank A to attract American dollars, and for Bank B - British pounds sterling. If the bank needs to have British pounds at its disposal, and Bank B needs dollar resources, then they can carry out a swap.

If the exchange rate on the date of the transaction is 1.6000, then bank A lends $16 million, bank B - £10 million. Art., banks exchange amounts of debt (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 responsible for its obligations on the international capital market, regardless of the quality of performance by the other bank of its obligations under the swap). At the end of the agreement, the banks carry out a reverse exchange of debt amounts and each of them pays off with its creditor.

Rice. 13.3. V

But the exchange of principal amounts contains credit risk, because on the date of completion of the transaction the exchange rate may differ significantly from the rate that was on the date of conclusion. However, the banks exchanged fixed amounts, and at the end of the swap, they must return exactly these amounts to each other.

It is also possible to carry out 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 attract resources 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 with annual interest payments. This implies that during these five years the bank must pay interest on the bonds in US dollars. At the same time, the bank has income from assets in British pounds sterling. Consequently, 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 exchange are possible:

Interest payments at fixed rates;

Interest payments at floating rates;

Payments at fixed rates to payments at floating rates.

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 borne by the dealer or by 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 financial instrument, swap option, a contract that gives its buyer the right to enter into a swap transaction at a specified date in the future.

Swaption call- a swaption, which 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, which provides the buyer with the right 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 simultaneously making a counter-sale of a similar asset at a floating rate, then he can enter into a put swaption, thereby completely shifting all risks to the seller of the swaption. If for any reason the current floating rate is lower than the previously agreed fixed purchase rate, the trader will bear a loss. Having used the swaption, he will receive a fixed payment, 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 transaction);

Rate (fixed rate of the underlying swap);

Duration (usually ends two business days before the start date of the underlying swap) (“term” is the amount of deferral of the swap);

Date of the underlying swap;

Additional commissions and deductions;

Frequency of settlement of payments under the underlying swap.

Like others options, A swaption provides the right to enter into a contract in the future with the conditions currently agreed upon, but does not obligate it to do so. The fee reflects the variability of compliance with the agreed characteristics of the swap in the future.

The form in which borrowers can most easily raise the money they need is not always the form that best suits their goals. Let's say Company A discovers that it's easiest to raise money with a fixed interest rate when what it really needs is variable-rate funds. Company B, on the other hand, has no problem raising funds at a floating rate, but really needs money at a constant interest rate that is not too expensive for it.

The solution could be a swap - in our case, an interest rate swap. Company A issues fixed interest bonds and Company B issues floating interest bonds. Then they agree

on a swap (exchange) of its interest payment obligations. Company A pays a variable rate of interest on a loan to Company B, and Company B pays a fixed rate of interest on a loan to Company A, subject to certain adjustments to reflect the relative strength of the two parties to the transaction. Through this mechanism, each party ultimately receives its money in a form that suits it, at a cheaper interest rate than if it had borrowed directly on those terms.

The principle here is that each company borrows in the form that gives it the greatest comparative advantage. In reality, the mechanism is more complex. Companies usually do not directly seek counterparties to the swap, but enter into a swap agreement with a bank, which can either find a counterparty (receiving its own small commission) or can act in this capacity itself. Once entered into, a swap can subsequently be traded or adjusted depending on changing market conditions.

The second type of swap is a currency swap. Company A may be able to borrow money at the best possible price. favorable conditions in German marks because her credit rating is high in Germany, where she is famous. But she needs American dollars. Company B can most easily raise funds in US dollars, but requires German marks. Therefore, company A issues bonds in German marks, and company B borrows in dollars. They then exchange them in a swap deal, so each ends up with what it needs, paying interest in the currency it was swapped for. Since everyone takes where he has the most good conditions for a loan, both participants receive cheaper funds than if they took out a loan directly in the currency they needed. Again, a bank can act as an intermediary. In many swaps, interest payments and currency are exchanged together.

It is believed that at some points almost 80% of the funds collected on the European market are simultaneously involved in swap transactions.

Scheme of operation of a currency interest rate swap

Exchange of principal amounts

At the beginning of the swap, the Company and the Bank borrow equivalent amounts in the respective currencies and exchange them at the agreed rate. This rate is taken as the spot rate. Alternatively, notional principal amounts of foreign currency may be exchanged without actual delivery of the currencies. This is the spot phase of a currency interest rate swap.

Rice. 1. Scheme of exchange of principal amounts.

Counterparties exchange interest payments

During the term of the swap, the Company and the Bank exchange interest payments on the principal amount at the rates agreed upon when entering into the swap. Rates can be fixed or variable, and payments can be made once or twice a year. The frequency of swap payments generally depends on the frequency of interest payments on the underlying loans.

Rice. 2. Interest payment exchange scheme.

The Swiss francs received from the Bank cover the interest payment on the loan in Swiss francs. Likewise, US dollars received from the Company cover the Bank's interest payment in US dollars.

Reverse exchange of principal amounts

At the expiration of the swap, the Company and the Bank exchange principal amounts again at the original exchange rate.

As a result of the currency interest rate swap, the Company had the opportunity to convert a loan in Swiss francs into US dollars, and the Bank - a dollar loan into Swiss francs.

Rice. 3. Scheme of reverse exchange of principal amounts.

In the example of a swap agreement between the Company and the Bank, the interest rates used to make payments under the swap are fixed. Such a swap is also called a currency-interest rate swap with fixed/fixed rate.

However, some currency interest rate swaps also use floating rates for one or both currencies. Such swaps are called cross-currency. For example, in a cross-currency fixed/floating rate swap, a fixed interest payment in one currency is exchanged for a floating interest payment in another currency.

Features of currency interest rate swaps

A cross-currency interest rate swap typically involves the exchange of currencies between counterparties at the beginning and end of the transaction. If an exchange does not occur at the beginning of the transaction term, it must occur at the closing of the transaction. The exchange of principal amounts entails the appearance of additional credit risk.

Interest payments are made by the parties in full.

Interest payments on two currencies can be calculated at a fixed or floating rate for one currency and a floating rate for the other.

Participants in swap transactions

Currency swap transactions are most often carried out by (large) banks. They are the dominant participant in the swaps market. In this case, two currencies are exchanged between banks with the original currencies being returned to each other at the end of the transaction. The exchange is carried out in the form of two opposite currency transactions, concluded simultaneously, but with different terms for the delivery of currencies: SPOT - for one transaction and forward - for the other (this scheme is reflected in Fig. 2.) As a result, both banks receive at their disposal the purchased on condition SPOT currency for the period before its sale under a forward transaction (6, pp. 78-84).

Rice. 2 SWAP operation scheme

SWAP operations are convenient for banks: they do not create open position(the purchase is covered by the sale), temporarily provide the necessary currency without the risk associated with changes in its exchange rate.

SWAP transactions are carried out between:

commercial banks(market-makers)

directly between central banks countries

between commercial banks and central bank countries

In the second case, they are agreements on mutual lending in national currencies. Since 1969, a multilateral system of mutual currency exchange has been operating through the Bank for International Settlements in Basel based on the use of swap transactions, which is used by the central banks of countries to carry out effective foreign exchange interventions.

Admission of participants to the swaps market is regulated by national legislation (6, pp. 41-50).

Currency and interest rate swap

A cross-currency interest rate swap involves exchanging interest payments in one currency for interest payments in another currency.

Currency interest rate swaps typically involve an exchange of principal amounts. The notional principal is exchanged at the inception of the transaction, usually at the prevailing SPOT rate. Interest payments are made at a fixed, floating or zero coupon rate. At the expiration of the swap period, the principal amount is exchanged in the opposite direction at the original spot rate (5, pp. 8-12).

In effect, a cross-currency interest rate swap allows a borrower or lender to exchange a loan in one currency for a loan in another currency without any currency risk. (currency risk does not arise only if the swap is held until its expiration).

A cross-currency interest rate swap is essentially a spot transaction followed by a series of foreign exchange forwards.

The validity period of cross-currency interest rate swaps is usually at least one year.

Use of currency and interest rate swaps

Example. JAP is a Japanese multinational company that needs to raise $100 million over 5 years to finance the construction of a facility in the United States. JAP can borrow Japanese yen in the domestic market at a fixed five-year rate of 1.5%, but the cost of borrowing US dollars is LIBOR + 0.25%. Let's assume that the current USD/JPY spot rate is 110.00.

To raise 11 billion, JAP issues a 5-year euro yen bond with a coupon rate of 1.5%. At the prevailing spot rate, the notional principal amount of the Eurobond is equivalent to $100 million. The company requires dollars to finance the construction of the enterprise.

American ABC Bank requires the equivalent of $100 million in Japanese yen to expand its operations. The bank would prefer to raise funds at a fixed rate in order to have certainty about future cash flows. ABC can raise dollars in the domestic market at a flat LIBOR rate, but a five-year yen loan at a fixed rate will cost him 3.5%.

JAP and ABC decide to enter into a cross-currency interest rate swap that allows them to take advantage of favorable borrowing rates in their home markets. Provided that credit ratings both parties are the same, the savings from the transaction will be distributed approximately equally between them. In table 1 presents the positions of both organizations (7, pp. 69-75).

Table 1. Positions of JAP Company and ABC Bank

In order to obtain the loan that is needed, organizations enter into a swap. Both organizations need to assess the risks associated with the possibility of non-fulfillment of obligations by the counterparty. If this happens, then the counterparty who did not receive interest payment, is still obligated to make payments on his underlying loan.

The role of market makers

Currency interest rate swap agreements are almost never entered into directly by end users. This process most often involves a market maker and two unrelated clients who want to enter into a swap, but not necessarily with each other. For example, the perceived credit risk associated with a direct swap agreement may not be acceptable to either party. The market maker bank, acting as an intermediary, offers clients a double swap in which both parties receive a guarantee of interest payment.

Rice. 3.

The intermediary receives a fee, the amount of which depends either on the size of the notional principal amount, or on the spread of quoted prices for payments under the swap - swap rates, or on both.

It is rare that a market maker has underlying asset necessary to exchange the principal amounts in the swap. Typically, a bank covers a position in a currency-interest rate swap with a counter contract with another counterparty, which allows it to manage currency and interest rate risks.

If the terms of the counter contract exactly match the terms of the original contract, the risk is completely eliminated. However, it retains credit risks associated with both counterparties.

Banks quote swap rates for current spot rates against 6-month LIBOR for US dollars. Bid and ask quotes are usually offered for a number of currencies. As an example, below, in table. 3, quotes are given for the British pound sterling.

Table 3. Example of quotes for the British pound sterling

These quotes mean that, for example, the bank is willing to enter into a four-year swap at the current spot rate on the following terms:

? The bank receives a fixed rate (ask) of 7.52% on British pounds sterling and pays a floating 6-month LIBOR rate on US dollars;
? The bank pays a fixed rate (bid) of 7.48% on British pounds and receives a floating 6-month LIBOR rate.

By putting two cross-currency interest rate swaps together, the market maker is effectively in the middle of a double swap.

Rice. 4.

In the US and to a lesser extent in the UK, swap rates are quoted based on the yield on Treasury notes of the relevant maturity.

For example, a market maker might quote a swap based on a 5-year Treasury yielding 8.00% as a "70/75 over." This means that for a 5-year swap the market maker is willing to pay a fixed rate of 8.70% or receive a fixed rate of 8.75%.

Comparisons of cross-currency interest rate swaps should be made on a like-for-like basis, that is, comparing like with like.

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.

So, recently on the world financial markets The use of currency swaps has increased significantly.

Currency swaps are a way to avoid financial losses due to exchange rate changes.

In this case, a transaction is concluded that actually consists of two operations - the purchase and sale of currency - on an agreed date in the future and at a fixed rate.

It is most profitable to use swaps to reduce economic risks on long-term obligations in foreign currency.

What types of currency swaps exist, features and purposes of their use in practice - read the article.

Currency swaps are a foreign exchange market instrument

This group of foreign exchange market instruments includes the majority of forward transactions, which for the most part are 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 currencies are exchanged.

Spot forward.
In this case, the first exchange (first leg) occurs on the spot date, that is, on the second business day after the transaction is concluded, and the reverse exchange (second leg) occurs on the forward date, for example, 3 months after the first date
Forward-forward (forward against forward).
Here, the first exchange (first leg) occurs on the first forward date, and the reverse exchange (second leg) occurs on a later forward date, which is called the forward-forward date.
For example, a forward-forward swap may begin 3 months after the transaction is concluded and end 6 months after the transaction is concluded. This transaction is called a 3x6 forward-forward swap.
Short dates.
These are swaps with a maturity of less than one month. For example, the first leg can be executed on spot conditions, and the second leg after 7 days (1 week). Some short-term swaps are executed even before the value date under spot conditions, for example, the first leg today and the second tomorrow.

To summarize, we note that within the framework of a currency swap:

a single over-the-counter transaction is carried out with two value dates;
there are two legs, while the second assumes the opposite action relative to the first;
the exchange operation is performed twice;
value terms can vary from one day to 12 months;
usually the base currency amounts are identical for both legs;
quotation is carried out in forward points.

Who uses

As already mentioned, currency swaps represent a single transaction with a single counterparty. Since the bank usually buys and sells the same amount of currency at set rates, there is no obvious foreign exchange risk.

differential speculation interest rates;
cash flow management in the dealing room;
servicing internal and external clients;
conducting arbitrage operations to make a profit due to the difference in prices for two financial instruments.

While a spot market trader speculates on exchange rates, a forward trader speculates on interest rate differentials.

Source: "fx-fin.net"

Currency swaps

Currency swap is two currency operations- buying and selling with two different value dates, one of which is the spot date. Currency swap is one of the most common instruments of the foreign exchange market; their share in turnover is significantly higher than the share of both spot transactions and outright forwards.

A currency swap is completed as a single transaction with a single counterparty. However, for the purpose of calculating profits and losses in accounting, a swap is reflected as two independent but interrelated transactions, each of which corresponds to a specific side (or leg) of the swap.

Please note that currency swaps are not the same as cross-currency or interest rate swaps. Currency interest rate swaps involve an exchange of principal amounts followed by an exchange of interest payments over the life of the swap.

In currency swaps, only the principal amounts are exchanged on the value dates without any interest payments. Interest rate swaps involve only one currency, while currency and cross-currency interest rate swaps always involve two.

The following three types of swaps are most widespread:

Spot forward. In this case, the first exchange (first leg) occurs on the spot date, that is, on the second business day after the transaction is concluded, and the reverse exchange (second leg) on the forward date (for example, 1 month after the first date).
Forward-forward (forward against forward). Here, the first exchange (first leg) occurs on the first forward date, and the reverse exchange (second leg) occurs on a later forward date. For example, a forward-forward swap may begin 3 months (first leg) after the spot date and end 6 months (second leg) after the spot date. This transaction is called a 3x6 forward-forward swap.
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 - 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 quotation is given in forward points, which in this case are called swap points.

Example. On July 10, Bank A enters into a three-month USD/DEM currency swap for $10 million. The amount of the base currency on both legs of the transaction 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 deposits money market. For currency swaps with fixed periods, the first value date is the spot date, and the second is one of the forward dates, which is calculated from the spot date and is called the “term from 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 whose validity period does not exceed one month. The most common short dates and their symbols 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, non-standard.

Example. Today is July 9th, therefore the spot date is July 11th. Let the second value date be September 25th. It falls between the second and third months, the value dates for which are September 11 and October 13.

The swap is traded on the over-the-counter market, so banks can quote for almost any non-standard day; the necessary calculations can be performed by the trading Money system 3000.

Quotes are determined based on linear interpolation. Thus, the price for a swap with a maturity of two and a half months can be calculated based on the prices for two- and three-month swaps.

Example. Let's consider the spot swap - September, IMM:

Value date - Spot date, as usual.
value date - Any date that coincides with the term of foreign exchange derivatives traded on the International Monetary Market (IMM) (a division of the Chicago Mercantile Exchange). These dates are the third Wednesday in March, June, September and December. To use IMM value dates, you need to know what dates the third Wednesday falls on in March, June, September and December.

Forward-forward dates

In the fixed-period examples discussed so far, the first value date of a currency swap is the spot date, but forward-forward contracts also exist. The diagram below shows the sequence of events for a 2x5 forward-forward swap with a spot date of July 3rd. Both forward dates are measured 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 being that in this case the first value date is also forward.

Source: "sergioforex.com"

Currency Swap

Currency swap - English. Currency Swap is a combination of two opposite currency exchange transactions for the same amount with different value dates.

Dates applicable to the swap:

the date of execution of a closer transaction is called the value date,
the date of execution of a reverse transaction that is more distant in terms of the term - the end date of the swap (English Maturity).

Types of swaps:

If the currency exchange transaction closest in date is the purchase of currency, and the more distant one is the sale of currency, such a swap is called “Buy and Sell Swap”.
If, first, a transaction is carried out to sell a currency, and the reverse transaction is the purchase of a currency, this swap will be called “sold/buy” (English: Sell and Buy Swap).

By number of counterparties:

As a rule, a currency swap is carried out with one counterparty, that is, both currency exchange transactions are carried out with the same bank. This is the so-called pure swap.
However, it is permissible 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 terms, currency swaps can be divided into three types:

standard swaps (from spot) - here the nearest value date is spot, the distant one is on forward terms;
short one-day swaps (before spot) - here both transaction dates included in the swap fall on dates from spot. For example, one transaction is in spot-tom format, and the second is on the second business day after the transaction is concluded (spot);
forward swaps (after spot) - they are characterized by combinations of two outright transactions, when a transaction closer in terms of maturity is concluded on forward terms (the value date is later than spot), and the opposite transaction is concluded on the terms of a later forward.

Currency swaps, despite the fact that in form they represent currency exchange transactions, in their content they relate to money market operations.

Currency swap example

Let's look at the example of a currency swap. The American company has a subsidiary in Germany. To implement the 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 bonds in the United States in the amount of $40.05 million 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 USA that needs a similar amount of investment. It can either issue bonds for €30 million at a fixed interest rate of 6%, or for $40.05 million at 8%+1% (risk premium) in the US.

In any case, both companies face significant currency risk, which will be subject to 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 purchase positions for both companies and reduces interest costs for both parties. This is due to the fact that each company takes out loans in national currency at a lower interest rate (without risk premium).

This gives each company a comparative advantage. The principal loan amount will be transferred through the bank:

US$40.05 million American company— a 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:

A subsidiary of an American company annually transfers 30 * 0.06 = 1.8 million euros 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 a loan in US dollars.

Thus, a currency swap fixes the rate three times:

Principal loan amounts are exchanged at the spot rate of EUR/USD 1.3350.
The exchange rate for annual interest payments (from year 1 to year 4) will be fixed at EUR/USD 1.7800 (USD 3.204 million/EUR 1.8 million).
The exchange rate upon repayment of the interest payment for the fifth year and return of the principal amount of the loan will be EUR/USD 1.3602:

When carrying out a currency swap transaction, the parties fixed the exchange rate, which made it possible 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 execution date of a closer transaction is called the value date, and the execution date of a more distant reverse transaction is called the swap maturity date. Swaps are usually concluded for a period of up to 1 year.

The first currency swap transaction (exchanging USD for CHF) was carried out in August 1981 between the American company IBM and International Bank reconstruction and development.

If the nearest conversion transaction is a purchase of a currency (usually a base one), and a more distant one is a sale of a currency, such a swap is called buy and sell swap (buy/sell, b + s).
If first a transaction is carried out to sell a currency, and the reverse transaction is a purchase of a currency, this swap will be called sold/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 carried out with the same bank.

However, it is permissible 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 250,000 Swiss francs (CHF) against the Japanese yen (JPY) with a spot value date and simultaneously sold that 250,000 CHF against JPY on a 3-month forward (outright trade) - this would be called a 3-month swap Swiss franc into Japanese yen (3 month CHF/JPY buy/sell swap).

According to terms, currency swaps can be classified into 3 types:

Standard swaps
Short overnight swaps
Forward swaps (after spot)

Standard swaps

If the bank carries out 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 swap or s/w swap. Since a standard swap transaction contains 2 transactions: the first - on spot, and the second - outright, which are concluded simultaneously with one counterparty bank, then in their rates they have a common spot rate.

One rate is used in the first conversion transaction with a spot value date, the second 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 a given period (hence their second name: 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 forward terms (at the swap expiration date); on the Offer side, the quoting bank sells the base currency on the swap expiration date.

Thus, on the bid side, the quoting bank carries out a currency swap of the sell and buy type (sell spot, buy forward). In this case, his counterparty performs a buy and sell swap.

On the offer side, the quoting bank conducts a buy and sell currency swap (buy spot, sell forward), and its counterparty conducts 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 expiration date.

Short overnight swaps

If the first transaction is carried out with a value date of tomorrow (tomorrow), and the reverse one is on spot, such a swap is called tom-next (tomorrow - next swap or t/n swap).

Short swaps are quoted similarly to standard swaps in the form of forward punts for the corresponding periods (overnight - o/n, volume-next - t/n).

In this case, the calculation of transaction rates is based on the rules for calculating the outright rate for the pre-spot value date:

If forward points are increasing 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).
If forward points are decreasing from left to right (the base currency is quoted at a discount), the exchange rate for the first transaction should be higher than for the second.

In this case, the current spot exchange rate can be used both for the value date (before spot) and for the swap expiration date (directly at spot).

The main thing is that the difference between the two rates is 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 closer in terms of maturity is concluded on forward terms (the value date is later than spot), and the opposite transaction is concluded on terms of a later forward.

Forecasting is the core of any trading system, in this regard, well-made Forex forecasts can make you extremely wealthy.

For example, a bank dealer entered into 2 transactions simultaneously: a 3-month forward outright transaction to sell 1 million USD against EUR and a 6-month forward outright transaction to purchase 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;
transaction type: swap;
amounts;
counterparty;
direction of transaction: 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 spot and the other outright, which are concluded simultaneously with one counterparty bank, then in their rates they have a common spot rate.

One spot rate is used in the first conversion transaction with a spot value date, the second is used to obtain the outright rate for the reverse conversion.

Therefore, 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 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 bilateral quote, for example:

Thus, the rule for choosing the side of a 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 end date of the swap.

In practice, many clients require currency swaps with intermediate maturities. Such deadlines are called non-standard.

Since the swap is traded on the over-the-counter market, banks can quote for almost any non-standard day; Automated systems help perform the necessary calculations.

Quotes are determined based on linear interpolation. Thus, the price of a swap for a period of two and a half months can be calculated based on the prices for two- and three-month swaps. In Russia, the most widespread and liquid market is the short-term swaps market. In essence, this operation is a hidden deposit.

When deciding which transaction is more profitable for the bank to complete - direct attraction of interbank loans, or a short-term swap - the dealer is guided by the following indicators.

Suppose the overnight ruble rate on the market is 10%, and the dollar overnight rate is 1.5%. The dealer requests quotes for swap rates (in practice, these are the current market rates for TOD and TOM transactions), which look like this:

A swap transaction (selling dollars for the purpose of buying rubles with the TOD value date followed by a reverse exchange with the TOM value date) will make sense if the rate is less than 10%, that is, the swap price will be cheaper than attracting ruble interbank loans on the money market.

(31.8760/31.8665 - 1) x 365 = 10.88%

It should be taken into account that when concluding a swap transaction, 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 more than opportunity cost, which also needs to be taken into account.

10,88%+ 1,5% = 12,38%

From the calculation, it turns out that concluding a swap transaction at these current market quotes is unprofitable for the bank compared to the alternative possibility of operations in the money market. However, if the calculation resulted in the price being less than 11.5%, the dealer would enter into a swap.

A similar algorithm is applicable to a situation where a dealer is trying to find an opportunity to attract dollars on more favorable terms with current rates monetary and foreign exchange markets.

As noted, currency swaps represent a single transaction with a single counterparty. Since the bank usually buys and sells the same amount of currency at set rates, there is no obvious foreign exchange risk.

Purposes of using currency swaps

Forward traders use swaps primarily for the following purposes:

speculation on interest rate differentials;
managing the flow of funds in the dealing room for the purpose of liquidity management;
servicing internal and external clients; conducting arbitrage operations to make a profit due to the difference in prices for two financial instruments.

While a spot market trader speculates on exchange rates, a forward trader speculates on interest rate differentials.

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 the EURO will increase. 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:

Raise a loan in EURO for 3 months and hold the position, monitoring the situation daily in the hope of a quick rise in rates and the possibility of providing a loan for more high percent.
Use a currency swap, that is, buy and sell EUROS (sell and buy US dollars) and hold the position, monitoring the situation daily.

A forward raider manages the flow of short-term funds to maintain liquidity.

For example, in areas that specialize in spot trading, money market trading and forward trading, this can be done using short-term swaps. A forward trader may be contacted by a dealer in a corporate client service department with a request to quote a swap for one of the clients.

Corporate client enters into a forward outright transaction to purchase US dollars for EUROS at a fixed rate with 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 EUROs in 3 months at the established rate.

If after 3 months the dollar rises, the bank will have to pay more to buy them. To cover this risk, the bank can take the following actions:

attract a loan in EURO for 3 months
buy US dollars for EUROs at the spot rate
place American 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.

Basically, if the bank wants to take risks and hopes for a favorable change exchange rate, he can hold this position until the value date and close it on spot. However, banks usually do not take such risks long terms and try to close positions.

To cover the forward, the outright bank conducts operations on the money market - borrows EUROS and provides a loan in US dollars. A cheaper option is to cover the outright forwards by executing the opposite outright transaction on the same value date.

However, there is a risk of changes in the exchange rate. The size of the forward points may not change (as it depends on the difference in interest rates), but the spot rate, which is part of the forward rate, may change.

Another way to hedge currency risk in this case is to simultaneously conclude an outright transaction by concluding an inverse transaction on the spot, that is, turning the outright into a swap. The bank, first of all, needs to cover spot risk. By selling a dollar forward to a client, he buys dollars on the spot market. The bank is now long the dollar position on the spot deal and short the three-month forward.

To close the time gap between the two cash flows, you can perform the following swap:

sell USD/buy EUR spot;
buy USD/sell EUR 3-month forward.

The first leg of the swap provides financing for the spot transaction, and the second leg is the forward outright. This example shows how a bank can manage a forward outright position using a currency swap. Swaps also allow you to benefit from interest rate differentials between two currencies. The swap rate is determined by the spot rates of the relevant currencies, interest rates and the duration of the swap.

Source: "market-pages.ru"

Forex Currency Swap

A currency swap is a combination of two opposite conversion transactions that account for the same volume of the base currency, but differ in value dates. Currency swap is also called overnight (transfer trading position every other night) or rollover.

If two conversion transactions with different value dates are carried out by different counterparties, such a swap is usually called structured. However, this type of operation is not typical when trading on the international Forex currency market.

Let's look at this situation as an example. Counterparty (bank or brokerage company) purchased 1 million dollars against the Japanese yen with a spot value date, and sold this million on a 2-month forward basis. Then this operation 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 they distinguish:

overnight or short-term 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. Standard transactions are characterized by the nearest value date – spot, and the distant one – forward. Spot is the second business day after the transaction is concluded.

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.

A currency swap, as mentioned above, is an exchange of cash flows in different currencies at 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 end date of the swap, the reverse operation is performed and final settlements for the swap are made depending on the party to the transaction and the fixed rates.

Regular currency swap (overnight) for currency pair Dollar/Ruble looks like this:

This is a real currency swap concluded on the MICEX on one of the trading days. Let's look at it in more detail:

The first part of the transaction (the first leg of the swap) is the purchase of 2 million dollars for rubles at the rate of 34.7116 with the settlement date being today.
The second part of the transaction (the second leg of the swap) is the sale of 2 million dollars 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 completing such an operation.

As a result of this transaction, we received 2 million dollars this day, and the next business day we have an obligation to return 2 million dollars and get back rubles. The difference in ruble equivalent is our income or loss from the swap.

Currency swaps are 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+rate of currency A * days until the end of the swap/days in the year)/(1+rate of currency B * days until the end of the swap/days in the year)-1)

For example, for a one-day Dollar/Ruble swap, the rate on dollars is 0.25% (Currency B), the rate on rubles is 8.50% (Currency A), time bases for dollars are 360, for rubles - 365, the current market rate is 34.7116, swap - Buy/Sell:

Swap rate = 34.7116 * ((1+0.085*1/365)/(1+0.0025*1/360)-1) = 0.0078

The direction of the transaction is important in a currency swap. I looked at a Buy/Sell type swap, where we receive a premium in swap points for buying dollars for rubles.

During the reverse operation Sell/Buy, 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.

Economic sense A currency swap is as follows: if we have one currency and a shortage of a second currency, we can enter into a swap for a certain period of time and make up for this deficiency. In this case, we will either receive or pay a premium due to the difference in interest rates between currencies.

Currency swap is used by banks and financial institutions just to finance its obligations in one currency (for example, dollars) at the expense of other currencies (for example, Rubles or Euros), that is, to manage liquidity.

It can be concluded both on a stock 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 foreign exchange 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, with an increase in demand for any currency, the profitability of this instrument may increase, exceeding the average profitability of money market instruments, or decrease and have a lower profitability.

From the point of view of a private investor, a currency swap can be used as a tool for transferring positions into foreign currencies, and also as a carry-trade tool, which I will talk about in my next blog posts about finance and financial markets.