Foreign Exchange Swaps

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A foreign exchange swap is the simultaneous purchase and sale of one currency against another for two different value dates. One of the value dates is usually the spot date and the other is a date in the future. In a typical swap transaction, one currency amount is held constant for both dates of the transaction. Most foreign exchange swaps have a maturity of less than one year.

A forward/forward is a swap where both the near date and the end date are forward dates.

In fact, a swap may be most easily understood as simply the combination of a spot and a forward, or the combination of two forwards. It can be the combination of a purchase with a simultaneous forward sale or a sale with a simultaneous forward purchase. Like forward contracts, swaps are regularly for periods of one, two, three, six and 12 months from the spot value date. Frequently, however, the date is customized to meet a client's needs.

Forward contract prices are determined, as before, by the current spot price between the two currencies and the interest rates prevailing in each of the two countries. For example, a company could sell dollars and buy Swiss francs spot, and buy dollars and sell Swiss francs three months forward. The cash flows in such an exercise is similar to borrowing one currency (Swiss francs) and investing in another (dollars). The exposure to the company is one of interest rate risk rather than currency risk. Consequently, a bank will only charge, or pay, the interest differential.

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