If you know that either you or your business has an fx requirement that involves the short term need for one currency and then trading this back to your base currency then an FX swap could be the right hedging tool for you. Here we explain FX swaps in detail, provide working examples and compare an FX swap vs FX forward.
Our Top Recommended Providers to Buy Foreign Exchange Swaps
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Our top providers for FX swaps have all been in existence for 15+ years providing clients guidance on what FX swaps are and when it might be the most appropriate solution for them to buy FX swaps.
What is an FX swap?
A foregin exchange swap involves two transactions – a purchase and sale of identical amounts of one currency for another – entered into at the same time.
FX swaps are one of the fastest growing FX instruments in use today, accounting for 49% of daily FX volumes. This could perhaps be a reflection of the current risk appetite in the market – buyers wanting to completely remove exchange rate risk if they know they will require their base currency again in the future.
Let’s take the following example for a closer look at an FX swap…
A business headquartered in America also sells its services in the EU and is looking to trade EUR to USD to finance its core American business. But in two weeks time the firm knows it will require EUR again to pay European suppliers. The company could make a trade on the spot to buy USD now, and then change USD back to EUR on the spot in two weeks time (option 2 in our diagram below). However, in these two weeks the euro could appreciate against the dollar and the business will have to pay more USD to secure the same amount of EUR it traded originally.
Instead the company could agree to enter into an FX swap contract (option 1 in our diagram below). The EUR USD swap still allows the company to fund itself in USD for the short term and then receive funds back to EUR in two weeks time without any exchange rate fluctuations.
In this example had the company traded €100,00 EUR @ spot on Day 0 they would have received $110,000 in both scenarios. However, on day 14, the company would have only received the same amount of €100,00 EUR in return had they agreed to enter into a swap. Had they waited two weeks to convert USD to EUR at spot, then in the example above, $110,000 would have achieved $95,700 EUR. (Note for simplicity this example does not take into account the spread your provider would charge or a slight difference in the forward rate due to interest rate differentials).
FX Swap vs FX Forward
In virtually all cases an FX swap involves a foreign exchange spot transaction, often referred to as the near leg, and a forward contract going in the opposite direction, often referred to as the far leg. Both trades are executed simultaneously and for identical values. So it’s not so much an FX swap vs FX forward question as a swap will encompass a forward contract.
Just a quick note on FX swap rates – the only difference in an FX swap will be in the rate for the forward contract as forward rates will differ slightly to spot rates in order to account for the interest rate differential between the two currencies. This is explained in our full guide to forward pricing here.
FX swaps can occasionally involve two forward contracts, and in this instance are referred to as a forward swap. Sometimes they can also be known as a forward – forward swap. In this case the forward which is set to mature earliest in the forward swap would be regarded as the near leg of the swap, and the forward which is due to mature latest in the forward swap would be regarded as the far leg of the swap.
If you are wondering about the difference between an FX forward vs FX swap then it’s simply a case that the FX swap involves making two simultaneous agreements at the same time. If, for example, a company made a spot transaction to purchase AUD with GBP and then booked a separate forward contract after that trade was made to buy GBP again with AUD, they would still be opening themselves to exchange rate risk during the time it takes them to book two separate trades.
Deposit on FX swaps
As FX swaps typically involve a forward contract on the far leg of the swap it’s likely a deposit will be required for this leg of the trade. Just like when a client enters into a forward contract on its own the deposit should be around 10% of the value of the swap.
Different Types of Currency Swap
Confusingly, although the name might suggest it, a currency swap is not technically an FX swap. Actually, a currency swap is an abbreviated name for a cross currency interest rate swap. A derivative product that is used when there is an exchange of currencies between two parties. The most common purpose of a currency swap transaction is for companies to achieve cheaper funding in alternative countries. I.e. a US based firm is likely to achieve a lower interest rate loan in the US than a UK firm. And vice versa, the UK firm is likely to achieve a lower interest rate loan than the US firm. So let’s say both the UK firm was seeking a loan in the US and the US firm was seeking a loan in the UK, then instead of attaining these loans individually they could agree to a currency swap between each other. Agreeing both the principal amount that should be exchanged and the interest rate repayments.
In an FX swap contract there is no exchange of interest. It’s simply just one party using an FX swap hedging itself from exchange rate risk. A currency swap aids two firms in removing exchange rate and interest rate risk.
In summary, we hope to have cleared up the relationship between an FX swap vs FX Forward and highlighted when an FX swap would be a useful tool. As with all FX products there is a time and place where FX swaps will be the most relevant solution and are best suited as part of a wider hedging strategy. But just like with an FX forward contract, you can completely hedge your position in the market with an FX swap too. Readers interested in a greater variety of hedging tools should also refer to our guide on FX options.
Thinking of using other transaction types? View our hedging guide: