What is Forex Swap
A forex swap transaction occurs in two legs for shifting the value date of a forex position to some other date in the future. It can also refer to the quantity of pips i.e. swap points that are added or subtracted by the foreign exchange trader from the commencing trade date’s exchange rate known as spot rate for obtaining the forward forex rate in the process of pricing a swap.
The first tier of forex swap transaction essentially involves buying or selling a defined quantity of currency against another at a rate mutually arrived at through consensus on an initial date. The initial date is termed as near date as it is going to be the first date to feature in the context of current date.
The second tier of forex swap sees the same volume of currency being concurrently bought or sold against another currency at a second stipulated rate on a far date i.e. other value date. Such a deal efficaciously and dramatically shield the prevailing spot rate from any risk exposure as spot market risk that is initiated through the first tier of swapping is effectively closed down without delay in the second tier.
Forex swap rates are mathematically derived for a given value date by factoring in the cumulative cost involved when one currency is lent and other is borrowed in the time period that stretches from the spot date to the value date. This is termed as cost of carry which sees conversion into currency pips for addition or subtraction from the spot rate.
The computation of carry takes place by considering the day’s gap between spot to forward date along with the existing interbank deposit rates for the currency pair to the forward value date. In forex swap, the party selling the higher interest rate currency forward will experience a positive carry whereas the one buying it will see negative carry.
Forex swap is employed by trader for rolling a prevailing open forex position forward to a later date for avoiding or delaying the delivery requirement of contract. It can also be utilized for bringing the delivery date closer. Corporations resort to forex swap in the event of an awaited currency cash flow shielded by a forward outright contract gets delayed by one more month.
Forex swap can prove to be of immense help to retailers and corporations alike in engaging in profitable foreign exchange trading.
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