FX Swap

Exchange currencies now and reverse it later

Two exchanges bundled into a single trade: currencies swap one way today and back the other way on an agreed future date, both rates fixed at inception. Because the second leg undoes the first, the trade takes almost no view on where the exchange rate goes — what it does is move cash from one currency to another for a defined period, which makes it a funding and liquidity tool rather than a directional one. It is the busiest instrument in the FX market.

Open in the app · FX · intermediate

The lesson

1. What it is

An FX swap packages two exchanges into one contract: currencies are swapped at today’s rate (the near leg) and swapped back at an agreed forward rate on a future date (the far leg). Both rates are agreed at the outset, and both legs are with the same counterparty under one confirmation.

2. How it works

The near and far rates differ only by the forward points. A firm holding dollars that needs euros for three months sells dollars for euros today and contracts to reverse the trade in three months — the economic effect is borrowing one currency while lending the other, and the points are the interest differential between them.

Because both legs move together, the swap is priced as a single number — the points. The absolute spot level used is largely a matter of convention, provided both legs are struck off the same base.

3. Why it’s used

FX swaps manage short-term liquidity across currencies, roll a maturing forward hedge out to a later date, and move cash where it is needed without taking an outright currency position. By turnover they are the largest single instrument in the FX market.

In the BIS triennial survey FX swaps account for roughly half of all FX turnover — more than spot and outright forwards put together.

4. Key terms

Near leg, far leg, forward points (which are the swap’s price), and the two value dates. Very short tenors are common, including overnight and “tom-next” trades that shift settlement by a single day.

With spot settling two business days out, a tom-next swap moves a position from tomorrow’s date to the spot date — the standard way to keep rolling a position that would otherwise have to be delivered.

5. Risks to watch

Because both legs are fixed at inception, outright FX risk largely cancels out — but the position is still exposed to moves in interest rate differentials, and the far leg carries counterparty and settlement risk until it completes.

Settlement risk is real when principal moves in two currencies in different time zones. CLS settles a large share of FX turnover on a payment-versus-payment basis so that neither leg pays unless both do.

Funding a euro bond purchase for three months

A US asset manager buys €50,000,000 of German government bonds but holds only dollars. In EUR/USD the euro is the base currency, so the rate is dollars per euro.
On the near leg it buys €50,000,000 at spot 1.0800, paying $54,000,000.
Three-month dollar rates are 4% and euro rates 2%, so the three-month forward is 1.0800 × 1.0100 ÷ 1.0050 = 1.0854 — 54 points above spot.
On the far leg it sells the same €50,000,000 back at 1.0854, receiving $54,270,000.
It ends with $270,000 more dollars than it started with, having held euros throughout and taken no view on EUR/USD.

The 54 points are the interest gap, not a forecast. The manager lent dollars at the higher rate and borrowed euros at the lower one, and $270,000 on $54,000,000 is 0.5% over three months — the 2% annual differential.

Key terms

Near leg — The first exchange, usually at or close to the spot rate and the spot date.
Far leg — The reversing exchange on the later value date, struck at the forward rate agreed at inception.
Swap points — The difference between the far and near rates, which is the price of the swap and reflects the interest differential.
Tom-next — A one-day swap rolling a position from tomorrow’s value date to the next business day.
Value date — A date on which one of the two legs delivers; every FX swap has two of them.
Cross-currency swap — A longer-dated relative that also exchanges interest payments over its life, which an FX swap does not.

Every key term, A to Z

In practice

Banks use FX swaps continuously to fund balance sheets that borrow in one currency and lend in another, and corporate treasuries and money-market funds use them to push cash to whichever currency needs it that week. Fund managers use them to roll currency hedges: when a forward hedging an overseas portfolio matures, a single FX swap closes the old leg and opens the next one.