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The forex swap implies an exchange between two identical amounts of currencies, consisting in two simultaneous actions: a purchase and a sale. One transaction has usually the same date as the swap so is a foreign exchange spot trade and the other has a future date so is a foreign exchange forward transaction. The forex swap is a derivative financial instrument that can be used for hedging or currency speculation. Large financial institutions use the forex swap each day in order to fund their foreign exchange balances, this being the most common use of the forex swap. Other financial institutions or investors can use forex swap as a speculative instrument with the purpose of obtaining profits.
The two parts of the forex swap, the spot forex transaction and the forward forex transaction, implying the same amount of currency and being executed in the same time, are counterbalancing each other. On the financial market there can also be forex swaps based on two forward transactions. The basic principle is the same, but the spot transaction is replaced with another forex forward transaction. In this case both simultaneous transactions have different future dates. As stated before, the forex swap is mostly used by financial institutions when closing their foreign exchange balances. At the end of each day, these institutions close their foreign exchange balance and reopen them the next day. To do that they usually buy or sell a currency amount settling tomorrow and will sell or buy the exact amount back settling the day after. Speculators do the same transaction if they predict a price change in the future, so the difference between de sell and buy price would be their profit. |
