In the forex market, often a “two-legged” currency transaction is used to “swap” or shift the value date of a Forex position to some other date. Such a practice is called forex swap in the currency market.
In a forex swap transaction, the first leg requires that a certain amount of a particular currency is bought or sold against another particular currency. This type of transaction is usually carried out at an agreed upon rate and the date of performing the transaction is called the near date. This is because it’s the first date with respect to the current date.
In the second leg, another value date is chosen for selling or buying the same amount of currency but at a different agreed upon rate. This date of transaction is often known as the far date.
This forex swap deal can result in almost null net exposure with respect to the prevailing spot rate. This is because while the first leg opens up the spot market risk, the second leg closes it down instantly.
Calculation of Forex Swap Points
For a particular value date, the forex swap points can be calculated mathematically. For this calculation, knowing the overall cost involved in lending one currency and borrowing another one, during the period between the spot date and the value date, will be important. This is also called the “cost of carry”. By adding and subtracting this to or from the spot rate, this will be converted into currency pips.
The “cost of carry” or the forex swap points can be computed starting from the number of days from the spot till the forward date, and adding the prevailing interbank deposit rates for the currencies transacted to the forward value date.
For the trader who sells the currency at the higher interest rate currency forward, the forex swap points are generally called to be positive. On the other hand, for the trader who purchases the higher interest rate currency forward, the “cost of carry” will be negative.
Uses of Forex Swaps
A forex swap is often used when a trader wants to shift an existing open forex position to delay the delivery of the contract. It can be also used to bring the delivery date nearer. At the same time, a business may use a forex swap for the purpose of hedging when they perceive that a forward contract is going to delay for an extended period of time.