Foreign Exchange Swap
In 1981, the US-based company IBM and the world bank Initially enter the Foreign Exchange swap agreement with different currencies. Now the Fx Swaps are the highest trading in the forex market and continue their profits in the market share. Speculators are also used the Fx Swaps.
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What is a Foreign Exchange Swap?
Foreign Exchange Swap is different from Interest Rate Swap (IRS) or Cross-currency IRS and also be known as FX Swap or Forex Swap or Currency swap. Fx swaps must be involved in the agreement of the two different companies or Institutions with two different exchanges, one borrows one currency and the other can lend at the initial(spot) date and it can be reversed the exchanging currency amount at the time of maturity date.
How does it work?
The FX Swaps has two different parties that party A has borrows X currency from Party B receives at the sport rate and Party B borrows y currency party A receives at the maturity. The set of the agreement for the foreign Exchange swaps has two legs.
An initial exchange that can be doing the transactions between the two currencies at the spot rate also be called as first leg and the near leg.
A maturity date a reverse direction exchange transaction will be done between the two currencies and also be called as second leg and far leg date.
RIL Ltd, an Indian company having a subsidiary in the U.S is to raise a fund for its subsidiary company of $100000 so it can be borrow of rates 8% and 12%. Google, a U.S company having a subsidiary company in India is to raise a fund for its subsidiary company of Rs. 70Lacs so it can be borrow of rates 5% and 15%.here $1=rs70.Reliance is paying Rs.70L to Google $1L and Google $1L to Reliance and receive Rs. 70Lacs.
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Benefits and Risk associated:
- It can be exchanged one currency into another currency at an agreed exchange rate.
- Sometimes Exchange rates are volatile so the FX Swap benefited from the unfavorable events.
Disadvantages of FX Swaps:
- Further, the FX Swap is not allowed to be extended.
- Once we can enter the FX Swap it must be settled and cannot cancel the transaction.
Risk Associated with FX Swap:
- The main risk associated with the FX Swap due to volatility in the unfavorable events in the exchange trade is “Currency Risk”.
- Transaction risk and credit risk when the counterparty defaults.
- The risk between the two currency transactions in the form of swap transactions will not be entirely offset due to the difference in the Fx swap and underlying exposure is called Basis risk.
When the fluctuations are happening in the foreign exchange rates due to appreciation and depreciation of the currency, one can enter into the FX Swap transaction so that they can avoid future loss in the exchange rates.
Author: John Earla
About Author: Currently pursuing Financial Risk Management from GARP(US) and completed Graduation in Bcom computers. John is interested in finance and also Risk Analysis.