FX Swaps and Currency Swaps

Two different products share the word "swap" in currency markets. An FX swap combines a spot exchange of currencies with a forward exchange in the opposite direction, usually over days to months. It is the most traded instrument in the entire foreign exchange market, used for short term funding and hedging. A cross currency swap (often called a currency swap) is a longer term contract in which two parties exchange principal and periodic interest payments in two currencies, often over several years. Both are central to how global banks and companies fund themselves.

FX swaps#

An FX swap has two legs:

1. Near leg: exchange currencies today (or on the spot date) at the spot rate.
2. Far leg: reverse the exchange on a future date at the forward rate.

The difference between the two rates, the forward points, reflects the interest rate difference between the currencies. See FX Forwards and Forward Points.

According to the BIS 2022 survey, FX swaps made up about half of global FX turnover, around $3.8 trillion a day. They are used to:

• Fund in a foreign currency without currency risk.
• Roll forward hedges and positions. Retail rollover uses short tom next swaps. See Rollover and Swap in Forex.
• Manage liquidity across currencies.

Cross currency swaps#

A cross currency swap typically involves:

1. Initial exchange of principal at the spot rate.
2. Periodic interest payments in each currency, fixed or floating, for the life of the swap.
3. Final re exchange of principal at the original rate.

Pricing and the basis#

In theory, the interest rates exchanged should make the swap fair under covered interest parity. In practice, there is a spread added to one leg, the cross currency basis, reflecting supply and demand for funding in each currency. Since the 2008 crisis, this basis has often been negative for many currencies against the dollar, meaning borrowers pay extra to obtain dollars through swaps. See Cross-Currency Basis.

Central bank swap lines#

Central banks use currency swaps with each other. During the 2008 crisis and in March 2020, the Federal Reserve provided dollars to other central banks, such as the ECB, Bank of Japan and Bank of England, through swap lines, easing global dollar funding stress. See The Federal Reserve and the FOMC.

FX swap vs cross currency swap#

Risks#

• Counterparty risk: large principal exchanges create big exposures. See Market, Credit and Counterparty Risk.
• Rollover risk: short term FX swap funding may become expensive or unavailable in a crisis.
• Basis risk: changes in the cross currency basis affect valuations.

Frequently asked questions#

What is an FX swap?#

A combination of a spot currency exchange and a forward exchange in the opposite direction, used for short term funding and hedging.

What is a cross currency swap?#

A longer term contract in which two parties exchange principal and interest payments in two different currencies.

Why are FX swaps the most traded FX instrument?#

Because banks, funds and companies use them every day to fund in foreign currencies, roll hedges and manage liquidity.

Next, learn how currency options work in FX Options.