The Reserve Bank of India (RBI) had announced to conduct a forex swap (also referred to as dollar-rupee swap) of $5 bn. This tool is being used for the first time by RBI, wherein the dollars with banks will be swapped with rupee by RBI.
This article will tell all you need to know about the topic ‘Forex Swap’. Economics is an important segment of theIASexam and is also extensively linked to current affairs.
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What is a Forex Swap?
In finance, a foreign exchange swap (forex swap, or FX swap in short) is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates and may use foreign exchange derivatives. A forex swap allows sums of a certain currency to be used to fund charges designated in another currency without acquiring foreign exchange risk. It permits companies that have funds in different currencies to manage them efficiently.
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Structure of a Forex Swap
A foreign exchange swap has two types of transactions – a spot transaction and a forward transaction – that are executed simultaneously for the same quantity, and therefore offset each other. Forward foreign exchange transactions occur if both companies have a currency the other needs. It prevents negative foreign exchange risk for either party. Foreign exchange spot transactions are similar to forward foreign exchange transactions in terms of how they are agreed upon; however, they are planned for a specific date in the very near future, usually within the same week.
To know more about the Foreign Exchange Management Act, visit the linked article.
Why did RBI conduct a Forex Swap?
The market is always facing tighter liquidity as businesses rush to pay tax in advance as the end of the financial year draws near.
Also, the demand for rupees is always expected to spike in the closing weeks of the financial year as a result of huge spending towards the general elections that were to start soon after March. So, the timing of the RBI’s auction, at the end of the financial year seems to have taken into account these factors.
For the RBI, this helped to boost its forex reserves by another $5 billion.
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FAQs
A forex swap allows sums of a certain currency to be used to fund charges designated in another currency without acquiring foreign exchange risk. It permits companies that have funds in different currencies to manage them efficiently.
What is the structure of a currency swap? ›
A currency swap is an agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency. At the inception of the swap, the equivalent principal amounts are exchanged at the spot rate.
What is the meaning of forex swap? ›
In finance, a foreign exchange swap, forex swap, or FX swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward) and may use foreign exchange derivatives.
What is the formula for the FX swap? ›
Swap Points in FX Swaps are the interest rate differential between two currencies. They are calculated by 'Swap Points = Spot Rate - Forward Rate'. C. Swap Points are the fees charged by the intermediaries in an FX Swap and can be calculated as 'Swap Points = Spot Rate x Forward Rate'.
Why do banks use FX swaps? ›
Key takeaways
US banks use FX swaps to borrow dollars short-term from other banks and lend them longer-term to non-banks. This means that US banks are net interbank dollar borrowers in FX swaps.
Are currency swaps legal? ›
In finance, a currency swap, also known as cross-currency swap, is a legal contract between two parties to exchange two currencies at a later date, but at a predetermined exchange rate.
How are swaps structured? ›
The swap is structured to match the maturity and cash flow of the fixed-rate bond, and the two fixed-rate payment streams are netted. TSI and the bank choose the preferred floating-rate index, which is usually the London Interbank Offered Rate (LIBOR) for a one-, three-, or six-month maturity.
What is structure in forex trading? ›
The structure of the foreign exchange market, commonly known as the forex market, is uniquely decentralised and operates over-the-counter (OTC). Unlike traditional markets with a central exchange, forex is a vast network of dealers, brokers, and financial institutions globally.
What is swap term structure? ›
The swap curve is the term structure of interest rates derived from a periodic exchange of payments based on fixed rates versus short-term market reference rates rather than default-risk-free government bonds.
What is an FX swap for dummies? ›
A FX Swap is a combination of a spot and a forward transaction. In a FX Swap an amount of one currency is purchased (or sold) in a spot transaction and subsequently sold (or purchased) in the forward.
An FX swap is suitable for a party requiring the base currency at a future date. An FX forward is ideal for a party seeking to hedge its currency exposure. It can last several years, depending on the agreement between both parties.
Why is my swap so high in Forex? ›
A Forex swap rate depends largely on the underlying interest rates for the currencies in the pair you are trading. There is also a custody fee incorporated into swap rates. If the costs of holding an asset are high (such as with commodities) negative swaps will usually be observed for both long and short positions.
How to calculate swap in forex? ›
For forex, here's the formula to calculate swap:
- Swap = (Pip Value * Swap Rate * Number of Nights) / 10.
- Pip value: $1.
- Swap (long) rate: -3.3154.
- Swap fee: (1* -3.3154 * 1) / 10 = -$0.33.
(1) An initial exchange of two currencies on a near leg date, commonly spot. (2) A later reverse-direction exchange of the same two currencies, on a far leg date. For example, euro might be paid and dollars received in the near leg, with euro received and dollars paid in the far leg.
What is an example of a swap? ›
For example, a company paying a variable rate of interest may swap its interest payments with another company that will then pay the first company a fixed rate. Swaps can also be used to exchange other kinds of value or risk like the potential for a credit default in a bond.
Is RBI forex trading legal in India? ›
Who are authorized by the Reserve Bank to sell foreign exchange for travel purposes? Ans. Foreign exchange can be purchased from any authorised person, such as an AD Category-I bank and AD Category II. Full-Fledged Money Changers (FFMCs) are also permitted to release exchange for business and private visits.
What is the difference between interest rate swap and currency swap? ›
An interest rate swap involves the exchange of cash flows between two parties based on interest payments for a particular principal amount. A currency swap involves the exchange of both the principal and the interest rate in one currency for the same in another currency.
What is the difference between FX forward and FX swap? ›
An FX swap grants companies access to cheaper interest rates, while an FX forward allows a company to hedge against currency fluctuations.
What is the function of a currency swap? ›
Currency swaps are over-the-counter derivatives that serve two main purposes. First, they can be used to minimize foreign borrowing costs. Second, they could be used as tools to hedge exposure to exchange rate risk.
