Foreign Exchange (Backward Valuation & FX Swap/Money Market Hedge)

How are TOD (today) and TOM (tomorrow) Determined

  • Determine whether they are a premium or discount
  • If it is at a discount, cross add to the prevailing spot rate
  • If it is at a premium, cross subtract to the prevailing spot rate

Foreign Exchange Swap (FX Swap)

  • Is a pair of currecncy transactions, one purchase, one sale, for two different value dates, one of which is spot and a reverse exchange on the forward date at two foreidn exchange rates agreed on the transaction date
  • Most widely traded instruments
  • Actually ‘indirect’ money market deals executed through the foreign exchange market
  • Through executing a FX swap, one is actually lending one currency and at the same time borrowing another currency via two separate foreign exchange transactions
  • Three common types of FX swaps:

Spot against forward

  • First exchange takes place in the spot date (2 business days)
  • Reverse exchange takes place on the future date

Forward against forward

  • The first exchange takes place on a forward date and is reversed on a later forward date

Short dates

  • Swap which run less than a month

Basic Features of a Swap

  • The amount of the deal currency is the same, with the other non-deal currency amount varying according to the spot and forward rates
  • The difference between 2 agreed FX rates  are the swap points (a reflection of the interest differential between two currencies for the particular swap period)
  • The swap can be on premium, discount or par value

Uses of Foreign Exchange Swap

  1. Swapping of surplus currencies
  2. Creation of deposits borrowings in another currency
  3. An alternative to illiquid money markets
  4. Speculation
  5. Roll-over of Spot FX position
  6. Cash management

Advantages of Foreign Exchange Swap (FX Swap)

  • Reduction of credit risks
  • Minimal impact in the bank’s balance sheet
  • Possible tax advantage
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