Forex swap how it works

A forex swap is the process of buying and selling of equal amount of currency for another concurrently with two separate value dates which may use forex inferential. It is a two phase currency transaction which is used to push the value date of an exchange to a later date.  The purchase and sales of these currencies are done together i.e. the deal is agreed upon on the value date which is often referred to as near date and is finalized on a later date commonly known as the forward date.

HOW FOREX SWAP WORKS

Forex swap still follows the same method of buying and selling or selling and buying currencies based on prediction of a profit being made but on a different or an indirect pattern. For a forex swap to take place, there must be two parties involved the party giving and the one receiving. The two parties are mediated by a broker if they are not really familiar with the type of contract but if otherwise the presence of a broker may be removed.  A contract is signed which is the most integral part of a forex swap transaction which should contain the amount to be exchanged, the near dates and forward dates, the parties involved and any other detail that might be needed. After this the deal is carried out. To explain further let's look at an example. A Nigerian company needing money to transact business in the United States, goes to a company in the United States which may or may not transact in Nigeria to collect the dollar equivalent of the Naira amount he needs to carry out business at the present forex rate and promises to return the collected money at another date in its Naira equivalent which will totally depend on the exchange rate of the period without knowing whether the money will appreciate or depreciate.  Now the most important thing to note in this example and in forex swap is not the money given but the value of the money given on return whether it appreciates or depreciates within the specified period of time agreed upon. Profits can only be made by the United States Company when the exchange rate is higher in their favor upon the arrival of the forward date stipulated.

Forex swap is not only done by companies, individuals take part in swaps too.  It has no minimum amount for trade activities, only what the two parties agree upon.  It can take from three days to twelve months to complete depending on the agreement made but never in a day.

RISKS INVOLVED IN FOREX SWAP

There are certain risks involved in foreign exchange swap since no forex trade is risk proof. There is the case of a party defaulting in its obligations leading to the other party having to sign a new contract thereby increasing its exposure to the present market rate imbalance.

Another is the uncertainty of the exchange rate which will put either party at risk of making profits or losses in the business transacted.

In conclusion forex swap holds in one hand the power to make profit and on the another hand the risk of losing money just like every other forex deal, therefore the onus lies on the parties involved to take the necessary steps to grasp the profit making side rather than the loss.  The keyword is to trade wisely.

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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