Swaps form a critical part of forex trading. It provides investors with a myriad of trading utilities and functions. In plain English, swaps are agreements between parties to exchange cash flow sequences; within a given period. Now there are various types of swaps operating in forex; each having their own set of functions. Like forex forward swaps involve trades of forwards contracts.
Now a forward swap is a different entity altogether. This type of swap is an agreement resulting from mixing two different swaps; each with different time-spans. These kinds of swaps fulfill specific time-span wants of traders.
To get a better understanding; consider this typical forward forex swap example;
Nancy is an investor. She wants to opt for a three-year time span forward contract; which begins one year from today. So, she can either go for one year swap or four-year swap; she is free to choose anyone. This flexibility helps in meeting Nancy’s portfolio demands.
The above example shows how useful these swaps can be. But there are other benefits of forward swaps as well. You can consider the following to be the other major advantages of forex forward swaps;
- Risk hedging
A primary attribute of opting for these swaps is that it helps mitigate risks. Companies that think interest rates will change in future; use swaps to change fixed rates with floating rates options.
So if you are an investor, swaps and forward swaps can help you avoid drastic fluctuations and their side effects.
- Income increment
Forex forward swaps or any swaps for that matter; help in increasing income. So, if you opt for swaps; financial intermediaries will get additional incomes in the form of brokerage, etc.
Thus, it helps multiple levels of market operators to benefit from trading in this form.
- Reduced borrowing expenses
One of the major benefits of these swaps is they help traders borrow at lower costs. In other words, theory of comparative costs helps in mitigating these expenses.
When both borrowers trade with comparative advantage; all parties concerned obtain funds at lower expenses.
- Useful rectification tool
Forward forex swap and other similar swaps are excellent financial balancing tools. If you are a trader, then you can use this tool to monitor major asset-liability differences.
Let’s say; a financial institution acquires some fixed rate bearing assets. It also acquired some floating rate liabilities. Now if market pivots change interest rates in either direction; then the institution will become financially imbalanced. So, to balance out this contingency, they can opt to swap fixed rates for floating rates; which will reduce the asset-liability imbalance.
Thus, one can say that forward forex swap are very effective financial balancing catalysts.
- Greater market access
Often traders use these swap types to enter new markets. They venture out into unknown markets; which help in gauging other parties’ comparative advantages.
So, traders get a wider field of view and get to choose the best fund sources at respectable rates.
Summarising, you can suggest that forex forward swaps help investors in undertaking more flexible trade options. It provides a much-needed buffer against detrimental market pivots.
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.