In fx, what is a swap and what impact does it have on the market? Fx trading entails trading with two pairs. In other words, you have to sell one currency in order to purchase another one. In that case, you have to pay interest on the borrowed and earn interest on the currency you have. The difference between the interest you pay and the interest you get is referred to as swap in fx. If such a difference is positive, then you are suitable for a net swap credit. However, if the difference is negative, your account will be debited the right swap amount. The negative difference arises when you get less interest than the interest you pay.
Swap allows the position of a currency to stay open within a period of 24 hours without necessarily exchanging the currencies. Swap simply takes interest rate differences into consideration. For instance, one is likely to benefit from the swap if they are long with the base currency having more interest rate in comparison to the quote currency. However, if one is long with a lower interest on the base currency than the quote currency then swap works against them. Swap can also work against you in cases where you are short with a higher interest rate on the base currency in comparison with the quote currency. However, when one is short and has a lower interest rate in the base currency in relation to the quote currency, then they will gain from the swap.
FOREX SWAP CAN BE USED ON BEHALF OF A FOREIGN CURRENCY LOAN
If one party needs 300,000 Australian dollars for 100 days, instead of borrowing 300,000 Australian dollars, the party can borrow the equivalent amount in US dollar and engage in a foreign exchange swap. First, the parties will have to convert the US dollar funds to Australian dollar at a commonly decided exchange rate. After which they will later re-exchange the Australian dollar back to US dollar after the one hundred days at a settled swap rate.
FOREX SWAP IS ALSO USED TO EXTEND FORWARD EXCHANGE CONTRACTS
For instance, if an importer has a US dollar forward Exchange Contract expected to mature in one or two days time. As a result of shipment delay, in cases where the importer does not require paying currency for another month, then there are two alternatives. The first alternative entails settling the current Forward Exchange Contracts within 2 days and investing US dollar for a month. The importer would have the urge to borrow Australian dollar in order to pay for the US dollar. The second alternative would be settling the Forward Exchange Contract within two days, after which they can rely on a foreign exchange swap to distract the cash flow for at least one month.