FX Swap - SGEB

1 FX Swap1--nnnDefinitionPurposeExampleAn fx swap agreement is a contract, in which one party simultaneously borrows one currency and lends another currency to a second party. The repayment obligation is used as collateral and the amount of repayment is fixed at the FX forward rate. FX swaps can be considered riskless collateralized borrowing/lending. The contract virtually allows you to utilize the funds you have in one currency to fundobligations denominated in a different currency, without incurring foreign exchange the fx swap is two exchange contracts packed in one: a spot foreign exchange transaction, anda forward foreign exchange transaction The most common use of FX swaps is for institutions to fund their foreign exchange swaps are also used by importers and exporters, as well as institutional investors who wish to hedge their positions.

2 They are also used for speculative diagram below illustrates graphically the flow of funds in a typical EUR/USD the start of the contract company A gives company B EUR in the amount of X, which later receives in the same amount at maturity. Company B gives USD in the amount of X times S, the spot exchange rate to company A at the start. At maturity company A pays back company B USD in the amount of X times F, the forward rate. FX Swap2nnCalculationRiskSince the swap contract is virtually the difference between a forward and a spot contract, it is expressed as F S (where F = forward, and S = spot)F S =S * [((1 + r1)/(1 + r2))T 1]where,r1 = simple interest rate in the term currencyr2 = simple interest rate in the base currencyT = tenor (periods of interest accrual)

3 The risks involved in FX swaps are similar to those characteristic of the forward risk If one of the counterparties defaults on its obligations, the other party has to sign a new contract, thereby increasing its exposure to market interest rate fluctuationsExchange rate risk- By fixing the exchange rates, at which the currency will be bought, the party forgoes the opportunity of profiting from a favorable exchange rate movement. Additionally, unfavorable exchange rate movements may take away further profit opportunity for the party (in the face of opportunity cost).Interest rate risk Since the price of the forward contract is dependent on the differential between the interest rates that can be earned with eh two different currencies, variations in those interest rates can change the price of a forward contract, and thus also change the terms of a swap.

4 The change can be favorable, as well as unfavorable to each party.