Forex Investment and Currency Trading

• Agreement between two parties to exchange a given amount of one currency for another and after a specified period of time, to return the original amounts swapped
• Consists of two legs; a spot transaction and a forward transaction or two forward transactions with different forward dates
• The two legs are executed simultaneously for the same or different quantities

Example

• A company that exports goods expects an incoming EUR receipt that week. The company previously sold the EUR as a hedge. The counterpart has delayed the payment for 3 months because of an unexpected funding issue. The company then needs to swap the EUR forward for three months into USD. This will enable them to finance and bridge the gap between selling the EUR and receiving them. The original trade is unwound at market rates and re-hedged in order to match the new exposure date

• In this example, you are “buying and selling”
  • Buying the near date and selling the far date
  • Borrowing Euros / lending U.S. dollars of 3 months
  • The “cost of carry” is the interest rate differential between the two currencies
  • “Swap points” and “forward points” are the same thing
• You buy EUR 50 million spot and sell EUR 50 million forward three months
• Spot rate is 1.2750, and forward points are –0.0007, so the three month forward is 1.2743
• You will settle the cash difference between your hedge and the new spot rate. The new hedge will be at current market rates
• In this example, the cost of carry is positive, i.e. you lose points