FX Swap Market Mechanics

CHAPTER 3: FOREIGN EXCHANGE

Market Mechanics

Swap points are quoted with a spread – bid and offer as shown in Table 3-5. Three columns are added to the normal quotations namely, ‘Value Date’, ‘Maturity’ and ‘No of Days’. These three columns are added to ease our calculation at a later section of this chapter.

Table 3-5

In general, quotes are often represented as 'bid/offer', which we have splitted and given their own column. The bid is equivalent to a sell-buy swap while the offer is equivalent to a buy-sell swap from the perspective of the price provider. A sell-buy or buy-sell always refers to the commodity or base currency, which in the case of USD\MYR is USD. If a bank takes the offer, it will have a swap to sell-buy or sell USD spot and buy USD forward.

Let’s assume a bank gives the 2M bid at 140 for USD10,000,000. Table 3-6 simplified the transaction to two foreign exchange transactions - a spot and a forward, from the perspective of the giving bank

Table 3-6

Dates and rates on the first and second leg will look slightly different for O/N and T/N transactions. If a bank takes the O/N offer at 2.1 the calculation for the nearest leg will be sightly different as shown in the following table.

Table 3-7

Note the rate on the 1st and 2nd leg of the contract. USD/MYR exchange rate is assumed to be 4.2000 but neither the 1st Leg of the 2nd Leg of the contract uses the rate. This is primarily due to the fact that the settlement date for both legs are prior to the spot date of January 8, 2015. The second leg is one business day prior to the spot date while the first leg is two business day prior to the date.

Consequently, the USD/MYR rate for the 2nd leg is adjusted by deducting the T/N swap point of 2.1 from the USD/MYR exchange rate of 4.2000 to arrive at 4.19979. Similarly, the USD/MYR rate for the 1st leg is derived by deducting the transacted swap point of 2.1 from the USD/MYR rate in the 2 leg. However, for practical purposes this may not be done due to the voltility of the exchange rate. Consequetly and the spot fx rate may be used as the rate for the first leg.

The bank exposure in Example 3-2 was eliminated from USD borrowing, USD/MYR spot FX transaction and a MYR lending. The exposure can also be eliminated using the FX swap market. Based on swap points quoted in Table 3-5, the bid one-month swap however, is 60. The bank can hit the bid to eliminate the exposure but there will be a loss of 15 points.