FX SWAP • The Spot Purchase and Forward Sale of Currency. The Two Transactions are Executed Simultaneously and are based off the Same Spot Rate
FX Swap Rates • As with a forward contract the Bank will quote a spot and a forward rate for both sides of the market • GBP/CAD 2.3378- 2.3403 1 Month Points 14 12
FX SWAP RATES • However it is only the Forward Points representing the differential in interest rates between the two currencies that will affect the swap. • The forward points to be used will be determined by the forward transaction in the Swap. • The Same Spot Rate will be used for both the purchase and sale of the currency
EXAMPLE • Your Canadian subsidiary tells you that it wishes to borrow 3 million Canadian dollars for one month (30 days). Their local bank will lend at 5.5% pa. Your GBP interest cost is 6% pa. • Is it cheaper for the subsidiary to borrow from you or from the bank?
THE SWAP CALCULATION 1 Questions to ask 1 What will it cost in CAD? 2 In the Swap, what side will we be on in the forward? (this will determine the spot rate to use) 3 Therefore how many GBP do we need to borrow today to give CAD 3,000,000? 4 Therefore how many GBP will we have to pay back at 6.0% in the future? 5 At the forward rate, how many CAD will be needed? 6 Is this more or less than borrowing CAD directly?
THE SWAP CALCULATION 2 • Borrowing CAD directly from the local bank will cost? • 3,000,000 x .055 x 30/365 = 13,561.64
THE SWAP CALCULATION 3 Spot GBP/CAD 2.3378 - 2.3403 30 Day Points 14 12 1 month forward outright 2.3364 - 2.3391 Today At spot of 2.3403 Buy CAD 3,000,000.00 Sell GBP 1,281,886.94 1,281,886.94x.06x30/365 = 6,321.63 Forward At forward of 2.3391 Sell CAD 3,013,248.68 Buy GBP 1,288,208.57
ANSWER • Borrow CAD Direct at 5.5% Cost CAD 13,561.64 Borrow CAD via the swap Cost CAD 13,248.68 So, on financial basis, do the swap Effective interest rate in CAD 13,248.68 x 365/30 = 5.37% 3,000,000
USES OF THE SWAP Can be used to • invest or borrow in a foreign currency for a specified period of time without creating an fx exposure • concentrate funds from a number of different currencies into one currency to obtain better rates without creating an fx exposure • offset surplus funds in one currency against deficit in another currency for a specified period of time without creating an fx exposure