Forex swap vs. Currency Swap

Using swaps, two parties can exchange financial instruments. Swaps are derivative contracts that serve this goal. Although these instruments can have a variety of values, exchanging money when both parties agree on a particular notional principle is the most common. Banks don’t typically alter the principle.

Each cash flow has what’s known as a swap leg. Frequently, one leg is made up of fixed cash flows, while the other is variable and moves according to various interest rates, foreign exchange rates, other indexes, etc.

In this article, let’s learn the difference between Forex Swaps and Currency Swaps in detail!

What is Forex Swap?

An agreement to concurrently buy one currency and loan another at a starting date, then exchange the payments at maturity, is known as a foreign exchange swap and a Forex swap. Given that the swapped sums are utilized as repayment collateral, it is helpful for risk-free financing.

A Forex swap transaction has two legs. The first leg of the swap involves buying or selling a certain amount of one currency against another at the going spot rate. A similar quantity of currency is traded or purchased at the forward rate against the other currency in the dual leg of the trade.

Example of Forex Swap

Consider a straightforward scenario where a business has 500,000 Euros but needs USD in five months. The company currently has money in euros; it can utilize it to meet its needs without taking a chance at fluctuating exchange rates. The business can trade the 500,000 Euros to the bank at the present rate in exchange for the US dollar equivalent and arrange to buy the Euros back and exchange them for US dollars in five months.

What is a Currency Swap?

A contract between two groups to exchange a certain amount of various currencies is known as a currency swap. In a conventional currency swap, two parties agree to exchange, or swap, a series of amounts made in a currency for a similar sequence made in another currency. 

Example of Currency Swap

An interest rate, an agreed-upon borrowing quantity, and a maturity date must all be established for such an exchange to be successful. The parties participating in currency swaps have a competitive advantage because they may now get loan foreign money at a lowered fee with less vulnerability to exchange rate risk. Sign up now for the deriv real account.

How Forex Swaps distinguishes Currency Swaps?

Cross currency and foreign exchange swaps are frequently used interchangeably because of their similarity, but other factors make them different.

Interest Payment

Interest payments are where the two diverge most. Both parties in a cross-currency swap must make recurrent interest costs in the currency they borrow. 

While in comparison to the foreign exchange swap, the groups own the quantity being traded. But in the currency swap, the parties get loans in the form of money from their home or banks before exchanging the loans.

However, currency swaps are marginally more difficult than foreign exchange swaps. It is because the amount swapped operates as compensation collateral. There is a danger of default if the party does not make the interest or total payment by the due date, which results in the party’s inability to repay the loan.

Some other factors Forex Swaps vs. Currency Swaps

• Typically, two groups may exchange or swap an amount of payments principal and interest in the same currency for the number of transactions in another as part of a foreign exchange transaction.
• FX swaps are agreements between two parties to purchase or sell a certain quantity of money at a predetermined rate and purchase or sell the same value of the currency at a pre-examined rate.
• Currency and foreign exchange swaps are similar because they help businesses receive foreign currency with little exposure to exchange rate risk and help businesses hedge foreign exchange risk.

Conclusion

A currency exchange rate is another name for a currency swap; conceptually, the two are very similar. But there can be very tiny variations. Technically speaking, a cross-currency swap is identical to a Forex swap. However, in addition to exchanging rules at the start and end of the swap, the two parties also exchange interest charges on the loans made during the swap’s existence.