What Is Foreign Currency Swap and How It Works
Swap in simple words is the exchange of the same items. Foreign currency swaps are the swap of foreign currencies that is precisely what they usually are.
In foreign currency swap, party X borrows the total sum of $A, from party Y and at the mark rate and at the same time lends the second party the same sum in any other currency, let say in Euros.
By this, both the parties have a reimbursement obligation to one another. The party X has to pay back the same amount in dollars while on the other hand the party Y has to pay back the total amount in Euros, at the further rate at which both parties agreed at the beginning of the agreement.
Thus, foreign currency swap works in a way that collateralized borrowing or lending in order to shun risk arise due to exchange rate.
There are a lot of market participants like financial institutions, their customers and the institutional shareholders who wish to show their foreign currency positions, and entrepreneurs use foreign currency swaps.
Every day earnings in worldwide foreign currency markets in 2010, was much closer to a whopping about $4 trillion.
More than 38% of this entire per day activity was because of spot transactions that in simple words mean currency exchange for instant delivery.
While remaining 62% consists of foreign currency derivatives. Among these foreign currency derivatives, the share of the lion with 45% went to swap.