A currency swap is a financial contract that lets two parties exchange cash flows denominated in different currencies. In foreign exchange markets the term covers a few related instruments, but the two most common meanings are (1) an FX swap — a short-term spot and forward pair used for funding or rolling currency exposure — and (2) a longer-term currency or cross‑currency swap that can exchange both interest payments and principal over months or years. Below I explain how these work, why institutions and traders use them, and what to watch out for. Trading carries risk; this article is educational and not personalised advice.
FX swaps: the short, practical structure
An FX swap combines two transactions executed at the same time for the same notional amount but different value dates. The near leg is usually a spot exchange (you exchange currency now), and the far leg is a forward exchange (you reverse the exchange at a pre‑agreed future rate). Because the two legs offset, an FX swap provides temporary access to a foreign currency without creating a lasting open currency position.
Think of an exporter who receives euros today but needs US dollars to pay a supplier this week. Instead of selling euros on the spot and re‑buying them later (which exposes the company to exchange‑rate moves), the exporter can enter an FX swap: sell euros for dollars on the spot leg and agree to buy euros back for dollars on the forward leg at a known rate. The company gets the dollars it needs now and locks the cost of reversing the trade later.
Cross‑currency / currency swaps: longer and more complex
A currency (or cross‑currency) swap is typically a longer agreement in which the two parties may exchange principal amounts at the start and at maturity and also swap periodic interest payments in different currencies. One party might pay a fixed rate in euros while receiving a floating rate in dollars, or vice versa. These contracts are common when two firms want to effectively borrow in each other’s currency markets or hedge long‑term currency and interest‑rate exposure.
A classic example is two companies that each borrow in their domestic market at favourable terms and then swap their debt service obligations to match the currency of their revenue. Principals may be exchanged at the start and end, or they may remain notional and be used only to calculate interest flows.
Step‑by‑step example of an FX swap (numbers)
To make the mechanics concrete, imagine a short-term FX swap between USD and CAD. A company has USD 100,000 it doesn’t need for 30 days but needs CAD today. The near leg uses a spot rate of 1.30 (1 USD = 1.30 CAD), so the company sells USD 100,000 and receives CAD 130,000. At the same time the far leg agrees that in 30 days USD 100,000 will be re‑bought at a forward rate of 1.301 (slightly different because of interest differentials), which means the company will pay CAD 130,100 to get USD 100,000 back. The CAD 100 difference over 30 days is the financing cost of having CAD now instead of USD — often cheaper than borrowing on an overdraft line and without taking a market exposure beyond the agreed forward.
Overnight swaps in retail forex (rollovers)
Retail traders see a different, but related, meaning of “swap” as the overnight rollover interest. When you hold a currency position overnight you are effectively borrowing one currency and lending the other. Brokers apply a daily swap (credit or debit) that reflects the interest‑rate differential between the two currencies plus a small broker margin. If you go long a currency with a higher interest rate against a currency with a lower rate, you may receive a small payment each night; the opposite position will usually incur a charge.
For example, if the US interest rate is higher than the Eurozone rate, a trader who is short USD/long EUR may receive a positive swap when holding the position, while a trader long USD/short EUR will likely pay the swap. Brokers normally publish “swap long” and “swap short” values for each pair and apply them at the daily rollover time, with a triple‑swap charged on the broker’s designated week day to cover the weekend settlement.
How swaps are priced (in plain terms)
Forward rates and swap points reflect interest‑rate differentials between the two currencies. In broad terms, when you move from a spot to a forward rate you adjust for the difference in what you would earn or pay by holding each currency for the contract period. If Currency A has a higher short‑term rate than Currency B, the forward price of A (quoted against B) will tend to trade at a discount relative to spot, and the swap points quantify that adjustment.
Traders and institutions use the idea of interest‑rate parity to link spot, forward and interest rates: forwards move to reflect the cost or benefit of funding one currency versus another. For retail purposes you don’t need to calculate this yourself — your broker’s forward/swap tables do it for you — but it helps to know that swap payments are not arbitrary: they come from real market interest differences.
Common uses of currency swaps
Firms and financial institutions use these instruments for practical funding and hedging reasons. Corporates use FX swaps to manage short‑term liquidity when cash flows arrive in one currency but bills are due in another. Longer currency swaps let companies convert a domestic loan into foreign currency exposure (or vice versa) without going into the foreign debt market directly. Traders use overnight swaps as part of carry‑trade strategies, where they hold positions that earn positive interest differentials. Central banks and large institutions also use swaps as liquidity or policy tools.
Risks and caveats
Currency swaps reduce some kinds of risk but introduce others. Exchange‑rate risk matters if the contract involves later reconversion of principal at a fixed rate and the parties fail to settle as agreed. Interest‑rate risk affects the value of cash flows when one leg is floating. Counterparty risk — the chance the other side fails to perform — is important in bilateral swaps; large institutions mitigate this with collateral, central clearing, or careful credit checks. Liquidity risk means you may not be able to unwind a long swap position quickly or at a fair price. For retail traders, broker policies matter: swap rates and calculation methods differ across brokers, and they can change the values or the triple‑swap day. Operational and legal risks also exist: documentation, settlement conventions and holiday calendars all affect timings and costs.
Also remember that retail “swap” charges (overnight rollover) and institutional FX swaps are related but not identical instruments. If you’re a trader, check your broker’s swap schedule and test how swaps appear in a demo account before relying on them in live trading. Trading carries risk; this information is educational and not personalised investment advice.
Practical tips for traders and treasurers
If you manage corporate cash flows, use an FX swap when you need short‑term funding in a currency you don’t hold — it can be cheaper and less risky than repeated spot conversions. For traders thinking about carry strategies, remember that positive swap income can be eroded by adverse price moves, broker policy changes, or sudden shifts in interest‑rate expectations. Always compare swap rates across providers, factor the triple‑swap day into your holding costs, and avoid using swap income as the main justification for high‑leverage positions.
Try these steps before using swaps in live trades: review the contract terms (near leg/far leg dates), confirm whether principals are exchanged, verify the forward rate and how swap is calculated, and run the scenario in a demo environment. For institutions, legal documentation and collateral arrangements are crucial; for retail traders, pick a regulated broker and read the rollover policy.
Key takeaways
- FX swaps combine a near‑date exchange and a reverse forward; they’re used for short‑term funding and rolling currency exposure.
- Currency (cross‑currency) swaps are longer and can exchange principal plus interest payments in different currencies.
- Swap pricing reflects interest‑rate differentials (forward points) and varies by counterparty or broker; retail rollover charges differ across platforms.
- Trading carries risk; this is educational information and not personalised advice — always check terms, test in a demo, and manage counterparty and liquidity risk.
References
- https://en.wikipedia.org/wiki/Foreign_exchange_swap
- https://www.investopedia.com/terms/f/foreign-currency-swaps.asp
- https://www.fe.training/free-resources/financial-markets/foreign-currency-fx-swap/
- https://deal.tdsecurities.com/tdfx/assets/docs/Swaps_Product_Card.pdf
- https://www.dukascopy.com/swiss/english/marketwatch/articles/what-is-swap-in-forex-trading/
- https://www.investopedia.com/terms/c/currencyswap.asp