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Swap Transactions - Forex

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A swap is a contract in which two parties engaged in transacting a deal agree to exchange their respective cash flows or financial assets on which they have decided to trade at Forex.

These are private management between parties to exchange cash flows according to some pre-arranged formula. The parties to the swap contract are known as counter-parties. In swap, one party agrees to exchange his set of selected currency pair or cash flow with the pre-determined set of cash flows of the other party.

For example, one party is currently receiving cash flow or currency at the decided value from one investment but like to have cash flow from other type of investment. In such case, swaps are used to exchange the source of investment to have the cash flow or currency pairs in terms of Forex to be exchanged within the support of the swap dealer.

Characteristics of swaps:

These are considered to be the special type of financial derivatives used by traders at capital market to raise funds from their desired sources but they can be used at Forex trading platform as well with relevance to the regulation of the Forex trade.

• Swap arrangements are tailor-made to the needs of the counter-parties.

• Swaps are not subject to the regulations like futures and options.

• The swaps are bilateral agreements and the potential default risk is there. The swap dealer can provide a counter-guarantee.

As the swaps are private arrangement between the parties, different types of swaps have emerged over the years. Swaps are, in fact, a part of financial engineering and attempt to cope with the requirements of a party.

The features of swaps helped a lot to traders to make arrangement required to make the trading deals easily and transact the exchange of currency pairs in their desired manner.

Types of swaps: Currency swaps and Interest rate swaps

• Currency Swaps: A currency swap is the transaction between two parties in which one party promises to make the series of payment to the other party at the specific date and value at the exchange for a payment from the other party in different currencies.

In currency swaps, the cash flows of different currencies are swapped. Currency swaps can be used by firms that operate in one currency but need to borrow in another currency. For example, say a Company A ltd. And B Ltd. Want to borrow cash in $ and in £ respectively. But A Limited can borrow at cheaper rate than B Limited can borrow $ at a cheaper borrowing capacity of the other company. The rationale for currency swap lies in the fact that one borrower has a comparative advantage in borrowing in one currency, while other borrower has an advantage in borrowing in another currency.

In currency swap, one party holds one currency and swaps it for another currency held by the other party. The swap arises when one party provides one currency in exchange of other. The purpose of currency swap is to arrange the funds denominated in other currency.

• Interest rate Swaps: Interest rate swap is an agreement between two parties in which each party makes a series of interest payments to the other at determined dates at different rates.

At least one of the interest rates is variable, i.e. a floating rate, in the sense that the rate at which interest payments will be made at a later date is not known. The most common type of interest rate swap is known as 'Plain Vanilla' swap in which one rate is fixed and the other rate is floating.

These are some of the trading altitudes applied at the Forex trading market with the aim to transact deal in the desired manner of the parties involved in the exchange trades.

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