Foreign exchange swap points are the price of a foreign exchange swap. An FX swap combines two opposite exchanges of the same amount of currency: a near leg, usually for spot value, and a far leg on a later date. The swap points are the difference in pips between the exchange rates of the two legs. They express, in exchange-rate terms, the interest a party gives up on one currency and earns on the other while the swap is outstanding.
The figures equal foreign exchange forward points for the same dates. The difference is one of use: forward points are added to spot to price a single outright forward, whereas swap points price a two-legged transaction used for funding, liquidity management and rolling positions forward. Banks, corporate treasuries and central banks trade them in large volumes in the money markets.
Foreign exchange swap points in plain terms
Imagine two neighbours who each need the other's car for a month. They swap keys today and agree to swap back in a month. If one car is worth more to borrow, the neighbour getting the better deal pays a small fee for the month. Nothing about the cars themselves changes hands for good.
An FX swap is the same arrangement with currencies. One party hands over euros and receives dollars today, and both agree to swap back later. Because one currency earns more interest than the other, the side that gets the higher-interest currency pays for the privilege. The swap points are that fee, built into the exchange rate used on the return trip.
How swap points price a swap
The far-leg rate is the near-leg rate plus the swap points. Suppose a company holds euros but needs US dollars for three months. With EUR/USD at 1.0850 and three-month swap points of +54, it sells €10 million for $10,850,000 on the near leg and agrees to buy back €10 million at 1.0904, paying $10,904,000, on the far leg. The extra $54,000 is the cost of borrowing dollars against euros for three months. In effect, the swap works like a secured loan, much as a repurchase agreement uses securities as collateral, with each party's currency protecting the other.
The interest rate implied by swap points for the quote currency can be backed out as:
- and are the near-leg and far-leg rates, and equals the swap points divided by 10,000 for four-decimal pairs.
- is the base currency interest rate and the number of days between the legs.
- and are the day-count bases of the two currencies.
With a euro rate of 2.5 per cent over 90 days, the implied dollar rate is [(1.0904 ÷ 1.0850) × (1 + 0.025 × 90/360) − 1] × 360/90 ≈ 4.5 per cent, matching the market dollar rate. When the implied rate differs from the actual cash rate, the gap is the cross-currency basis.
Short-dated swaps and rolling positions
Swap points are quoted for very short periods as well as standard tenors. Overnight (O/N) swaps run from today to tomorrow, tom-next (T/N) from tomorrow to the next day, and spot-next (S/N) from spot to the following day. Traders and retail FX platforms use tom-next swaps to roll open spot positions forward each day, so the swap points determine the daily financing charge or credit on a position. Corporate hedgers use swaps to extend or bring forward a hedge when the timing of an underlying payment changes, adjusting the value date without opening a new outright exposure.
Swap points in funding markets
FX swaps are the most traded instrument in the global foreign exchange market according to the Triennial Survey of the Bank for International Settlements, largely because banks and investors use them to obtain dollar funding by swapping their own currency. In periods of stress, demand for dollars through swaps pushes swap points away from the levels implied by interest rates, widening the basis. Central banks respond with central bank swap lines, which supply dollars to local banks. Swap points are also a main input for liquidity management by bank treasuries that fund assets in one currency with deposits in another.
An FX swap should not be confused with a cross-currency swap, a longer-dated contract that exchanges principal at the start and end and periodic interest payments in between, covered under currency swaps. FX swaps have no interim interest payments; the interest differential is entirely captured in the swap points. Because the principal is exchanged and returned, FX swaps can create large settlement exposures, which is one reason many are settled through payment-versus-payment arrangements.