Banks use this trade to raise foreign currency for a short period, and institutional investors use it to limit the currency risk of foreign currency assets.

Combining spot and forward trades in opposite directions

An FX swap is a pair of trades, agreed at the same time, that buy and sell the same amount of foreign currency in opposite directions, one settling first and the other settling later. The typical form combines a trade settled at the spot exchange rate with a trade settled at the forward exchange rate1. The trade that settles first is called the near leg, and the trade that settles later is called the far leg. The near leg closely resembles a spot trade, and the far leg closely resembles a forward contract such as an FX forward2.

Consider a hypothetical example in which Bank F, a Japanese bank, raises US dollars for 180 days to fund its investments and loans. Bank F enters into a USD 10 million FX swap with Bank G. In the near leg, Bank F buys USD 10 million at 150.00 yen per dollar. In the far leg, 180 days after the near leg, Bank F sells the same USD 10 million to Bank G at 147.061 yen per dollar. The rates for both legs are set on the day the trade is agreed.

In this example, the near leg is a spot trade that settles on the second business day after the trade is agreed3. In other forms, the near leg is also set on a future date, or the swap covers a very short period, such as settling the next day and exchanging back the day after. The turnover survey of the Federal Reserve Bank of New York (the New York Fed) counts these forms as FX swaps too4.

Near-leg and far-leg payments

In an FX swap, the amount of foreign currency is the same in both legs. Only the yen amounts differ, by the difference between the two rates. Bank F's payments and receipts are as follows.

↑ Receive　↓ PayBank F, which raises dollars through the FX swapNear legFar leg (in 180 days)+USD 10 millionDollars−1.5 billion yenYen+1,470.61 million yenYen−USD 10 millionDollars
Figure 1Near-leg and far-leg payments and receipts from Bank F's side
Figure description

This diagram shows the payments and receipts in the two legs from the side of Bank F, which raises dollars through the FX swap. In the near leg, Bank F pays 1.5 billion yen and receives USD 10 million. In the far leg (180 days after the near leg), it pays USD 10 million and receives 1,470.61 million yen. The length of each arrow is a rough guide to the amount in yen, with dollars converted at 150.00 yen per dollar in both legs. The dollar amounts are the same in both legs, and the yen that Bank F receives is 29.39 million yen less than the yen it pays.

Bank G's payments and receipts are the exact opposite of the diagram. In the near leg, it delivers USD 10 million and receives 1.5 billion yen, and in the far leg, it receives USD 10 million and pays 1,470.61 million yen. Only the principal amounts of the two currencies change hands, and there are no interest or other payments between the two legs4.

From Bank F's side, it hands over yen and receives dollars, then returns the dollars on the maturity date and gets its yen back. This has the same shape as borrowing dollars for 180 days using yen as collateral5.

Because the far-leg rate is set on the day the trade is agreed, Bank F receives 1,470.61 million yen whatever the spot exchange rate is in 180 days. Suppose instead that Bank F had only bought dollars at the spot exchange rate, without the swap. It would then have to sell the USD 10 million at the spot exchange rate in 180 days to turn them back into yen. If the spot exchange rate in 180 days were 160.00 yen, Bank F would receive 1.6 billion yen, 129.39 million yen more than with the swap. At 135.00 yen, it would receive 1.35 billion yen, 120.61 million yen less. With the FX swap, the yen amount no longer rises or falls with currency risk while Bank F holds the dollars.

The price is set in forward points

FX swaps are traded in forward points, the difference between the rates of the two legs6. The forward exchange rate is found by adding the forward points to the spot exchange rate or subtracting them from it7. In the example, the far-leg rate of 147.061 yen is the near-leg rate of 150.00 yen plus forward points of −293.90 sen (−2.939 yen). The yen difference of 29.39 million yen between the two legs is the size of the forward points, 2.939 yen, multiplied by USD 10 million.

The formula and calculation of covered interest parity, which gives the forward exchange rate from the interest rates of the two currencies, are covered in Covered Interest Parity and FX Forward Points. The figures in the example are the same as those in the worked example there (a spot exchange rate of 150.00 yen, a yen interest rate of 0.50%, a dollar interest rate of 4.50%, and a period of 180 days). Forward points reflect the interest rate differential between the two currencies, and the forward exchange rate of the currency with the higher interest rate is, as a rule, lower than its spot exchange rate7. The forward points in the example are negative because the dollar interest rate is higher than the yen interest rate.

From Bank F's side, receiving 29.39 million yen less corresponds to the FX swap cost. Expressed as an annual rate, the cost is the forward points annualized, and it includes the interest rate differential between the two currencies6.

Raising, investing, and hedging foreign currency

FX swaps are used to raise another currency for a set period using the currency you hold as collateral, or to convert the currency you hold into another currency and invest it. When banks and institutional investors secure foreign currency for their investments and loans, they often use trades such as FX swaps5. When a financial institution outside the United States raises dollars by exchanging its home currency for dollars through an FX swap, the trade is called dollar conversion (doru-ten in Japanese). Dollar conversion is in effect secured funding with the home currency as collateral, so it is relatively easy to use even for financial institutions whose unsecured dollar funding is limited8.

A party that holds dollars, like Bank G in the example, can convert its dollars into yen through an FX swap, invest the yen, and get the dollars back on the maturity date. A financial institution that can use both the money market and the FX swap market, and does not worry about counterparty credit risk, behaves as follows. When it invests dollars, it compares investing in the dollar money market with converting the dollars into another currency through an FX swap and investing that currency, and it chooses the higher yield. When it raises dollars, it compares the cost of borrowing dollars in the money market with the cost of raising another currency and converting it into dollars through an FX swap, and it chooses the cheaper one9.

In practice, there are periods when raising dollars through FX swaps costs more than the interest rate in the dollar money market5. This gap is expressed as the cross-currency basis, a signed value seen from the side of the yen or other currency, which is negative when raising dollars is expensive10. When the extra cost of raising dollars is expressed as a positive amount, it is called the dollar funding premium5.

FX swaps are also used for hedging the currency risk of foreign currency assets. In Japan, life insurance companies and other institutional investors use FX swaps and cross-currency swaps to limit currency risk when they invest in foreign currency assets11. Investing in foreign currency assets with the currency risk hedged is economically the same as raising dollars through an FX swap using yen or another currency as collateral and buying dollar-denominated assets with those dollars12.

Differences from cross-currency swaps

FX swaps and cross-currency swaps both exchange the principal amounts of two currencies for a set period and exchange them back on the maturity date. Because the two have similar economic effects, arbitrage is thought to link their markets13. The main differences are as follows.

Item FX swap Cross-currency swap
Main term Mostly under one year13 Usually one year or longer13
Interest payments during the term None Interest in the two currencies is exchanged at set intervals
Principal exchanged back at maturity The same foreign currency amount, at a rate that differs from the starting rate by the forward points The same amounts as at the start

The two also differ in how they pay the interest rate differential between the two currencies: an FX swap pays it through the far-leg rate, and a cross-currency swap pays it through the interest exchanged during the term. A cross-currency swap that exchanges short-term interest rates in the two currencies during the term (which the Bank of Japan Review calls a cross-currency basis swap) keeps the principal exchanged at maturity the same as at the start, but in essence it is no different from an FX swap14. How the payments of a cross-currency swap are structured is covered in Cross-Currency Swaps.

In the New York Fed's turnover survey for April 2025, 61% of the FX swaps reported in the United States had a maturity of 7 days or less15.

Notes

  1. Bank of Japan, "「外国為替市況」の解説" (Explanation of the "Foreign Exchange Market Rates", in Japanese), "1. 3ヶ月フォワード・スプレッド" (1. Three-month forward spread) under "（参考）「時系列統計データ検索サイト」に過去計数のみ掲載の項目" (Reference: items published only as past data on the Time-Series Data Search Site). The source calls this trade a swap and gives a spot purchase combined with a forward sale as an example. ↩

  2. Alexei G. Orlov and Rajiv Sharma, "Which Witch is Which? Deconstructing the FX Markets Activity" (U.S. Commodity Futures Trading Commission, version of May 2, 2023), "2.1.3 FX OTC derivatives" (page 7). ↩

  3. Bank of Japan, "「外国為替市況」の解説" (Explanation of the "Foreign Exchange Market Rates", in Japanese), "1. スポット・レート" (1. Spot rate). ↩

  4. Federal Reserve Bank of New York, "Turnover in the United States, April 2025," "Foreign exchange swap" under "4. Instrument definitions" in Annex I (pages 11–12 of the PDF). ↩ ↩2

  5. Bank of Japan, "グローバルな為替スワップ市場の動向について" (Bank of Japan Review, July 2016, in Japanese), "最近のドル資金調達プレミアム拡大" (Recent widening of the dollar funding premium, page 1). The source uses "為替スワップ" (FX swaps) to cover both FX swaps and cross-currency basis swaps. An English version is available: "Recent Trends in Cross-currency Basis" (Bank of Japan Review 2016-E-7, September 2016). ↩ ↩2 ↩3 ↩4

  6. Bank of Japan, "為替スワップを利用した米ドル資金の調達コストの動向について" (Bank of Japan Review, March 2012, in Japanese), note 2 (page 7). The source calls forward points "直先スプレッド" (spot-forward spread). An English version is available: "Recent Developments in U.S. Dollar Funding Costs through FX Swaps" (Bank of Japan Review 2012-E-3, April 2012). ↩ ↩2

  7. Institute for International Monetary Affairs, "直先スプレッドと先物相場の算出方法" (How the spot-forward spread and the forward rate are calculated, in Japanese), the opening paragraph. The source calls forward points "直先スプレッド" (spot-forward spread) and "スワップポイント" (swap points). ↩ ↩2

  8. Bank of Japan, "為替スワップを利用した米ドル資金の調達コストの動向について" (Bank of Japan Review, March 2012, in Japanese), "はじめに" (Introduction, page 1). ↩

  9. Bank of Japan, "為替スワップを利用した米ドル資金の調達コストの動向について" (Bank of Japan Review, March 2012, in Japanese), "ドル転コストの構成要素" (Components of the dollar conversion cost, page 2). The source uses the euro and the dollar as its example and assumes that counterparty risk is not considered (also note 1, page 7). ↩

  10. Bank of Japan Financial Markets Department, "店頭デリバティブ取引データからみた通貨スワップ市場：感染症拡大の影響とその後の回復を中心に" (The cross-currency swap market seen through OTC derivatives data, focusing on the impact of the spread of COVID-19 and the subsequent recovery) (Bank of Japan Review, May 2021, in Japanese), "通貨スワップ取引の概要" (Overview of cross-currency swap trades, page 2). ↩

  11. Bank of Japan Financial Markets Department, "店頭デリバティブ取引データからみた通貨スワップ市場：感染症拡大の影響とその後の回復を中心に" (Bank of Japan Review, May 2021, in Japanese), note 7 (page 7). ↩

  12. Bank of Japan, "グローバルな為替スワップ市場の動向について" (Bank of Japan Review, July 2016, in Japanese), "（投資家のドル建て資産需要）" (Investors' demand for dollar-denominated assets, page 2). ↩

  13. Bank of Japan Financial Markets Department, "店頭デリバティブ取引データからみた通貨スワップ市場：感染症拡大の影響とその後の回復を中心に" (Bank of Japan Review, May 2021, in Japanese), note 4 (page 7) and "通貨スワップ取引の概要" (Overview of cross-currency swap trades, page 2). ↩ ↩2 ↩3

  14. Bank of Japan, "グローバルな為替スワップ市場の動向について" (Bank of Japan Review, July 2016, in Japanese), note 1 (page 7). ↩

  15. Federal Reserve Bank of New York, "Turnover in the United States, April 2025," the "Maturity" section (page 5 of the PDF). The maturity is the original term to maturity when the trade was agreed. ↩

  16. Federal Reserve Bank of New York, "Turnover in the United States, April 2025," Annex I (pages 10–12 of the PDF). ↩