Jack Garcia#41

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What are FX swaps and how do they function?

An FX swap combines two transactions: a spot exchange and a forward contract, reversing at maturity. For example, a bank might swap USD for EUR spot, agreeing to reverse in 1 month at a forward rate. FX swaps allow participants to borrow/lend currencies and manage funding mismatches. They dominate interbank markets, with daily turnover above $3 trillion. Benefits: liquidity, flexibility, and credit risk reduction compared to unsecured loans. Risks: exposure to counterparty default, collateral management complexity, and pricing volatility tied to cross-currency basis. Institutions use FX swaps for short-term hedging, carry trades, and liquidity optimization. Retail traders encounter them indirectly in swap/rollover costs when holding overnight positions. Understanding FX swaps helps explain why rollover rates differ and why funding markets can drive currency trends.