Dec 22, 2011

Posted by in Stock Market News | 0 Comments

The Pros and Cons of a Forex Swap

Where Forex Swap Originates

forex swapThe concept of arranging a forex swap originates in politics. As a specific example, once a restriction was put into place by the United Kingdom on the exporting of British money which was counteracted by the idea of limited time exchange of foreign currency which allowed commercial trade to work around political agenda. This sort of exchange come full circle and operate like this a set amount of one type of money is traded for a set amount another type and when it is traded back at a future date, the exact same amount of each type of money is traded back.

There is no set time allotment for such exchanges, but common time frames include three months, one week, or just overnight. For instance, one trader has 80 British pounds sterling and swaps with another for 150 American dollars. In three months time the same amount of 150 American dollars will be returned for the British pounds sterling back. That is how a forex swap works. The investment value lies withing the fine print.

What Does a Forex Swap Do?

Given the assumption that both types of money retain their same trade value over the three months the only major difference between the two types of money is the interest rates that are able to be obtained by each. Because the basic idea behind a forex swap is to help keep money trade between countries stable, prices are usually adjusted so that that difference is accounted for in the math and the trade remains equivalent.

Swaps usually stick to short time frames to compensate for the potential danger that the fairness of the trade will be effected by the changes in the individual value of the types of money. Since the trade is fixed on particular amounts of each type of money if one has a significant change in value, one party may be forced to pay out an amount that has gained a significant amount more value than the other. If the values of the world were fixed, the 80 pounds would always equal 150 dollars, but if values change within the time of a forex swap the 80 pounds may have the same value of only 120 dollars by the end. This results in a significant amount of value changing hands instead of remaining even.

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