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What is Swap in Forex?
Forex swaps are tools that traders use for improved currency management.
This basically involves a swapping agreement where one party lends a currency to another party, and at the same time there is a borrowing of another currency. So a swap agreement involves the borrowing and lending of two currencies in an equal amount over a set period of time. Forex swaps are favoured as they are considered to be a risk free lending arrangement. At the end of the day both parties will have swapped an amount which includes interest as well as principal payments of the two currencies at maturity.
Let us give a practical example in order to better explain this:
Say there is Party A, based in Canada, that requires EUR, and Party B from Europe which requires CAD. With an FX Swap the two parties exchange the two currencies between them, and they establish a maturity period of six months. Let’s say that the exchange rate of this swap includes 1.5EUR/CAD with the total amount of 15,000 CAD or 10,000 EUR. The two parties are predicting that the CAD is going to depreciate when compared to the EUR. As a result, they finalise the forward rate as 1.8 EUR/CAD. Party A borrows 10,000 EUR and also lends 15,000 CAD to Party B. when the six months lapse, Party A will receive 18,000 CAD and at that point they will return 10,000 EUR to Party B. To arrive at these figures the following formula is used: 10,000 EUR X 1.8 EUR/CAD = 18,000 CAD.
To determine the swap size, the interest rates issued by the central banks will be considered. The bigger the currency pair rate’s difference, the bigger the Forex swap size will be. Swap commissions charged by brokers will also have an impact, and since currency rates change, these swap rates vary. Many traders will generally consider the fees, especially the spread. In the case of long term and medium term trading, the swap is one of the most important factors. This is because if the trader does not hold any position overnight, then there won’t be any earnings on the swap, or pay it. A swap can be positive or negative. This depends on the exchange rate differences of the currencies. For instance, if you keep your position open, then on every transfer, the amount that gets deposited in the account will be a positive swap.
Many brokers offer a swap free account service to their users in order to avoid swaps. In such a case there will not be interests. This applies to Muslim forex traders who cannot receive or pay interest in any form due to Islamic laws. Considering the may brokers available, it may be somewhat challenging to choose the best option while also taking into account swap rates. Hence it is recommended that one uses brokers’ swap comparison tools to make an informed choice.
This basically involves a swapping agreement where one party lends a currency to another party, and at the same time there is a borrowing of another currency. So a swap agreement involves the borrowing and lending of two currencies in an equal amount over a set period of time. Forex swaps are favoured as they are considered to be a risk free lending arrangement. At the end of the day both parties will have swapped an amount which includes interest as well as principal payments of the two currencies at maturity.
Let us give a practical example in order to better explain this:
Say there is Party A, based in Canada, that requires EUR, and Party B from Europe which requires CAD. With an FX Swap the two parties exchange the two currencies between them, and they establish a maturity period of six months. Let’s say that the exchange rate of this swap includes 1.5EUR/CAD with the total amount of 15,000 CAD or 10,000 EUR. The two parties are predicting that the CAD is going to depreciate when compared to the EUR. As a result, they finalise the forward rate as 1.8 EUR/CAD. Party A borrows 10,000 EUR and also lends 15,000 CAD to Party B. when the six months lapse, Party A will receive 18,000 CAD and at that point they will return 10,000 EUR to Party B. To arrive at these figures the following formula is used: 10,000 EUR X 1.8 EUR/CAD = 18,000 CAD.
To determine the swap size, the interest rates issued by the central banks will be considered. The bigger the currency pair rate’s difference, the bigger the Forex swap size will be. Swap commissions charged by brokers will also have an impact, and since currency rates change, these swap rates vary. Many traders will generally consider the fees, especially the spread. In the case of long term and medium term trading, the swap is one of the most important factors. This is because if the trader does not hold any position overnight, then there won’t be any earnings on the swap, or pay it. A swap can be positive or negative. This depends on the exchange rate differences of the currencies. For instance, if you keep your position open, then on every transfer, the amount that gets deposited in the account will be a positive swap.
Many brokers offer a swap free account service to their users in order to avoid swaps. In such a case there will not be interests. This applies to Muslim forex traders who cannot receive or pay interest in any form due to Islamic laws. Considering the may brokers available, it may be somewhat challenging to choose the best option while also taking into account swap rates. Hence it is recommended that one uses brokers’ swap comparison tools to make an informed choice.