Forex Queries

Here I wish to explain the meaning of this term in more detail. The swap rate is to the foreign exchange market what the interest differential is to the money market.

The swap rate is not an exchange rate; it is an exchange rate differential When the interest differential between the U.S. dollar and the pound sterling was 3 percent in favor of the pound, the swap rate for three-month delivery was .0180 below the Spot rate of $2.4000/£. This .0180 swap rate is equivalent to a 3 percent plenum discount of the forward pound rate relative to the spot pound rate. 

In the foreign exchange market, a rate is the price at which individuals are willing to exchange currencies.

At the swap rate of .0180, nobody is willing to exchange any currency. However, the swap rate of .0180 is related to the spot rate of $2.40/£ at which pounds are traded against dollars for two business days’ delivery. The swap rate is also related to the outright forward rate of $2 .3820/£ for three-month pound delivery (2.40 .0180). The rates at which transactions are carried out in the foreign exchange market are either the spot or the various forward rates. The swap rate is the link between the spot rate and the forward rate, or the link between two forward rates for two different maturity dates. This link is directly related to the net accessible interest differential between the two relevant currencies.

The fact that a swap rate is not an exchange rate becomes particularly clear when one wants to find reciprocal rates. For example, the exchange rate for German marks against U.S. dollars may be US$0.40/DM in U.S. terms or DM2.50/US$ in German terms. One rate can be derived from the other by simply finding the reciprocal of one of the rates; in other words,

2.50 =1/0.04 this calculation can be done with spot rates as well as forward outright rates, but it cannot be done with swap rates. If we have the following rates in U.S. terms:

Spot rate $0.40/DM
Three-month forward outright rate $0.41/DM
Three-month swap rate $O.Ol/DM.

And if we would like the same rate in German terms, we can get what we want by finding the reciprocal of the spot rate and the forward outright rate. The reciprocal of the swap rate would be meaningless.

To obtain the swap rate in German terms we have to find the difference between the spot and forward outright rates expressed in German terms.

Accordingly,

Spot rate (1 / 0.40) DM2.5000/$

Three-month forward outright rate (1 -:- 0.41)
DM2.4390/$
Three-month swap rate (2.50 - 2.4390)
DMO.0610/$

Swap rates are not true exchange rates and may not be reciprocated to change the terms in which they are expressed.