A foreign exchange swap, or FX swap, is an agreement to exchange two currencies on a near date and reverse the exchange on a later far date, with both exchange rates agreed when the trade is struck. It gives a firm temporary use of one currency against another while fixing the later conversion. The two dates and the cash needed on each matter as much as the quoted rate.
The familiar structure combines a spot exchange with an opposite forward exchange. Both dates can instead be in the future. “Near” identifies the earlier settlement date; it does not promise instant settlement or a universal number of business days.
Read the trade from one party's side
Consider a fictional deliverable swap, with the near exchange at the start and the far exchange exactly one year later. Party A buys EUR at the near date and sells EUR at the far date. Rates are stated in USD per EUR, and amounts are currency units, not millions. Ignore fees and bid–ask spreads in this example.
| Agreed date | A pays | A receives | Agreed rate, USD per EUR |
|---|---|---|---|
| Near: start | USD 120 | EUR 100 | 1.20 |
| Far: one year later | EUR 100 | USD 122 | 1.22 |
Party B has the opposite cash flow in each currency on each date. The same EUR 100 principal reverses direction, while the USD amount changes. There is no separate coupon stream between the dates.
Fictional one-year FX swap, viewed by Party A. Arrows show contractual payments; EUR 100 returns in the opposite direction. No interim coupons are stipulated.
The near rate is USD per EUR and the far rate is USD per EUR. Their difference is USD per EUR; multiplying by EUR 100 gives the USD 2 difference between A's dollar payments. It is a price difference across dates, not an automatic trading profit.
Suppose A borrows the initial USD 120 at a synthetic 2% simple annual rate, holds EUR 100 without earning interest, and returns those euros at the far date. The USD loan then requires . The swap delivers USD 122, leaving A USD 0.40 short. This added funding assumption illustrates why the full cash ledger matters; these stipulated swap rates are not claimed to be fair quotes for that funding environment. Investing or spending the euros would require including the resulting proceeds or replacement cost as well.
Why the far rate differs
An FX swap economically combines lending one currency with borrowing the other. Under an idealised covered interest parity benchmark, the near and far rates compensate for the currencies' different funding returns. For a near leg settling now, let and be USD per EUR and let and be the respective gross investment factors over the same interval. With frictionless matched borrowing and lending,
Converting euros now and investing dollars must then give the same terminal dollars as investing euros and selling the proceeds forward. Actual executable terms also depend on spreads, credit, collateral and balance-sheet constraints. The BIS explanation of FX swap pricing separates this benchmark from the cross-currency basis; its reference-rate examples are historical. A locked far rate is a contract price, not a forecast of the future spot rate.
For the funding replication behind that equation, FX and Commodities works through covered interest parity and both arbitrage directions. The full lesson requires membership; its public preview shows the outline and prerequisites.
A fixed conversion still leaves cash obligations
A firm can use the received currency to fund a matching asset until the far date. If the asset matures later, repeatedly renewing a shorter swap creates rollover risk: the next trade may be expensive or unavailable. The existing contract fixes its own exchange, not the terms of its replacement.
Counterparty credit risk also remains. At settlement, paying one currency before receiving the other can expose the full principal. Payment-versus-payment arrangements reduce that principal settlement risk by making the payments conditional on each other; coverage and the agreed settlement method must be checked. A small difference between near and far amounts does not mean only that difference needs funding. The BIS discussion of FX settlement risk explains the distinction.
An outright forward has one future exchange and no paired near exchange. A currency swap exchanges interest-payment streams in different currencies as well as any agreed principal flows. An FX swap's financing terms sit in its near/far exchanges rather than a separate periodic coupon stream. Contract cash flows are a better guide than maturity alone.
Sources
- BIS, Annual Economic Report 2025, “The FX swap market as linchpin”: currency funding, near/far exchanges and the distinction from currency swaps.
- BIS, “CIP, FX swaps, cross-currency swaps and the factors that move the basis”, 2016: interest parity and costs beyond the frictionless benchmark; historical reference rates.
- BIS, “FX settlement risk: an unsettled issue”, 2022: principal settlement risk and payment-versus-payment.
- John C. Hull, Options, Futures, and Other Derivatives, 9th Global Edition, Pearson, 2018, §5.10, pp. 139–141: currency units and covered interest parity replication.