Forex Swaps Pricing

Pricing FX Swaps

The cost of an FX swap is determined by the interest rate differential between the two swapped currencies. Just as in the case of outright forwards, arbitrage and the principle of covered interest rate parity will operate to make the cost of an FX swap equal to the foreign exchange value of the interest rate differential between the two currencies for the period of the swap.

The cost of an FX swap is measured by swap points, or the foreign exchange equivalent of the interest rate differential between two currencies for the period. The difference between the amounts of interest that can be earned on the two currencies during the period of the swap can be calculated by formula.

The counter party who holds for the period of the swap the currency that pays the higher interest rate will pay the points, neutralizing the interest rate differential and equalizing the return on the two currencies; and the counter party who holds the currency that pays the lower interest will earn or receive the points.
At the outset, the present value of the FX swap contract is usually arranged to be zero.

The same conditions prevail with an FX swap as with an outright forward—a trader who pays the points in the forward also pays them in the FX swap; a trader who earns the points in the forward also earns them in the FX swap.

For most currencies, swap points are carried to the fourth decimal place. A dollar-swissie
swap quoted at 244-221 means that the dealer will buy the dollar forward at his spot bid rate
less 0.0244 (in Swiss francs), and sell the dollar forward at his spot offer rate less 0.0221 (in
Swiss francs), yielding an (additional) spread of 23 points (or 0.0023).