What is Swaps?
Swaps is a method which you can use it to borrow money for a certain period of time. An Forex swap allows you to exchange one currency for another and then re-exchange back to the currency you first held.
Banks and others in the dealer market use Forex swaps to shift temporarily into or out of one currency for a second currency without having to incur the risk of a change in the exchange rate, which could happen if they were to hold an open position.
The use of Forex swaps is similar to borrowing and lending currencies on a collateral basis. Forex swaps provide traders with a way to use the foreign exchange markets as a funding instrument. They are used by traders and other Forex market participants in managing liquidity, shifting delivery dates, hedging speculation, and taking interest rate positions.
Although Forex swap can be attached to any pair of value dates, in reality a limited number of standard maturities account for most swap transactions. The first leg of the Forex swap usually occurs on the spot value date, and for about two thirds of all Forex swaps the second leg occurs within a week. Longer Forex swaps are available for one month, three months, or six months. Many foreign dealers arrange odd or broken dates for their traders, but the costs for those are higher than the standard maturities.
Buying or selling of swaps?
Forex swaps can be either a buy/sell swap, which means that you buy the base currency on the near date and sell it on the far date, or a sell/buy swap, which means you sell the base currency on the near date and buy it on the far date. For example, if you buy a fixed amount of pound sterling spot for dollars and sell those pounds sterling six months forward for dollars, that is called a buy/sell sterling swap.