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As an US investor, if I enter a basis swap in a foreign currency (say Euribor-Eonia basis in EUR), and book my trade using USD. I must have some sort of FX risk, right?

How do I hedge such risk? I'd imagine my delta to EURUSD is 0 at the time I enter this swap. But as market moves, my P&L either positive or negative. Does that mean I need to dynamically hedge this FX risk?

(please feel free to edit if my question isn't phrased clearly)

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Yes, you have a second order FX risk on the mark-to-market of your basis swap. However it is highly unlikely you will need to hedge it frequently.

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So near leg has an x EUR cost funded in USD and far leg returns y EUR. If the swap is even couldn't you use an FX forward to fix the price of the EURUSD cashflow at the far leg? Then you know the total cost of the basis swap no matter how the spot FX market moves.

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  • $\begingroup$ not my down vote, but... how do you predict future cash flows? $\endgroup$
    – Will Gu
    Sep 29, 2017 at 14:43
  • $\begingroup$ You don't need to predict future cashflows, you hedge the FX component of the far leg of the basis swap using an FX forward which fixes the FX rate on the far leg value date, thus fixing the USD cashflow. As its a swap you are hedging presumably you already know the far leg EUR amount, right? $\endgroup$
    – rupweb
    Sep 30, 2017 at 5:19
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    $\begingroup$ @rupweb, this is a not a fx basis swap containing a near leg and a far leg. it is a single currency basis swap with only periodic flows, no principal flows. $\endgroup$
    – dm63
    Sep 30, 2017 at 11:41
  • $\begingroup$ @dm63 like fixed for floating? $\endgroup$
    – rupweb
    Oct 1, 2017 at 20:17
  • $\begingroup$ No, floating for floating. Euribor versus eonia is one example. They are both floating rates. $\endgroup$
    – dm63
    Oct 1, 2017 at 21:43

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