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I am currently trying to compute the P&L of a FX swap and to understand it's implications.

Let's say when we sell 1M EUR spot eur/usd at 1.08 and at the same time buy a one month month forward eur/usd at 1.10. Then the net cash flow would be + USD $ 16,835. I have a few questions on this.

1.) Is this a P&L gain ?

2.) If it is, is the gain due to the interest carry of swap points as USD has a higher interest rate than EUR ?

3.) If I want to enter a speculation fx swap trade that the EUR interest rate will increase in one month versus the USD interest rate, then should I enter a fx swap to buy eur/usd at the near leg and sell EUR/USD opposite at the far leg ?

Thank you for your help and appreciate your explanation.

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1) no, EURUSD is quoted as USD per Euro. Therefore if you sell 1M Euros for 1.08 and buy them back one month forward for 1.10 you will lose USD 20,000.

2) during the month you will have to pay interest on the Euros you borrowed and receive interest on the dollars you own , which will be a net positive.

3) it sounds like you want to sell EURUSD 2mo forward versus buying it 1M forward. Say the 2mo rate is 1.12 and the 1Mo is 1.10. Then if the interest rates converge , these two rates would converge , delivering you a profit.

I’ve ignored the complication of the currency basis for the sake of clarity.

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  • $\begingroup$ Thank you dm63. I am just wonder if you can illustrate more on point 3 ? Also, I notice that some traders will trade fx swap which results in negative cash flow such as the trade illustrate in point 1. Why would they do so ? Is it some kind of speculation ? Thank you and appreciate your help. $\endgroup$ – kit Apr 5 at 14:25
  • $\begingroup$ The P&L is going to be the sum of -20000 from answer part 1) plus the net interest from answer part 2). Under the no longer accepted CIP Theory the Net interest in (2) would be exactly +20000, so the overall P&L would be zero. In reality, because of the currency basis dm63 mentioned, it will be less than that and the overall P&L will be a slight loss. You can interpret it as a "penalty" for borrowing USD, the world's Reserve Currency via an FX swap. Some traders who need to borrow USD may indeed be willing to pay this penalty/premium. $\endgroup$ – noob2 Apr 6 at 10:38
  • $\begingroup$ Thank you noob2. Why would I need to include interest in the P&L ? If I already have the base currency which in this case the EURO, then I don't need to borrow, then would my P&L be just the lost of 20k ? Thank you. $\endgroup$ – kit Apr 9 at 14:12

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