imported>Doug Williamson |
imported>Doug Williamson |
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| (FX swap). | | (ZCB). |
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| A composite over the counter foreign exchange transaction.
| | Securities which pay no intermediate coupons, but only a redemption amount, so that the whole of the return to investors is represented by their capital gain from their investment date to the redemption of the bond at its final maturity. |
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| ===Definition of FX swaps===
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| A foreign exchange swap is a composite over the counter (OTC) foreign exchange transaction which involves:
| | This may be beneficial for some taxpayers, especially high-income individuals. Historically, capital gains have been taxed less heavily than income in many tax systems. |
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| (A) An exchange of two different currencies
| | More recently, some of the historical differences in tax treatment - and the related tax planning opportunities - have been reduced. |
| #on a specific 'near leg' date
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| #at a fixed foreign exchange rate which is pre-agreed at the outset of the contract; and
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| | | For example, the UK Corporation Tax treatment is now more aligned with the accounting treatment of spreading the total gain across the whole life of the bond. |
| (B) A reverse exchange of the same two currencies
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| #on a later pre-specified 'far leg' date
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| #at a fixed exchange rate which is usually different and which is also pre-agreed at the outset of the contract.
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| ===Uses===
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| The uses of FX swaps include the transformation of short term borrowings or deposits from one currency into another.
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| ===Amounts of currency===
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| The amounts of currency in the far leg re-exchange are generally greater than those in the near leg, by the amount of interest payable or receivable in the currency which the customer is swapping into.
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| For example, when hedging a deposit with a swap, the far leg amount will usually be greater than the amount in the near leg, by the amount of interest receivable on the swapped deposit. | |
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| Similarly, when hedging a borrowing using a swap, the far leg amount will normally be greater, by the interest payable on the swapped borrowing.
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| As the FX swap is an OTC contract, the provider and the customer are free to tailor the amounts of currency to be exchanged in this way, to meet the customer's individual hedging requirements.
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| ===Pricing===
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| The composite pricing of the FX swap is favourable for the price-taker, compared with the pricing of two related outright contracts, for example for spot exchange and forward re-exchange of the same currency pair.
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| The reason that the market maker can give a better price for the price-taker, is that the market maker is not taking any foreign exchange risk on the composite transaction.
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| The market-maker can hedge its position by a borrowing and a deposit in the two currencies being swapped.
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| The prices and cost for the price-taker therefore only reflect the bid-offer spreads on the hedging interest rate contracts.
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| The market maker does not need to strike any hedging foreign exchange contracts. This saving - of the spread on the hedging FX contract - is reflected in the favourable pricing for the customer.
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| ===FX swap viewed as simultaneous borrowing and deposit===
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| An FX swap agreement can also be viewed as a simultaneous borrowing of one currency, and a lending of the other currency, with the same counterparty.
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| ===Interest rate swaps and cross-currency interest rate swaps===
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| FX swaps should not be confused with [[interest rate swap]]s, nor [[cross-currency interest rate swap]]s, which are both different.
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| == See also == | | == See also == |
| * [[Foreign exchange]] | | * [[Coupon bond]] |
| * [[Swap]] | | * [[Reinvestment risk]] |
| * [[Swap points]] | | * [[Zero]] |
| * [[Spread]] | | * [[Zero coupon]] |
| * [[CertICM]] | | * [[Zero coupon yield]] |
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| [[Category:Manage_risks]] | | [[Category:The_business_context]] |
| | [[Category:Financial_products_and_markets]] |
(ZCB).
Securities which pay no intermediate coupons, but only a redemption amount, so that the whole of the return to investors is represented by their capital gain from their investment date to the redemption of the bond at its final maturity.
This may be beneficial for some taxpayers, especially high-income individuals. Historically, capital gains have been taxed less heavily than income in many tax systems.
More recently, some of the historical differences in tax treatment - and the related tax planning opportunities - have been reduced.
For example, the UK Corporation Tax treatment is now more aligned with the accounting treatment of spreading the total gain across the whole life of the bond.
See also
