A synthetic financial instrument is a combination of two or more instruments, designed to replicate the cashflows from another instrument.
A synthetic two-year deposit can be built from a simultaneous combination of:
- A one-year deposit to start today and
- A forward contract to re-deposit the maturing proceeds after one year, at a pre-agreed rate for the second year.
A synthetic forward foreign exchange contract can be built from a simultaneous combination of:
- A spot foreign exchange contract
- A borrowing in one of the currencies and
- A deposit of equal maturity in the other currency.