Swap - what is it in simple terms?
Swap - what is it in simple terms?

Video: Swap - what is it in simple terms?

Video: Swap - what is it in simple terms?
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Forex trading requires knowledge of certain terms. One of them is "swap". What is it and why is it needed, read on.

Definition

Swap is the transfer of open trades through the night. It can be positive (commission charge) and negative (commission write-off). Most often, this operation is resorted to when concluding medium- and long-term transactions. Swaps are not charged during the day.

How the swap is formed

Every weekday at 01:00 Moscow time, all open trades are recalculated, that is, they are first closed and then reopened. For each of them, a swap is charged based on the current refinancing rate. The smallest percentage is provided for popular pairs (dollar / euro, pound / euro, etc.). Refinancing rates are presented per annum. But the interest rate swap is charged daily. Forex does not work on weekends. Therefore, from Wednesday to Thursday, a triple rate is charged.

swap what is it
swap what is it

What is a "swap" in simple terms?

To better understand the essence of the swap, you need to understand the mechanism of the trader. Forex provides quotes (price ratio) of currency pairs. When buying a EUR/JPI pair, two transactions occur simultaneously:euro and Japanese yen for sale.

But how can you buy a currency that is not available, having dollars or rubles in your account? The answer is simple - using swap. What it is? Let's take a closer look at what operations are performed when a trader presses the "Open order" button in the terminal under the conditions of the previous example.

  1. The Central Bank of Japan issues a loan at the refinancing rate.
  2. The received currency is immediately exchanged for the euro. The amount does not pass into the hands of the investor. She stays at the bank. Interest is charged on it.
  3. The Bank of Japan loan is repaid with interest received from the European Bank. The difference between these rates is the credit swap.

Positive and negative swap

Suppose an investor is long EUR/Yen. When making a transaction, first the euro interest rate is charged (0.5%), then the yen rate is subtracted (0.25%): 0.5% - 0.25%=0.25% - there is a positive swap. If the yen rate is 1%, the swap will be negative. This is the main principle of working on Forex.

interest rate swap
interest rate swap

It's important to know

You cannot make or lose all profits through a swap. What it is? The high leverage offered by brokers and the large price fluctuations will offset the impact of a small swap rate, even if it is negative. But extending your position just because of the positive difference in refinancing rates is not worth it. For breaking the rules"intraday" trading will have to pay with your deposit.

Views

Besides the FX swap discussed above, there is also a credit default swap (CDS). From the name it is clear that this operation is connected with the provision of a loan for exchange operations in the conditions of default.

credit swap
credit swap

In simple terms, a credit default swap is an analogue of insurance for a creditor. When a bank with a small amount of capital plans to issue a large loan to a reliable client, it must protect itself in case of default. Therefore, in addition to credit, he concludes a risk protection agreement with a larger financial institution at a certain percentage. If the borrower does not return the funds, the lender will receive compensation from another institution.

Swap transactions are carried out according to the same principle. The buyer is exposed to the risk of non-return of funds, and the seller is ready to compensate him for a fee. The first party gives the second all debt securities and receives funds on account of the issued loan. Payment can be a lump sum or divided into several parts. In one case, the seller repays the difference between the current and nominal value of the obligations, in the second, he buys the asset from the buyer.

CDS Benefits

The main advantage of this operation is that there is no need to create a reserve. In the example above, the bank must create a reserve in case of default by the borrower, which will severely limit other operations. Insuring their risks, the buyer is freed from the need to distractfunds from circulation.

CDS allows you to separate and better manage credit risks.

credit default swap
credit default swap

CDS VS: Insurance

The subject of a CDS transaction can be any obligation. For example, you can insure the risk of non-fulfillment of delivery conditions. Consider an example.

The buyer transferred an advance payment of 80% to the equipment supplier in another country. Delivery must be made within two months. The term is long, and therefore there is a risk of unpredictable situations, loss of funds. In such a situation, the buyer can insure his risks with the help of CDS.

The law does not provide for the formation of reserves in cases of providing protection through a swap. Therefore, it costs less than insurance. The reliability of the seller is assessed only by the buyer of the swap. What it is? A license to operate is not required. CDS is not controlled by the regulator, exchanges, so its registration is associated with fewer formalities. Any organization or individual with the appropriate capabilities can become a seller of protection - a company, a bank, a pension fund, etc.

credit default swap
credit default swap

CDS can be applied even when the buyer does not have direct agreements with the borrower. For example, if a company purchases bonds in the secondary market. There is no impact on the borrower, and it is difficult to assess the probability of its default.

Swap in the international market can be used even when there is no real credit risk. In this case, we are talking about non-fulfillment of obligations by states(sovereign risk). Theoretically, you can also purchase protection against non-payment of a mortgage, the contract for which has not yet been concluded, and it is not known whether it will be concluded. But there is practically no point in such insurance.

CDS in financial crisis

The new instrument immediately attracted the attention of speculators. The market was on the rise, default was not expected. Why not take advantage of "free" money? The situation changed in 2008. Banks could not service their debts and began to go bankrupt one after another. The fifth largest bank in the US, Bear Stearns, was sold in 2008 for a nominal sum, and the collapse of Lehman Brothers is considered the beginning of the active phase of the financial crisis.

The insurance company AIG was saved at the expense of the US government. Of all the swaps issued ($400 billion), the banks alone needed to transfer $22.4 billion. Every financial institution on Wall Street had both large CDS claims and liabilities. The state first of all rushed to save the largest institution - JP Morgan Bank, but not directly, but through corporations that bought up financial toys.

swap simple
swap simple

In order for all buyers of CDS to receive satisfaction, it would be necessary to declare a total default of the largest banks in the US and Europe. Wall Street, the City of London would simply cease to exist. Even before the crisis, Warren Buffett called all derivatives "weapons of mass destruction." The collapse of the financial system was only averted by an infusion of public funds. Despite all the consequences of the crisis, the CDS "bomb" did not explode, but onlymade itself felt.

Disadvantages of CDS

All the described benefits are practically unrelated to market regulation. Given the trend towards tightening control over financial institutions, over time, all of them will be lost. The crisis of 2009 prompted government agencies to revise the norms in the field of financial regulation. It is likely that the Central Banks will introduce mandatory reserves under the protection of sellers.

Default swap will not solve the problem of default of financial obligations. During a crisis, the number of defaults increases. The risk of bankruptcy not only of companies, but also of the state is increasing. During such periods, buyers of swaps try to collect payments from sellers. The latter are forced to sell their assets. This vicious circle only exacerbates the crisis.

swap operations
swap operations

Swap-free accounts

The value of refinancing rates is important to consider when opening a position for a long period (2-3 weeks). In such cases, it is better to use swap-free accounts. They are in demand with every broker. However, brokers compensate for the lack of a credit rate with additional commissions.

Conclusion

Briefly summarizing all of the above about the swap. What it is? Swap is the difference in interest rates of the Central Bank, which is charged daily on all open positions. For popular world currencies, this influence is almost imperceptible. But when opening a long position in "exotic" currencies of third world countries, it is better to immediately transfer funds to swap-free accounts.

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