How FX Swaps Affect Returns on Foreign Currency Bonds

Summary

The document asks how a USD investor should compare keeping cash in dollars with using a USDJPY FX swap to fund a Japanese bond. It distinguishes the implied yield from the swap from the bond’s yield and asks whether a swap alone could be preferable when its quoted implied yield exceeds the dollar cash rate.

It offers no resolved calculation or answer. The central conceptual issue is that an FX swap converts funding between currencies and its implied rates reflect the relative funding costs; they should not be treated as a standalone investment yield without specifying the cash flows and direction of the transaction. A bond purchase adds the bond’s coupons and price risk, while the comparison also depends on funding terms and costs. The example gives illustrative rates but leaves these mechanics and assumptions unspecified, so it does not establish that the apparent pickup is an arbitrage or that a swap alone earns the quoted rate.

Key ideas

• An FX swap’s implied yield reflects the cost of exchanging funding between currencies.
• A foreign bond’s return must be assessed together with the swap cash flows used to hedge or fund it.
• Comparing a swap-implied rate directly with a domestic deposit rate can omit transaction direction and funding mechanics.
• The question provides example rates but no complete cash-flow analysis or definitive answer.

Tags

# FX Swaps to buy a foreign currency bond


# FX Swaps to buy a foreign currency bond












Lets say we have cash in USD, we can choose to put it in the bank at 3.75%.

Why would we choose to do a USDJPY FX swap to buy a Japanese bond if the Japanese fx implied yield is about 0.8%, then buy the Japanese bond which has yield 1.0% = 20bps pickup. But the USD yield is much higher, 3.75%? I’m trying to understand the reasoning behind choosing the FX swap in this scenario.

And also lets say, If the USDJPY fx implied yield is 4%, but the bond yield is only 1%. No other constraints, so would one just do the USDJPY swap to earn that 4% instead of 3.75%, but NOT buy the bond?

Thank you so much for any insight!

Is it because its a swap, so essentially That 0.8% in the JPY, allows us to change back to USD 3.75%?

So basically the same yield on a swap. Then theres this extra bps that you earn when buying the bond if its a higher yield than the fx swap.

Any clearer explanation is appreciated!

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.