How FX Swaps Affect Spot Exposure and Currency Basis

Summary

The answer distinguishes the spot-market effects of outright forwards and FX swaps used to hedge foreign investments. It says forwards can have a substantial effect on spot, while swaps generally carry much less direct spot delta. As an illustration, it reports that a 100 million US dollar swap against Mexican pesos has spot delta below 1 million US dollars for tenors shorter than a year in the cited market environment.

The response emphasizes that low direct spot exposure does not mean swaps have no market impact. Large swap transactions can move the funding basis between the currency pair, changing the cost of carry for maintaining a spot position and the pricing of an outright forward. The example is specific to the currencies, tenor, and rate environment mentioned; it is not presented as a universal conversion rule. The document gives a qualitative mechanism rather than a full explanation of hedge accounting or the mechanics of a particular fund’s transactions.

Key ideas

• FX forwards can have a larger direct spot impact than FX swaps, according to the answer.
• An FX swap can have relatively small spot delta despite a large notional amount.
• Large swap flows can affect the funding basis between two currencies.
• Changes in the basis influence spot carry costs and outright forward pricing.
• The numerical illustration is tied to a particular currency pair and market environment.

Tags

# FX hedged investments


# FX hedged investments












I was reading FX hedged investments do not have an impact on the FX rate. For example, a Japanese fund buying US treasuries fully FX hedged. I understand the hedging is usually done through short term FX swaps/forwards. Would you be able to explain why acquisition of foreign currency assets does not have an impact on the FX rate when the investment is FX hedged?

## Answer by river_rat (score 1)

https://quant.stackexchange.com/a/64022

Forwards have a large impact on the spot market, swaps much less so. For example a 100m usd swap against mxn has a spot delta of less than 1m usd for all tenors less than a year ( and actually quite a bit longer in the current rate environment).

Where swaps do impact the spot market is in the cost of carry, large swap transaction drive the funding basis between the currency pairs in question and that determines the cost of keeping the spot position open or the price of the outright forward.

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