How Spot and FX Swap Legs Create an MXN Carry Position
Summary
The document describes a peso carry trade built by buying MXN in the spot market and entering an FX swap that sells MXN spot and buys it forward. The paired spot transactions offset, while the forward leg creates exposure to supplying dollars through the derivatives market. The cited explanation characterizes the resulting position as short USD and long MXN, without an offsetting foreign-currency demand hedge, and notes that short maturities require repeated rollover.
The answers add that some accounts use swaps to roll a spot position rather than take delivery, and that the combined legs are economically equivalent to an outright MXN forward. These points explain the trade’s implementation and its connection to conventional carry trades, but the discussion does not quantify returns, funding costs, or the risks of a particular trade. The exchange also leaves open why a trader might choose the two-step swap structure instead of an outright forward.
Key ideas
- Buying MXN spot and selling it spot through an FX swap cancel each other in the spot market.
- The forward leg creates a short USD and long MXN exposure in the FX derivatives market.
- A short maturity means the position must be rolled, creating rollover risk.
- The combined spot and swap transactions are equivalent to an outright MXN forward.
- Some investors may use swaps to avoid taking delivery of the spot position.
Tags
Full text
# Trying to understand a carry trade
# Trying to understand a carry trade
Usually, carry trades involve borrowing in a low-yield currency and investing in a high-yield currency. For example, I borrow dollars and invest in Brazilian real (BRL), then use a rolling FX swap to hedge the FX risk (e.g., sell dollars spot and buy them back forward).
Recently, I read about a different carry trade on the Mexican peso (MXN) that involves the following steps:
- buy spot MXN
- enter a FX swap where you sell MXN spot and buy it back forward
From page 23 of a BIS paper$^\color{magenta}{\star}$,
> Carry trades (often implemented by hedge funds) would shift foreign currency provision from spot to FX forward markets. If MXN is the destination currency, market intelligence indicates that foreign investors would usually buy MXN spot, then implement an FX swap selling MXN spot and buying MXN forward. Here FX supply in the spot market is unchanged (the spot transactions cancel out), but foreign investors commit to supply USD in the FX derivatives market, as a result of their USD short/MXN long position. In the case of a carry trade, this position would be unhedged (there is no offsetting demand for foreign currency) and of very short maturity, thus implying rollover risks.
Would you be able to explain the rationale behind this?
$\color{magenta}{\star}$ Bank for International Settlements, Foreign exchange liquidity in the Americas, March 2017.
## Answer by user42108 (score 2)
https://quant.stackexchange.com/a/61333
"Would you be able to explain the rationale behind this [buy spot...enter a FX swap where you sell spot and buy it back forward]?"
Very few accounts want to take delivery of a spot position therefore they roll via the swap.
## Answer by nbbo2 (score 2)
https://quant.stackexchange.com/a/61349
Buy MXN spot and then swap MXN spot with forward is equivalent to an outright forward in MXN.
Outright forwards are one well established way of implementing the Carry Trade.
Why they prefer to do it in 2 steps rather than one, I don't know.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.