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Replicating a One-Year FX Forward with Swap Markets

Article Quant Q&A · Author: Riser
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Summary

The question sets up a one-year USDMXN forward hedge using quoted USD and Mexican peso swaps, cross-currency basis swaps, and spot FX. It asks how to hedge a forward sale by laying out the required transactions, their directions, and tenors, assuming borrowing and lending at the three-month USD reference rate. This frames forward replication as a combination of spot currency exchange and funding cash flows in each currency.

The supplied answer only points to the domestic swap quotes as a way to calculate a forward price; it does not provide the transaction sequence, cash-flow schedule, or hedge directions requested. As a result, the document offers little worked detail and does not establish a complete replication method. The market conventions and quoted rates form a specific setup, so applying the idea elsewhere would require matching settlement dates, payment frequencies, day-count rules, and basis spreads before constructing the hedge.

Key ideas

  • An FX forward can be related to spot FX and funding rates in the two currencies.
  • The setup includes domestic swaps and cross-currency basis swaps to represent the relevant funding markets.
  • A complete replication requires explicit transaction directions, maturities, and cash-flow dates.
  • The answer is incomplete and does not lay out the requested hedge.

Tags

ForexFuturesArbitrageDerivatives pricing
Full text
# Replicate by Arbitrage price of a forward


# Replicate by Arbitrage price of a forward












Given market(Mid):

1- USD Swap market (fixed for float). Float leg pays 3MLibor quarterly, act360. Fixed Leg pays annually, act360. Market is trading mid at 1.125%.

2- TIIE market. Fixed for float Swap. Float leg pays TIIE4W every 4weeks, act360. Fixed leg pays annually, act360. Market is trading mid at 4.25

3- 3MLibor vs 12MLibor USD basis swap. 3ML quarterly, act360 is exchanged for 12MLibor+S, annual, act360. The market for the spread is at mid -0.625%

4- XC Basis swap. 4WTIIE, paid every 4weeks vs 12MLibor+S. The spread S market is 1.

5- Spot FX, MXNUSD trading at 0.0505, Settlement T+0.

Q :You sell USDMXN 1Y fwd at mid: lay out the transactions needed to hedge the 1Y USDMXN fwd showing direction, tenor

Assuming you can borrow/lend at 3MLibor

How to approach this problem?

## Answer by user13524 (score 0)

https://quant.stackexchange.com/a/15399

You can make the use of 1 and 2 to calculate forward price

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.