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Rolling FX Swaps to Hedge Long-Term Foreign-Currency Assets

Article Quant Q&A · Author: Student
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Summary

The example describes a euro-based investor buying US Treasuries while hedging the dollar exposure with short-term FX swaps. At the outset, the investor purchases the Treasury and enters a one-year swap: dollars are received and euros paid at the near date, with the opposite exchange at the forward date. The stated exchange rates imply a euro amount due at maturity that differs from the initial amount.

At the end of the year, the investor enters another swap using the then-current spot exchange, exchanging the maturing euro amount for dollars and agreeing a new one-year forward exchange. The example illustrates how the hedge is rolled while the Treasury position continues. It is only a simplified cash-flow illustration: it does not explain valuation, collateral, transaction costs, changing asset values, or how hedge ratios should be adjusted over time.

Key ideas

  • The investor hedges a dollar-denominated Treasury position by entering an FX swap against euros.
  • The initial swap exchanges dollars and euros near term and reverses the currencies at a later forward date.
  • At maturity, a new swap can be entered using the then-current spot and forward rates.
  • The example illustrates rollover cash flows but does not address costs, collateral, or changes in the asset exposure.

Tags

ForexFixed incomeRisk managementDerivatives pricing
Full text
# Hedging with FX swaps


# Hedging with FX swaps












I am trying to get the mechanic of the swap rollover. Funds usually hedge FX risk of their long term foreign assets (eg UST) with short term FX swaps (usually maturity < 1yr), by rolling over fx swaps during the life of the trade. Can you show with a numerical example how the process works?

## Answer by dm63 (score 3)

https://quant.stackexchange.com/a/63081

Simple example: euro based investor wants to buy a USTreasury, currency hedged back into Euro. Investor executes the following 2 trades at t=0:

- purchase Treasuries for next day settle. Assume usd12mm purchase price.

- execute fx swap with cashflows at t=0 : receive usd12mm/pay €10mm and cashflow at t=1yr : pay usd12.0mm/ Rec €9.9mm. (I used spot =1.20 and forward =1.21).

In 1yr, execute the following fx swap : Rec usd12mm/ pay €9.9mm for spot , pay usd12mm/ rec €9.8mm for one year forward. Etc.

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.