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Using an FX Swap to Fund a Foreign-Currency Bond Purchase

Article Quant Q&A · Author: RiffRaffCat
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Summary

The document illustrates how a company with dollars can use an FX swap when it needs francs to settle a bond purchase and later expects to receive foreign-currency proceeds. In the example, the company exchanges dollars for francs for near-term settlement, uses the francs to buy a discounted franc-denominated bond, and agrees to exchange francs back into dollars at a forward rate on the bond’s maturity date.

The answer describes the transaction as an attempt to earn FX carry and identifies a third party that may broker the swap or act as counterparty. It gives illustrative spot and forward rates and calculates the resulting dollar proceeds against the initial dollar amount. The example assumes a zero-coupon bond, specified settlement timing, and a particular forward quote; it does not establish that the trade is profitable after transaction costs, credit exposure, collateral, or differences between the bond’s cash flows and swap dates. It also does not provide a full comparison with borrowing francs directly or discuss the risks of the bond investment.

Key ideas

  • An FX swap combines a near-term currency exchange with an agreed reverse exchange at a future date.
  • The near leg can provide the foreign currency needed to settle a bond purchase.
  • The forward leg can convert the bond’s foreign-currency proceeds back into the company’s home currency.
  • The example links the potential return to the forward exchange rate and describes a broker or counterparty role.
  • Settlement timing, transaction costs, credit exposure, and bond risks can affect the trade’s actual result.

Tags

ForexFixed incomeCarryExecution
Full text
# How currency swap works for big companies bond and cash management


# How currency swap works for big companies bond and cash management












Suppose a big company A holds 10 Million USD at T+0, and A knows that it will pay 9.9 Million CHF to buy a bond at T+1, why would company A be willing to enter a currency swap to buy CHF and sell USD at T+0, and then sell CHF and buy USD at T+1? Does this involve a third party financial intermediary and another counterparty? Is this used for FX exchange risk? Is company now borrowing 10 Million USD to do the currency swap or using the 10 Million USD on its hand to do the swap? Can someone offer me a numerical example to show the mechanism of such overnight or T+2 currency swap?

## Answer by AlRacoon (score 1, accepted)

https://quant.stackexchange.com/a/49543

This would be a trade for Company A to earn the FX Carry.

Assuming the CHF denominated bond is a 0 Coupon discount bond with a face value of 10MM CHF, is purchased at t and settles t+1.

The company will buy the bond and then do the following FX Swap:

1) Leg 1: Buy 10MM USD worth of CHF for quick settlement on t+1 (normal settlement of CHF is t+2); In other words, they will sell 10MM USD and receive 9.9MM CHF (Spot USDCHF is .99). They will have sold 10MM USD and will no longer have it on t+1. The 9.9MM CHF will be used to purchase the CHF denominated bond.

2) Leg 2: Sell 10MM CHF forward at the maturity date of the bond. On the maturity date they will receive USD. (example: say 30 day USDCHF forward is bid at .985, they will receive 10.152284MM USD at maturity).

The company will then earn 10.152284MM - 10MM = 0.155584MM USD over the 30 day investment.

This will involve a 3rd party, which will either broker your FX Swap or be the counterparty to the FX Swap itself.

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.