Dollar Swaps

A FX (forex; foreign exchange) swap is essentially a foreign currency loan secured by domestic currency collateral. You can think of it as an agreement to simultaneously borrow one currency and lend another at an initial date, then exchanging the amounts at maturity. It is useful for risk-free lending, as the swapped amounts are used as collateral for repayment.

There are two legs to every FX swap: first, a spot transaction, where the parties swap amounts of the same value in their respective currencies at the spot rate (exchange rate), and a forward transaction at the predetermined forward rate at maturity. The parties swap amounts again, so that each party receives the currency they loaned and returns the currency they borrowed.

FX swaps are useful for borrowing/lending amounts without taking out a cross-border loan. It also eliminates foreign exchange risk by locking in the forward rate, making the future payment known. Another similar type of swap (a cross-currency basis swap) eliminates interest rate risk.

The FX Swap market is enormous, with estimates of daily dollar-denominated volume around $3.2 trillion. And, as we can see from the fourth image (source), despite global central bank dollar reserves only around 60%, the dollar continues to dominate 88% of all FX transactions – trillions of dollars swapped and exchanged between international banks every day.

Walking that volume back during peacetime would take a slow-bleed over decades.

(If interested, we also have several videos on FX swaps)