Swap Rates | Forex Rollover

When rolling a position over to a new value date (to "the next day"), an operation called Swap is performed – the company charges or pays a certain amount depending on the interest rate differential between the two currencies involved in the transaction, on its direction and volume.

Swap Rates: How Rollover Works

Swap operations emerge in the “very top” of the currency market that is in the Interbank Market, and then go down affecting all levels of its hierarchy.

When making a deal to buy/sell a currency, the parties commit themselves to make final payments on the day, called Value Date. In the Spot market the settlement is carried out within two working days following the transaction. Thus, for example if a position is opened on Monday, the settlement is made not later than on Wednesday.

If a position remains open and is rolled over to the next day, in terms of mutual settlements, it means that the value date is transferred to a day ahead. The corresponding volumes of currencies involved in transaction are lent and borrowed in the interbank market at current deposit and credit interest rates.

Gains from lending and costs of borrowing are transferred to the client:

  • - The position is either re-opened automatically at a new, adjusted to swap, price and a new value date
  • - Or the position is left with the previous price, but the swap is credited to or deducted from the client’s account.

The cost of the rollover, or more precisely saying, its volume and sign, depends on the interest rate differential between the two currencies of the transaction. Normally, deposit and credit rates on the same currency are different (credit rate is usually higher). That is why the costs of rolling long and short positions over on the same currency pair are different.

When the Rollover is beneficial for a trader?

From the client’s perspective, the higher the rate for the currency purchased and the lower the rate for the currency sold, the more beneficial the position rollover will be. Swap rate is credited to the client’s account in case the applicable interest rate of the currency purchased is higher than the applicable rate for the currency sold. Alternatively, Swap rate is deducted from the client’s account.

What Should Be Taken into Consideration

Obviously, Swap conditions offered by different companies may vary dramatically: the cost of the position rollover on the same trading instrument sometimes is quite different. The question is how far a company has stepped away from the current rates of interbank market in Swap calculation.

Since the position is rolled over to a day ahead, these are Overnight Rates, which reflect the current situation in the money market and provide the most favorable Swap conditions for the client. However, if a company is far from the upper levels of the hierarchy of the market, the cost of the rollover gets worse for the clients just because each new level of the hierarchy adds to rollover costs its own interest; that is why real Forex Swap Rates may differ significantly from the interbank rates.

Other companies, providing trading services, often set their interest as a fixed percentage when calculating Swaps, thereby worsening conditions for the Client. The amount of such additional "commission" in different companies may also vary substantially.

When studying the conditions of Swap operations, it is also worth to pay attention to the difference between Swaps for Long and Short Positions. The greater the difference, the greater interest is added in the calculation by a company, because the spread between overnight deposit and credit rates is usually low in the interbank market, especially for liquid currencies.

When Swap Rates are Important

Swap operation is performed once a day, so the conditions of rollover are especially important for those who hold positions open for a considerable period of time, focusing not on intraday price fluctuations, but on more continuous movements, for clients who open strategic positions and trade on the trend on the basis of fundamental changes in the market.

In addition, favorable Swap conditions have a vital importance for clients using Carry Trade strategies. These strategies are based precisely on the interest rate differential between currencies, with borrowing in a currency with a lower rate, and depositing in a currency with a higher rate.

One more example of the “Interbank” Swap importance for the client is the case of lock mode hedging. Imagine that the client has opened a position expecting a certain movement in the market, but it has not begun yet. The client may wish to hedge the position through opening an opposite one (without closing the first position). Then the low spread between the rates, ensured by the “Interbank” Swap, will minimize the cost of maintaining such positions.

See an example of Swap Calculation for the Currency Pair AUDUSD

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