Swaps

Can profits be made by taking advantage of Forex interest rates?
In the Forex market, swaps refer to the process of simultaneously opening two opposite positions worth the same amount of money, but with different settlement dates. This is done whenever a trader intends to keep open a position overnight to gather interest. Depending on the difference between the interest rates of each of the currencies involved, the amount can be positive or negative.

This works by purchasing or selling a currency pair where the currency being bought will act as the deposit and the one being sold will act as the credit. If the deposit is entitled to an interest rate that is higher than the credit, the positive difference between them will equal the amount that will be added to the trader’s account overnight. On the other hand, if the difference negative, then that swap amount will be deducted from the account overnight.

To make this clearer, let’s use it in an example.

Let us say that the euro has an annual interest rate of 1% while the US dollar has 0.25%. I buy 10,000 units of the currency pair quoted as EUR/USD 1.2310 and keep it open overnight. To find out how my account will change tomorrow, I will have to compute for the swap amount.

First off, the difference between the two rates is positive 0.75%, with the deposit being greater than the credit. This means that an amount should be added to my account later on.

I then calculate the value of the position by multiplying the number of units (10,000) by the price ($1.2310) to end up with $12,310. I then multiply the value by the interest rate of 0.0075 to end up with $92.325, the yearly swap amount. To get the amount it will add each day, I divide it by 365 to come up with $0.25.

This strategy works the most when the two currencies involved have a large difference between their interest rates. This is true for pairs such as NZD/JPY and AUD/JPY.