A bank can do away withcurrency exposedthrough accommodation of forward transaction of a client by swap transaction. Swap transactions give a way to the bank to alleviate the exposure of currency in a forward trade. A swap transaction refers tosynchronous sale (or purchase) of spot foreign trade against a forward purchase (or sale) of a roughly equal amount of the foreign currency (Young, 1987). A swap can also be defined as the agreement that is conducted between two varying parties which aims at exchanging succession of cash flows for a certain set period of time. In such situations, as a contract is initiated one or more series of cash flows which are determined by random or certain variable which may be interest rate or foreign exchange rate or maybe commodity price (Gibson, 1998).Recently, swaps have increasedsuch that they currently include currency swaps and interest rate swaps.However, to illustrate how the bank can take out the currency exposure created, assume a bank client needs to purchase dollars three months forward against British pound sterling. The bank can deal with this exchange for its client and all the while kill the conversion scale hazard in the exchange by offering (acquired) British pound sterling spot against dollars. The bank will loan the dollars for three months until they are expected to convey against the dollars it has sold forward. The British pounds obtained will be utilized to liquidate the sterling loan. As such it will accommodate a customer’s forward transaction thus will have eliminated the currency exposure. Swaps transactions if conducted properly provide with methods of receiving a type of financing which would otherwise be lacking (Young, 1987).
Young, M. D., & Stein, W. L. (1987). Swap transactions under the commodity exchange act: is congressional action needed. Geo. LJ, 76, 1917.
Gibson, W. E. (1998). Are swap agreements securities or futures: The inadequacies of applying the traditional regulatory approach to otcderivaties transactions. J. Corp. L., 24, 379.