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Banks find it necessary to accommodate their clients’ needs to buy or sell FX forward, in...

Banks find it necessary to accommodate their clients’ needs to buy or sell FX forward, in many instances for hedging purposes. How can the bank eliminate the currency exposure it has created for itself by accommodating a client’s forward transaction?

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A bank can eliminate currency exposure by using swap transactions. This transaction involves the simultaneous sale (purchase) of spot foreign exchange against a forward purchase for an equal amount of foreign currency. For example:- suppose a bank customer wants to buy dollar three months forward against British pound sterling. The bank can handle this trade for the client and simultaneously neutralize the exchange rate risk by selling British Pound sterling against dollar. The bank will lend the dollars for three months until they are needed to deliver against the dollars it has sold forward. The British pounds received will be used to pay the sterling loan.

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