Question

I once was responsible for purchasing DM currency in order to pay a foreign supplier. Rather...

I once was responsible for purchasing DM currency in order to pay a foreign supplier. Rather than buying on the spot market, I would purchase forward exchange contracts.

How is this similar to a SWAP? What is going on that someone is willing to give me a fixed price on a future product or service?

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Answer #1

A single period SWAP is very similar to a Forward contract wherein the assets and cash flows are exchanged. For example in a forward contract, at time t=0, the buyer agrees to buy a certain number of currency at a future date at a price of 100. Now at time T, if the spot price is lower than 100, then the buyer is at a disadvantage while if the spot goes up, seller is at a disadvantage.

A single period swap would also involve similar cash flows and thus is similar to a forward contract. The seller is taking a position based on its estimate of market conditions and believes that price in the future would be lower than the forward price and hence based on that belief is offering a fixed price on a future product.

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