Currency and FX Swaps · Swaps Trading Guide
Cross currency basis helps explain why funding through a swap can differ from a simple comparison of interest rates in two currencies.
Begin with comparable funding
Covered interest parity links spot exchange, forward exchange and comparable interest rates in an idealized setting. Real funding markets include balance sheet constraints, collateral demands and differing access to cash. A cross currency basis quote captures an adjustment relative to the specified benchmark legs. It is not a universal surcharge applied identically to every transaction.
Read the quoted leg
A basis of negative 20 basis points means little until you know the currency leg to which it is applied and whether you pay or receive that leg. If a contract adds that spread to a 3% benchmark, the resulting rate is 2.8%. Receiving that coupon has different economics from paying it. Quote conventions can differ across markets.
Build the all in comparison
Compare borrowing directly in the desired currency with borrowing elsewhere and swapping the proceeds. Include the actual borrowing spread, swap terms, execution cost, collateral funding and any principal exchange. Using a central bank rate as your institution’s borrowing rate can make an apparent saving disappear once realistic financing is included.
Test the refinancing assumption
A cheap short transaction does not lock the same economics for several years. Future basis and dealer capacity can change before rollover. Analyze the amount that must be refinanced during stress and the cost of extending the hedge, rather than assuming today’s basis persists indefinitely.
Try it yourself
A floating coupon is the benchmark plus a basis of negative 0.25 percentage point. If the benchmark is 3.6%, what is the coupon rate?
Show the worked answer
The rate is 3.35%. Whether that is favorable depends on the payment direction and the economics of the other currency leg.
Further reading
Educational material, not a recommendation to transact. Numerical examples are hypothetical and simplify contract terms. Access, documentation, collateral and regulatory requirements depend on the product, jurisdiction and counterparties.
