FX · X7 · 9 min
FX swaps, funding and carry
Use an FX swap to borrow one currency against another, work out what rolling a position earns, and see what a carry trade risks.
In the news: “The yen jumped as carry trades unwound”: borrowing in one currency to hold another, and how it goes wrong.
The essentials
- FX swap
- A spot exchange and an opposite forward agreed together: in effect a loan of one currency backed by another. The two legs nearly cancel the exchange-rate risk, so a swap trades the gap between the two interest rates.
- Near leg and far leg
- The near leg is usually at spot; the far leg is the near rate plus the swap points. A near leg at 1.2700 with points of −22 gives a far leg of 1.2678.
- Uneven swaps
- If the legs differ in size, the difference is an position with exchange-rate risk: buy £10m spot and sell £12m forward, and you are short £2m for the forward date.
- Tom/next and short swaps
- Traders keep a spot position open by rolling it a day at a time with a swap. Other short swaps run overnight (today to tomorrow), spot/next and spot/week.
- Carry
- What each roll pays or costs: a day’s interest gap. Long $10m against euros with dollars paying 2 points more earns about $556 a night; long the lower-yielder, it costs you. A Friday roll covers three nights.
- The carry trade
- Borrowing a low-rate currency to hold a high-rate one. It breaks even if the high-yielder falls by the rate gap over the period held; in a rush to exit, the jumps, as the yen did in August 2024.
Swap far leg and daily carry
Far = near + points × pip; carry per night ≈ N × rate gap ÷ 360
- points
- swap points, negative when the first currency pays more interest
- pip
- 0.0001, or 0.01 in yen pairs
- N
- size of the position
- rate gap
- rate on the currency you hold minus the one you owe (use 365 for sterling)
How it works
1. Borrowing one currency with another
A Japanese insurer has yen but needs dollars for a year. It hands over yen for dollars today and agrees now to swap them back in a year at a fixed rate. That pair of trades is an : in effect a loan of dollars, backed by the yen.
2. Near leg and far leg
The first exchange is the near leg, usually at spot. The second is the far leg, at the near rate plus the swap points, which work like the from the last lesson. A near leg at 1.2700 with points of −22 gives a far leg of 1.2678.
3. What a swap really trades
Almost the same amount goes out and comes back, so a move in the exchange rate barely matters. What a swap trades is the gap between the two currencies’ interest rates, through the points. That makes it the cheapest way to borrow a currency, and the most traded FX product.
4. Rolling a position each day
Traders rarely take delivery of currency. To keep a spot position open, they roll it a day at a time with a swap: close it for tomorrow and reopen it for the day after. Other short swaps run overnight (today to tomorrow), spot/next (spot to the next day) and spot/week (spot to a week later).
5. Carry: what the roll pays
Each roll pays or costs a day’s interest gap, the carry. Long $10m against euros, with dollar deposits at 4% and euro deposits at 2%: carry ≈ $10m × 2% ÷ 360 = $556 a night. Long the lower-yielder, it costs you. A Friday roll covers three nights.
6. Uneven swaps
If the two legs differ in size, the difference is an ordinary forward position. Buy £10m spot and sell £12m forward, and you are left short £2m for the forward date. That part does carry exchange-rate risk.
7. The carry trade
A borrows a currency with low interest rates to hold one with high rates, earning the gap. With a 4% gap held for a year, it makes money unless the high-yielder falls more than 4%, which is where the sits.
8. Why carry trades unwind
Carry pays small, steady amounts but loses in jumps. When markets get scared, many holders exit at once, the (the one borrowed) jumps, and months of carry can go in days, as the yen’s sharp rise did in August 2024.
Try it
Widen the gap between the two interest rates: the points, and the carry they pass on, grow with the gap and with time.
- Forward, 3m
- 1.2670
- Forward points
- −29.8
- Sterling trades at
- A discount
| Tenor | Outright forward | Forward points |
|---|---|---|
| 1 week | 1.2698 | −2.3 |
| 1 month | 1.2690 | −9.9 |
| 2 months | 1.2680 | −20.0 |
| 3 months | 1.2670 | −29.8 |
| 6 months | 1.2641 | −58.9 |
| 9 months | 1.2613 | −87.4 |
| 1 year | 1.2584 | −115.6 |
Sterling deposits earn more over 3 months, so sterling trades at a forward discount: the forward gives 29.8 pips fewer dollars per pound than spot, which takes back the extra interest. The higher-yielding currency trades at a forward discount.
Route 1: deposit pounds, sell them forward
£1,000,000 at 4.50% → £1,011,219, sold at 1.2670 → $1,281,236
Route 2: sell pounds now, deposit dollars
£1,000,000 at 1.2700 → $1,270,000, at 3.50% → $1,281,236
Worked example
You are long £10m against dollars, spot 1.2700. Sterling deposits pay 4.50% (out of 365 days) and dollar deposits 3.75% (out of 360). It is Friday, so the tom/next roll covers three nights.
- Sterling interest earned: £10,000,000 × 4.50% × 3 ÷ 365 = £3,699.
- Dollars owed: £10m × 1.2700 = $12.7m.
- Dollar interest paid: $12,700,000 × 3.75% × 3 ÷ 360 = $3,969.
- In pounds: $3,969 ÷ 1.2700 = £3,125.
- Carry: £3,699 − £3,125 = about £574.
About £574 for the weekend roll.
Check yourself
8 quick questions on the explanation above.
Practice
New numbers every set. Misses and guesses go into your review deck.
In the interview
Answer out loud in under a minute, then compare.
What’s an FX swap, and why is it the biggest product in FX?
How does a trader carry a spot position overnight?
Explain the carry trade and what makes it unwind.
Remember
Carry per day ≈ N × rate gap ÷ 360
An FX swap trades the interest gap, not the exchange rate; carry pays you to wait, until a jump in the funding currency takes it back.
Sources
- Bank for International Settlements — The market turbulence and carry trade unwind of August 2024 (BIS Bulletin No 90)
- Bank for International Settlements — Global FX trading hits $9.6 trillion per day in April 2025 and OTC interest rate derivatives surge to $7.9 trillion: Triennial Survey
Definitions and maths are standard textbook material; dated facts link to the sources above. Worked numbers are illustrative.