It is used to realize efficient cash management or to adjust the maturity dates of existing forward contracts.
Handling Surplus and Deficit Cash Positions
The international scope of business conducted by financial and non-financial organization will often require the management of cash flows in more than one currency. From time to time, an entity will find itself with surplus cash balance in one currency and deficit balances in another currency.
Netting of Foreign Exchange Exposures
Organization will often face situations where there are offsetting foreign currency inflows and outflows. The ideal situation in the most cases would occur if the amounts were equal and cash flows materialized on the same day. That seldom happens, however, and mismatches in timings and amounts predominate. If the issue is timing, the problem is a cash management issue similar to topic discussed above. The company may invest the temporary surplus or borrow to fund the temporary deficit.
Alternatively, it may do a cash-management swap. If the problem is not just timing of cashflows, but also different amounts of incoming and outgoing cash, then cash manager may view the difference as one exposure and handle it using forward contracts, currency options, or spot contracts.
Swapping Forward Contracts Forward at Historical Rates
Corporations often face considerable uncertainty in timing and/or amount when forecasting currency cashflows. Forward contracts that were dealt to hedge such flows may mature on a date that does not match the actual cashflow. In such cases, the maturity of the original forward contract creates cashflows for which there is no immediate offset.
Once again, the cash manager can borrow to fund the deficit, invest the surplus, or execute a cash-management swap. Another method to deal with this type of situation is to swap contracts at historical rates. This method involves dealing a swap in whichthe spot sale is dealt at a rate equaling the original forward contract rate. The new forward contract consists of the maturing forward rate adjusted by the current points and a working capital interest factor. .
Historical-rate rollovers have the same basic economic as market-rate saps. They also eliminate the need for any cash settlements on the original maturity date and avoid the accounting problems frequently associated with the FX gain/loss account. On small forward contracts, the actual dollar amount of the net settlement may be small, and cost of settling may be excessive given the amount involved. In other cases, an entity may not have the cash to settle on the swap but still want the swap done.
As a general comment, usage of historical-rate swaps varies from market to market, but this type of swap is not a heavily traded transaction. One of the major reasons is its susceptibility to abuse.
Handling Surplus and Deficit Cash Positions
The international scope of business conducted by financial and non-financial organization will often require the management of cash flows in more than one currency. From time to time, an entity will find itself with surplus cash balance in one currency and deficit balances in another currency.
Netting of Foreign Exchange Exposures
Organization will often face situations where there are offsetting foreign currency inflows and outflows. The ideal situation in the most cases would occur if the amounts were equal and cash flows materialized on the same day. That seldom happens, however, and mismatches in timings and amounts predominate. If the issue is timing, the problem is a cash management issue similar to topic discussed above. The company may invest the temporary surplus or borrow to fund the temporary deficit.
Alternatively, it may do a cash-management swap. If the problem is not just timing of cashflows, but also different amounts of incoming and outgoing cash, then cash manager may view the difference as one exposure and handle it using forward contracts, currency options, or spot contracts.
Swapping Forward Contracts Forward at Historical Rates
Corporations often face considerable uncertainty in timing and/or amount when forecasting currency cashflows. Forward contracts that were dealt to hedge such flows may mature on a date that does not match the actual cashflow. In such cases, the maturity of the original forward contract creates cashflows for which there is no immediate offset.
Once again, the cash manager can borrow to fund the deficit, invest the surplus, or execute a cash-management swap. Another method to deal with this type of situation is to swap contracts at historical rates. This method involves dealing a swap in whichthe spot sale is dealt at a rate equaling the original forward contract rate. The new forward contract consists of the maturing forward rate adjusted by the current points and a working capital interest factor. .
Historical-rate rollovers have the same basic economic as market-rate saps. They also eliminate the need for any cash settlements on the original maturity date and avoid the accounting problems frequently associated with the FX gain/loss account. On small forward contracts, the actual dollar amount of the net settlement may be small, and cost of settling may be excessive given the amount involved. In other cases, an entity may not have the cash to settle on the swap but still want the swap done.
As a general comment, usage of historical-rate swaps varies from market to market, but this type of swap is not a heavily traded transaction. One of the major reasons is its susceptibility to abuse.