Question

Differentiate between spot and forward exchange rates. What role do currency swaps play?

Answer 1

The spot rate is the rate at which the contract or transaction will happen immediately.

The forward rate Spot rate is the rate at which the contract or transaction will happen at a predetermined time in the future.
Ex:
Today is 1st january:
transaction: to purchase 1$

Spot rate ₹/$= 65.

Its means, if we want to do a transaction (to purchase 1$) today it will be done at ₹65.

3 Month forward Rate ₹/$= 70. Its means, if we want to do a transaction today for after 3 months it will be done at ₹70.

Even if the spot price after 3 months turns out to be ₹72/$.

The main difference is:
Spot - Immediately.
Forward- predetermined date in the future.

The role of a financial swap is
1. For heading purpose: To hedge the foreign currency risk or Interest rate risk.
2. To reduce the cost of borrowing.
3. To convert a floating rate into a fixed rate or vice versa.

It is generally done by Banks, Non-Banking Financial Institutions, Insurance Companies, Large and Midcap Companies etc.