Question

1. What are FX currency swaps. Why would Central Banks agree to such swaps? What specific policy measures has the Federal Reserve taken as a result of the Corona Virus epidemic that affect their market? Why?

Answer 1

Answer -

FX currency swap:

In finance, a foreign exchange swap, forex swap, or FX swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward) and may use foreign exchange derivatives. An FX swap allows sums of a certain currency to be used to fund charges designated in another currency without acquiring foreign exchange risk. It permits companies that have funds in different currencies to manage them efficiently.

A foreign currency swap is an agreement to exchange currency between two foreign parties, in which they swap principal and interest payments on a loan made in one currency for a loan of equal value in another currency.

There are two main types of currency swaps: fixed-for-fixed currency swaps and fixed-for-floating swaps.

Central Banks agree to such swaps because they used it to affect domestic liquidity, manage their forex reserves, and stimulate the domestic financial market and thus,  to defend a particular exchange rate at a time when foreign exchange reserves are under pressure.

Measures taken by the Federal Reserve due to Corona Virus epidemic are:

• Federal Reserve Board announces temporary change to its supplementary leverage ratio rule to ease strains in the Treasury market resulting from the coronavirus and increase banking organizations’ ability to provide credit to households and businesses.
• Federal Reserve Board broadens program of support for the flow of credit to households and businesses by establishing a Money Market Mutual Fund Liquidity Facility (MMLF)
• Federal bank regulatory agencies issue interim final rule for Money Market Liquidity Facility
• Federal Reserve Board expands its program of support for the flow of credit to the economy by taking steps to enhance liquidity and functioning of crucial state and municipal money markets
• Federal Reserve announces the establishment of a temporary FIMA Repo Facility to help support the smooth functioning of financial markets.
• In light of these developments, the Federal Open Market Committee has decided to lower the target range for the federal funds rate to 0 to 0.25 percent. This action will help support economic activity, strong labor market conditions, and inflation returning to the Committee's symmetric 2 percent objective.
• To support the smooth functioning of markets for Treasury securities and agency mortgage-backed securities that are central to the flow of credit to households and businesses, overcoming months the Committee will increase its holdings of Treasury securities by at least $500 billion and its holdings of agency mortgage-backed securities by at least $200 billion.
• In a related set of actions to support the credit needs of households and businesses, the Federal Reserve announced measures related to the discount window, intraday credit, bank capital and liquidity buffers, reserve requirements, and—in coordination with other central banks—the U.S. dollar liquidity swap line arrangements