What it means
Most currency trades settle two business days after the trade date, which is called the spot date. A trader who has an open position on the spot date but does not want to take or deliver the currency can roll it to the next day.
A tomorrow-next swap is one way to do this. In the swap, the trader buys a currency on one date and sells it back on the next business day at a slightly different price.
The difference between the two prices is called swap points, and it reflects the difference in interest rates between the two currencies for that one day. In effect, the trader is borrowing one currency and lending the other for a day.
Banks and large companies use these swaps to manage their daily liquidity and to keep positions open without settling them. A corporate treasury that expects a payment to arrive a day late might use a tomorrow-next swap to bridge the gap.
A trading desk might use it to carry a position over a weekend or a holiday without changing its risk. The price is quoted as swap points, which are added to or subtracted from the spot rate.
If the currency being bought has a lower interest rate than the one being sold, the points are usually in the trader's favour, and if not, the trader pays. The amounts are small for each day but can add up for large positions held over long periods.
Tomorrow next is one of several short-dated swaps, along with overnight and spot next. The differences depend on which date the swap begins and ends, and market convention sets the dates.
Readers should confirm the exact value dates with their bank, since holidays in either country can change them. For a finance team, the main lesson is that holding a currency position is not free.
There is a carrying cost or gain that depends on interest rates, and it should be included in profit calculations. Ignoring it can make a hedge appear cheaper or more expensive than it really is.
In practice
Real-world examples.
Example
A bank trader has a large euro position that is due to settle but wants to keep it open another day. The trader executes a tomorrow-next swap, which rolls the position without delivering the currency.
Example
A corporate treasurer expects a customer payment of 5 million euros to arrive one day after the settlement date. The treasurer uses a tomorrow-next swap to avoid an overdraft in the euro account for the extra day.
Example
A fund manager reviews the daily profit and loss of a currency hedge. The manager sees a small daily charge from rolling positions and includes it in the cost of the hedge.
Formula
Calculation
Tom/Next swap points (approx.) = spot rate x (interest rate of quote currency - interest rate of base currency) x days / 360
Suppose EUR/USD spot is 1.2000, the one-day US dollar rate is 5% and the euro rate is 2%, which gives a difference of 3%. These figures are illustrative only.
Swap points = 1.2000 x 0.03 x 1 / 360 = 0.036 / 360 = 0.0001, which is 1 pip (one hundredth of a cent).
On a position of 10,000,000 euros, the daily roll is worth 10,000,000 x 0.0001 = $1,000.
Over ten business days, the roll would be worth about $10,000, and its direction depends on whether the trader is long or short the euro.Case study
Seen in the real world.
Atlas Trading Company is an illustrative, fictional exporter that receives most of its income in euros and pays suppliers in dollars. The treasury team had hedged its euro income with a forward contract, but a large payment from a customer was delayed by two days.
The treasurer used tomorrow-next swaps to roll the settlement of the hedge until the money arrived. Each roll cost about $1,000 on the position, so the two days of delay cost about $2,000 in total.
The illustrative result was a clear view of the price of delay. The treasurer showed the sales team that the late payment cost $2,000, which helped persuade them to enforce the payment terms more firmly with the customer.
Watch out
Common mistakes.
- Assuming that rolling a currency position is free, when there is a cost or gain from the interest rate difference.
- Confusing tomorrow next with spot next or overnight swaps, which start and end on different dates.
- Forgetting that weekends and holidays change the dates and the number of days of interest.
Questions
People also ask.
What does Tom/Next mean?
It means a swap beginning tomorrow and ending the following business day, used to roll a currency position by one day.
Who uses tomorrow-next swaps?
Banks, trading desks and corporate treasuries use them to manage settlement dates and short-term cash needs.
Why is the price quoted in swap points?
Swap points show the small difference between the two legs of the swap, which reflects the interest rate gap between the two currencies.
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