Foreign Exchange Swaps and Currency Swaps
Two different instruments
A foreign exchange swap is a short-dated transaction combining a spot (or near-dated forward) leg and an offsetting forward leg in the same currency pair, used to manage short-term liquidity and roll value dates. A currency swap (cross-currency swap) is a longer-dated agreement to exchange principal in two currencies at inception and re-exchange at maturity, with periodic interest payments in each currency. Candidates must not conflate the two.
Mechanics and pricing
FX swaps are priced off the forward points for the relevant dates; the near leg is typically at or near spot and the far leg embeds the interest rate differential. They are a collateralised-style funding tool: the party lending one currency and borrowing another effectively borrows at the implied rate. Currency swaps involve both principal and interest; fixed-for-fixed, fixed-for-floating, and floating-for-floating variants exist. Understand that currency swaps create ongoing credit exposure and are documented under ISDA master agreements with credit support annexes.
Traps in questions
Frequent errors: describing an FX swap as involving interest payments (it does not - only the two exchange legs); forgetting the principal re-exchange in a currency swap; and confusing a cross-currency swap with a single-currency interest rate swap. Watch for questions about whether an FX swap creates a large credit exposure (near-dated, small relative to notional because the legs offset) versus a currency swap (larger, principal at risk).
Rule of thumb
If the contract has two currency legs and no periodic interest, it is an FX swap. If it has periodic interest in both currencies and principal re-exchange, it is a currency swap.
Worked example
A bank needs USD for three months and holds EUR. It executes a three-month FX swap: sells EUR/buys USD spot, and buys EUR/sells USD forward. No interest is paid; the cost is embedded in the forward points, which reflect the USD-EUR interest differential.