Thus, where a forward exchange market does not exist and where the local forex money market is not fully developed, the trader will be making decisions constantly about loans and deposits in the local currency. We can think of the purchase of forward dollars as a source of loan able funds in the local currency-a "printing press" for local currency. On the other hand, the sale of forward dollars will produce a demand for local funds-a "vacuum cleaner" absorbing local currency. For a foreign bank operating in the given local currency, the "printing press" effect is highly desirable; however, the "vacuum-cleaner" effect is unwanted. The bank would most likely prefer to lend the local currency instead of just exchanging it for dollars in the spot market. But the foreign bank also wants to be known as a foreign exchange trader who stands willing to both buy and sell in the exchange markets.

The possibility for operating in the forward market without absorbing needed local funds may be available in some currencies where the forward market is not absent altogether-although it may be very narrow. If we could find a way to eliminate the initial forward exchange position in the forward market, instead of the spot market, we could accomplish our exposure objectives without having to use needed local funds for this purpose. As an illustration, assume the earlier example in

Which we bought pesos against dollars value date day 90. If we could square the exchange position for day 90 also. Instead of in the spot market. there would be no impact on the availability of local funds. The original forward transaction called for the bank to buy pesos against dollars; the offsetting forward transaction calls for selling pesos against dollars. Then. the cash flows of the two forward transactions would offset one another on day 90 and there would be no cash flow associated with this transaction either before or after that day.

Following the same line of reasoning. if we want to be more aggressive. we can go farther and convert the vacuum-cleaner effect into the printing-press effect. Again. assume the initial forward transaction in which the bank is buying pesos against dollars value date day 90. Now, let's eliminate the net exchange position for a maturity longer than day 9o-in contrast to the spot market or day 90 as done earlier. That is. we sell pesos against dollars for. say. day 180. This accomplishes our objective of eliminating the net exchange position created by the initial forward transaction. However. the cash flows are not matched; we have a swap position. When day 90 arrives we have to borrow dollars to deliver on the original forward contract maturing on that day. We deliver dollars and receive local currency in exchange. This terminates the first forward transaction. However. the second forward transaction does not mature until 90 days later. The local currency we obtain from the first forward contract will not be needed to square the second contract until 90 days later. We now have local currency available for lending purposes for 90 days until we need it to close the other forward contract. The way we chose to square the net exchange position in this case. for a maturity longer than the original forward contract. succeeded in generating local currency for lending purposes for three months. We turned the potential vacuum-cleaner effect into an actual printing-press effect. But we also created a swap  position  -maturities of cash flows are not matched.

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