Currency Swap

See Also:
Currency Exchange Rates
Transaction Exposure
Exchange Traded Funds
Translation Exposure
Hedge Funds

Currency Swap

Currency swaps are used to manage exchange rate risk. In a currency swap, two counterparties exchange the interest and principal payments on loans in different currencies. The counterparties agree to a set exchange rate, a set maturity, and a set schedule to pay interest and principal. By fixing the exchange rate for the transaction, both counterparties hedge the risk of unfavorable exchange rate fluctuations.

Currency Swap Example

For example, a British company may need to borrow US dollars. But the only rate it can get on a dollar loan is too high. At the same time, a US company needs to borrow pounds, but the only rate it can get on a loan in pounds is too high.

The British company, however, can borrow pounds at an attractive interest rate and the US company can borrow dollars at an attractive interest rate. So the two companies decide to enter into a currency swap agreement.

The US company borrows dollars cheaply and then lends them to the British company. Meanwhile, the British company borrows pounds cheaply and lends them to the US company. Through the swap agreement, both companies end up benefiting from the other company’s attractive home-currency borrowing rate. It is a win-win situation.

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2 Responses to Currency Swap

  1. Ehsanullah January 23, 2016 at 12:12 pm #

    Hello

    the information which has given are very useful kindly give one practical example for better understanding

    • Lauren Broderick January 25, 2016 at 9:37 am #

      Hello Ehsanullah!

      Currency swap is used to navigate around high interest rates in a foreign country as well as provide a flexible payback and a negotiated fixed rate. Instead of taking a loan out at a bank, companies loan the currency from another company or institution. This is typically useful when dealing with international trade.

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