Currency Swap

A currency swap, also known as a currency swap, is an agreement to swap currencies between two foreign parties. The arrangement consists of the exchange of the principal and interest of a loan made in one currency for payments of principal and interest on an equivalent loan in another currency about foreign exchange market you. A party borrows a currency from a second party because it lends another currency to that party at the same time.



Understanding Currency Swaps

The purpose of a foreign exchange swap is generally to obtain foreign currency loans at lower interest rates than if the loan was borrowed directly in a foreign market. The World Bank first introduced currency swaps in 1981 to obtain German marks and Swiss francs Forex Trading Platform in India. This type of swap can be carried out on loans with a maximum term of 10 years. Currency swaps differ from interest rate swaps in that they also affect major stock exchanges. In a currency swap, each party continues to pay interest on the principal amounts exchanged during the term of the loan. After the swap expires, the principal amounts are exchanged again at a previously agreed rate (which would avoid transaction risk) or at the spot rate. There are two main types of currency swaps. With a fixed currency swap, fixed interest payments in one currency are swapped for fixed interest payments in another currency. With a fixed-to-float swap, fixed interest payments in one currency are exchanged for variable interest payments in another currency. In the latter type of swap, the principal amount of the underlying loan is not swapped.

Examples of Currency Swaps

A common reason for a currency swap is to get cheaper debt. For example, European company A borrows $ 120 million from US company B. At the same time, European company A lends US company B 100 million euros. The exchange is based on a spot rate of $ 1.2, which is linked to the London Inter Bank Offered Rate (LIBOR). The agreement allows loans to be taken out at the lowest interest rate foreign exchange market today.  In addition, some institutions use currency swaps to reduce the risk of expected fluctuations in exchange rates. If US company A and Swiss company B wish to receive each other's currencies (Swiss francs or USD), both companies can reduce their respective liabilities through a currency swap. During the 2008 financial crisis, the Federal Reserve allowed several developing countries facing liquidity problems to exchange currency for lending purposes.



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