Forex Swap

A currency swap (or cross currency swap) is a foreign exchange agreement between two parties to exchange principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest payments on an equal (regarding net present value) loan in another currency. Currency swaps are motivated by comparative advantage.

Structure

Cross-Currency swaps can be negotiated for a variety of maturities occassionaly in excess of 10 years.

Unlike interest rate swaps, currency swaps involve the exchange of the principal amount. Interest payments are not netted (as they are in interest rate swaps) because they are denominated in different currencies. Cross-Currency swaps are over-the-counter derivatives, similar to interest rate swaps.

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Uses

Currency swaps are often combined with interest rate swaps. For example, one company would seek to swap a cash flow for their fixed rate debt denominated in US dollars for a floating-rate debt denominated in Euro. This is especially common in Europe where companies shop for the cheapest debt regardless of its denomination and then seek to exchange it for the debt in desired currency.

For example, suppose a U.S.-based company needs to acquire Swiss francs and a Swiss-based company needs to acquire U.S. dollars. These two companies could arrange to swap currencies by establishing an interest rate, an agreed upon amount and a common maturity date for the exchange. Currency swap maturities are negotiable for at least ten years, making them a very flexible method of foreign exchange.

Currency swaps were originally done to get around exchange controls.

During the global financial crisis of 2008 the United States Federal Reserve System offered swaps to the Reserve Bank of Australia, the Bank of Canada, Danmarks Nationalbank, the Bank of England, the European Central Bank, the Bank of Japan, the Reserve Bank of New Zealand, the Norges Bank, the Sveriges Riksbank, and the Swiss National Bank[1] and also stable emerging economies such as South Korea, Singapore, Brazil, and Mexico.[2]

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History

Currency swaps were introduced by the World Bank in 1981 to obtain Swiss francs and German marks by exchanging cash flows with IBM. This deal was brokered by Salomon Brothers with a notional amount of $210 million dollars and a term of over ten years.[3]