What is currency swap

Interest Rate Swap: What's the Difference? Partner Links. A dual currency swap is a type of derivative that allows investors to hedge the currency risks associated with dual currency bonds.

What Is a Swap Bank? A swap bank is an institution that acts as a broker to two unnamed counterparties who wish to enter into an interest rate or currency swap agreement. Inflation Swap An inflation swap allows one to transfer inflation risk to a counterparty in exchange for a fixed payment. Fixed Price Definition Fixed price can refer to a leg of a swap where the payments are based on a constant interest rate, or it can refer to a price that does not change.

How Does a Currency Swap Work? A currency swap is a foreign exchange transaction that involves trading principal and interest in one currency for the same in another currency. Cross-Currency Swap Definition and Example A cross-currency swap is an agreement between two parties to exchange interest payments and principal denominated in two different currencies. These types of swaps are often utilized by large companies with international operations. Investopedia is part of the Dotdash publishing family.

Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. Interest rates can be fixed or floating. There are three variations on the exchange of interest rates: fixed rate to fixed rate; floating rate to floating rate; or fixed rate to floating rate.

This means that in a swap between euros and dollars, a party that has an initial obligation to pay a fixed interest rate on a euro loan can exchange that for a fixed interest rate in dollars or for a floating rate in dollars. Alternatively, a party whose euro loan is at a floating interest rate can exchange that for either a floating or a fixed rate in dollars. A swap of two floating rates is sometimes called a basis swap. Interest rate payments are usually calculated quarterly and exchanged semi-annually, although swaps can be structured as needed.

Interest payments are generally not netted because they are in different currencies. The Intercontinental Exchange. Accessed January 11, Advanced Forex Trading Concepts. Trading Instruments. Corporate Finance. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.

We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Take the example of a U. Up front, the company receives million Swiss Francs from the proceeds of the Eurobond issue ignoring any transaction or other fees and is able to use the Swiss Francs to fund its U. Because this issue is funding U. The company can convert this Swiss Franc-denominated debt into a U.

It agrees to exchange the million Swiss Francs at inception into U. In that way, the currency swap is used to Hedge A transaction that offsets an exposure to fluctuations in financial prices of some other contract or business risk. It may consist of cash instruments or derivatives. Unlike interest rate swaps, which allow companies to focus on their comparative advantage in borrowing in a single currency in the short end of the maturity spectrum, currency swaps give companies extra flexibility to exploit their comparative advantage in their respective borrowing markets.

There are two main types of cross-currency swaps: exchange of principal and exchange of interest. In the first case, two companies exchange principal amounts that determine their desired or agreed rate of foreign exchange. Let us look at a currency swap example here. At the end of the contract length, the companies will pay back the principal amounts they owe each other.

This will protect both companies from the risk of exchange rate fluctuations. However, both companies can agree to pay each other some interest rate values when the forex rate substantially changes during the life of the contract. In the second case, two parties agree to exchange their interest rate payments obligations on underlying loans. There is no principal exchanged at the outset, and the two parties are in a legally binding contract independent of the underlying lenders.

The interest rate payments can be fixed or variable. Companies can agree to exchange interest rate payments to reduce the cost of borrowing or to guard against other uncertainties related to the underlying principal amount. In finance, a currency swap, also known as cross-currency swap, is a legal contract between two parties to exchange two currencies at a later date, but at a predetermined exchange rate.

Usually, global banks operate as the facilitators or middlemen in a currency swap deal; but they can also be counterparties in currency swaps as a way to hedge against their global exposure, particularly to foreign exchange risk. Currency swaps have always been very convenient in finance. They allow for the redenomination of loans or other payments from one currency to the other. This comes with various advantages for both individuals and companies. There is the flexibility to hedge the risk associated with other currencies as well as the benefit of locking in fixed exchange rates for a longer period of time.