Foreign Currency Swap
Foreign currency swaps is an agreement to make a currency exchange between two foreign
parties. The agreement consists of swapping principal and interest payments on a loan
made in one currency for principal and interest payments of a loan of equal value in
another currency. Foreign Exchange Swap allows sums of a certain currency to be used to
fund charges designated in another currency without acquiring foreign exchange risk. It
permits companies that have funds in different currencies to manage them efficiently
A foreign exchange swap consists of two legs:
• a spot foreign exchange transaction, and
• a forward foreign exchange transaction.
Forward foreign exchange transactions occur if both companies have a currency the other
needs, it prevents negative foreign exchange risk for either party. Foreign exchange spot
transactions are similar to forward foreign exchange transactions in terms of how they are
agreed upon, however they are planned for a specific date in the very near future, usually
within the same week. It is also common to trade forward-forward, where both transactions
are for (different) forward dates.
The most common and simplest swap is a “plain vanilla” interest rate swap. In this swap,
Party A agrees to pay Party B a predetermined, fixed rate of interest on a notional principal
on specific dates for a specified period of time. Concurrently, Party B agrees to make
payments based on a floating interest rate to Party A on that same notional principal on the
same specified dates for the same specified time period. In a plain vanilla swap, the two
cash flows are paid in the same currency. The specified payment dates are called
settlement dates, and the time between are called settlement periods. Because swaps are
customized contracts, interest payments may be made annually, quarterly, monthly, or at
any other interval determined by the parties.