Currency Swaps

• Currency swaps have some key differences from interest rate swaps:

• There are two notional principal amounts;

• Each notional is in a different currency;

• The notionals are exchanged at the beginning of the swap and then again at the end of the swap.

• Periodic cash flow payments are made in different currencies.

• Currency Swap Steps:

1. Initial exchange of notionals.
2. Periodic exchange of coupon payments; given the different currencies, netting may not be feasible in currency swaps like it is for plain vanilla interest rate swaps.
3. Return of notional principals at swap expiration.

• Motivation: Because a company may have a borrowing advantage in one currency but wishes to have the debt exposure in another currency, the company may wish to enter a currency swap.

• Example: a U.S. company with high quality credit can borrow cheaply within the U.S. The company wishes to build a factory in Colombia, but does not have the credit history to borrow at comparable rates. The company may opt to finance the project with U.S. denominated debt and enter into a currency swap to receive U.S. and pay Colombian pesos.

• Common users of currency swaps are borrowers who wish to convert their debt into a different currency.

Swaps are can be referred to as an "exchange of borrowings" because the parties have independently borrowed financial capital and through the use of a swap have agreed to exchange the proceeds.