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:
- Initial exchange of notionals.
- 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.
- 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.
- CFA Level 2: Derivatives Part 2 – Introduction
- Introduction to Options
- Synthetic Options and Rationale
- One Period Binomial Option Pricing Model
- Call Option Price Formula
- Binomial Interest Rate Options Pricing
- Black-Scholes-Merton (BSM) Option Pricing Model
- Black-Scholes-Merton Model and the Greeks
- Dynamic Delta Hedging & Gamma Related Issues
- Estimating Volatility for Option Pricing
- Put-Call Parity for Options on Forwards
- Introduction to Swaps
- Plain Vanilla Interest Rate Swap
- Equity Swaps
- Currency Swaps
- Swap Pricing vs. Swap Valuing
- Pricing and Valuing a Plain Vanilla Interest Rate Swap
- Pricing and Valuing Currency Swaps
- Pricing and Valuing Equity Swaps
- Swaps as Theoretical Equivalents of Other Derivatives
- Swaptions and their Valuation
- Swap Credit Risk and Swap Spread
- Interest Rate Derivatives - Caps and Floors
- Credit Default Swaps (CDS)
- Credit Derivative Trading Strategies