• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer
Finance Train

Finance Train

High Quality tutorials for finance, risk, data science

  • Home
  • Data Science
  • CFA® Exam
  • PRM Exam
  • Tutorials
  • Careers
  • Products
  • Login

What are Foreign Currency Swaps?

Derivatives, PRM Exam, PRM Exam I

This lesson is part 5 of 9 in the course Swaps

Currency swaps are foreign exchange contracts in which two parties agree to exchange the principal and interest of a loan in one currency with the principal and interest of an equivalent loan in another currency.

The motive behind a currency swap is to enable each party to gain exposure to another currency at a more competitive rate. A currency swap deal will be driven by comparative advantage.

For example, assume that a US Company wants to do some business in India, and at the same time an Indian company is looking at taking a loan in the US. Both the businesses could find it difficult to get competitive financing. The Indian banks may offer a loan to a US company at 11%, while they may be willing to offer the same loan to an Indian company at a lower rate, say 7%. Similarly, it will be cheaper for a US Company to take a loan in the US compared to the Indian Company.

In the international market, the financing is expensive for both these companies; however, they have a cost advantage in their domestic markets.  The following table presents a hypothetical scenario:

  US Company Indian Company
Finance cost in US 6% 10%
Finance Cost in India 11% 7%

There is a clear comparative advantage if these two companies borrow in their home countries and exchange the cash flows.

Assume that both the companies have an equivalent loan requirement of $10million, and the current exchange rate is USD/INR 45.

The US Company will borrow $10million from a US bank at 6%. The Indian Company will borrow INR450mn from an Indian bank at 7%.

The swap transaction will take place as follows:

  1. After borrowing from their local banks, both the companies will exchange the principals at the beginning of the arrangement.
  2. As per the prescribed payment schedule (quarterly, semi-annually, or yearly), both the companies will exchange the interest payment on their loans.
  3. At the end of the swap agreement, the companies will re-exchange the principals.

Note that this example assumes a simplified scenario. In a real transaction, there will be a swap dealer who facilitates this swap deal. To pay commissions to the dealer, the interest rates will become slightly higher. If the spread is assumed to be 20bps, the actual interest rate will be 6.2% and 7.2%.

Previous Lesson

‹ Hedging Using Interest Rate Swaps

Next Lesson

What are Basis Swaps? ›

Join Our Facebook Group - Finance, Risk and Data Science

Posts You May Like

How to Improve your Financial Health

CFA® Exam Overview and Guidelines (Updated for 2021)

Changing Themes (Look and Feel) in ggplot2 in R

Coordinates in ggplot2 in R

Facets for ggplot2 Charts in R (Faceting Layer)

Reader Interactions

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Primary Sidebar

In this Course

  • How Interest Rate Swaps Work?
  • Details of an Interest Rate Swap Contract
  • Synthetic Relationship Between Swaps and Derivatives
  • Hedging Using Interest Rate Swaps
  • What are Foreign Currency Swaps?
  • What are Basis Swaps?
  • What are Volatility Swaps?
  • Swap Termination
  • Equity Swap Example

Latest Tutorials

    • Data Visualization with R
    • Derivatives with R
    • Machine Learning in Finance Using Python
    • Credit Risk Modelling in R
    • Quantitative Trading Strategies in R
    • Financial Time Series Analysis in R
    • VaR Mapping
    • Option Valuation
    • Financial Reporting Standards
    • Fraud
Facebook Group

Membership

Unlock full access to Finance Train and see the entire library of member-only content and resources.

Subscribe

Footer

Recent Posts

  • How to Improve your Financial Health
  • CFA® Exam Overview and Guidelines (Updated for 2021)
  • Changing Themes (Look and Feel) in ggplot2 in R
  • Coordinates in ggplot2 in R
  • Facets for ggplot2 Charts in R (Faceting Layer)

Products

  • Level I Authority for CFA® Exam
  • CFA Level I Practice Questions
  • CFA Level I Mock Exam
  • Level II Question Bank for CFA® Exam
  • PRM Exam 1 Practice Question Bank
  • All Products

Quick Links

  • Privacy Policy
  • Contact Us

CFA Institute does not endorse, promote or warrant the accuracy or quality of Finance Train. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.

Copyright © 2021 Finance Train. All rights reserved.

  • About Us
  • Privacy Policy
  • Contact Us