Currency Swaps

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Although a relatively recent invention, currency swaps have quickly become a vital and widely used financial instrument. Given the steady increase in globalization, understanding the potential benefits of using currency swaps is essential to any modern multinational business. Currency swapping works just as the name implies – different national currencies are swapped between two parties for an agreed amount of time. Investopeia.com defines a currency swap as “two notional principals [of different currencies] that are exchanged at the beginning and at the end of the agreement” (Cavallaro, 2011).

Typically, the reason to engage in a currency swap with another company is because a company may have a comparative advantage in getting a loan in one currency, typically their domestic currency, though they might desire the funds to be in a foreign currency. If they can find a counterpart who also has a comparative advantage in getting financing in their domestic currency, both companies can benefit though a currency swap.

To illustrate this, imagine that a well-know U.S. based corporation wants to expand its operations in Europe. Perhaps it will receive more attractive financing in the U.S. based on its reputation and contacts than in Europe; so the company can get a loan from a U.S. bank at a relatively low rate and then simply swap the dollars for Euros with a European company which needs USD and likewise has an advantage in financing options in its domestic currency (McCaffrey, 2007). Another reason a currency swap might be beneficial to a company is to hedge against currency fluctuations. Consider a U.S. firm that is seeking to hedge some of its euro exposure by borrowing in euros; by arranging a currency swap with a European com...

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...t of deregulation and integration of national capital markets and extreme interest rate and currency volatility…” (Shapiro, 2006, p. 312)

Figure 1 (Bank for International Settlements, 2007) (BANK FOR INTERNATIONAL SETTLEMENTS, 1999) (Bank for International Settlements, 2005)

Works Cited

Cavallaro, M. (2011, June 7). Hedging With Currency Swaps. Retrieved September 9, 2011, from Investopedia.com: http://www.investopedia.com/articles/forex/11/hedging-with-currency-swaps.asp#axzz1XRYSf5wt

McCaffrey, M. (2007, April 27). An Introduction To Swaps. Retrieved September 9, 2011, from Investopedia.com: http://www.investopedia.com/articles/optioninvestor/07/swaps.asp#axzz1XP2LnDyM

Shapiro, A. (2006). Multinational financial management (8th ed.). John Wiley & Sons.

Walmsle, J. (1992). Foreign Exchange and Money Markets Guide, The. New York: John Wiley & Sons, Inc.

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