Understanding corporate finance: derivative contracts: currency swap
Another way of hedging exchange risks is by the use of currency swaps. You are most likely to see currency swaps either between banks, or between a member of a large group of companies and a bank, usually hedging substantial borrowing or lending.
A currency swap is similar to an interest rate swap (CFM13320), in that the parties exchange interest obligations for an agreed period. But it has extra complications because two different currencies are involved. One of those currencies may be sterling: equally, a UK company may enter into a swap involving two different non-sterling currencies, for example the US dollar and the Japanese yen.
All currency swaps have two basic components:
- an exchange of interest receipts and obligations over the duration of the swap
- an exchange of currencies at the end.
There may also be an initial exchange of currencies, but this is optional.
See the example at CFM13430.