A currency swap is a foreign-exchange agreement between two parties to exchange aspects

(namely the principal and/or interest payments) of a loan in one currency for equivalent aspects
of an equal in net present value loan in another currency; see Foreign exchange derivative.
Currency swaps are motivated by comparative advantage.[1] A currency swap should be
distinguished from a central bank liquidity swap.

Contents
[hide]

• 1 Structure
• 2 Uses
o 2.1 Hedging Example
• 3 Abuses
• 4 History

• 5 References

[edit] Structure
Currency swaps are over-the-counter derivatives, and are closely related to interest rate swaps.
However, unlike interest rate swaps, currency swaps can involve the exchange of the principal.[1]

There are three different ways in which currency swaps can exchange loans:

The simplest currency swap structure is to exchange the principal only with the counterparty, at a
rate agreed now, at some specified point in the future. Such an agreement performs a function
equivalent to a forward contract or futures. The cost of finding a counterparty (either directly or
through an intermediary), and drawing up an agreement with them, makes swaps more expensive
than alternative derivatives (and thus rarely used) as a method to fix shorter term forward
exchange rates. However for the longer term future, commonly up to 10 years, where spreads are
wider for alternative derivatives, principal-only currency swaps are often used as a cost-effective
way to fix forward rates. This type of currency swap is also known as an FX-swap.[2]

Another currency swap structure is to combine the exchange of loan principal, as above, with an
interest rate swap. In such a swap, interest cash flows are not netted before they are paid to the
counterparty (as they would be in a vanilla interest rate swap) because they are denominated in
different currencies. As each party effectively borrows on the other's behalf, this type of swap is
also known as a back-to-back loan.[2]

Last here, but certainly not least important, is to swap only interest payment cash flows on loans
of the same size and term. Again, as this is a currency swap, the exchanged cash flows are in
different denominations and so are not netted. An example of such a swap is the exchange of
fixed-rate US Dollar interest payments for floating-rate interest payments in Euro. This type of
swap is also known as a cross-currency interest rate swap, or cross-currency swap