Currency Swaps

Although it is a relatively new invention, currency swaps are quickly becoming important and widely used financial instruments. Given the steady growth of globalization, understanding the potential benefits of using currency swaps is important for modern multinational companies. Foreign currency exchange, as its name implies, is exchanged using the agreed time between the two parties. Investopeia.com defines currency swap as "the nominal theme of two different currencies exchanged at the beginning and the end of a contract" (Cavallaro, 2011).

The most common two cross currency swaps are cross currency coupon swaps and cross currency basis swaps. Cross currency coupon swap is to purchase currency swaps while paying floating rates with fixed payment. Its strength is to allow companies to manage exchange rates and interest rate risks as desired, but companies purchasing tools are vulnerable to currency risk and interest rate risk. Cross currency-based swaps are defined as purchase currency swaps, while paying variable rates and fluctuating in different currencies. This tool has the same currency risk as the standard currency swap, but has the advantage that the company can acquire the current interest rate difference. However, the main disadvantage is that the company's main risk is interest rate risk, not currency risk.

Swap is like package of forward contract. Currency swaps can be used to avoid credit risk associated with parallel loans. Broadly speaking, currency swap is a contract between two companies that currently exchanges a certain amount of currency and returns the exchange at some point in the future. The absence of credit risk is due to the nature of the currency swap. The default for currency swaps means that currencies will not be exchanged in the future, and the default for parallel loans means that loans will not be repaid. Unlike parallel loans, currency swaps do not lose investment or revenue by default. The only risk of currency swaps is that the company has to exchange foreign currency at the new exchange rate in the foreign exchange market.

Cross Currency Swap - Cross Currency Swap is a contract between two counterparties to exchange different currency loans. The principal is exchanged for the first time and it is re-exchanged last. Between the start date and the deadline, a series of cash flows between the two parties will be reflected. This reflects payment of interest on the two exchange principal.