A currency swap is used by companies to hedge the exposure to foreign currency loans for operations or to take advantage of arbitrage opportunities that cross in the market.

A currency swap is an agreement in which two parties exchange contract, for a period of time, two streams of interest payments in different currencies, and at the end of the defined period, exchange the principal amounts equivalent to a type of change that was agreed at the start of the contract also swap.Las principal amounts are exchanged at the spot rate prevailing at the beginning of the contract.

Swaps in forex trading:

The two sequences or interest payment streams can be swap fixed-fixed, fixed or variable, fixed or variable, or variable by variable. A currency swap is different from an interest rate swap with the swap because currency is exchanged all of the principal and interest.

The flows of variable interest swaps of currencies are generally based on LIBOR (London Interbank Offer Rate) of six-month reference agreed for the USD. For other currencies are used similares.Los reference rate fixed interest flows are agreed at the beginning of the contract.

The advantages of participating in a currency swap is to allow management and active currency hedging exchange risk, as well as allow the parties access to markets where they can obtain cheaper funding sources. This allows a comparative advantage.

The disadvantages of a currency swap for the parties is that if one of them does not fulfill its obligations to the other party leaves exposed. There are credit risk issues that tend to be more complex than other types of transactions, in addition to a currency swap contract can be very expensive.

Application of a currency swap:

A currency swap can be used for hedging or arbitrage.

Imagine that an Australian company has obtained AUD 200 million dollars through the issuance of 132 million of bonds denominated in USD for a period of three years. The bonds have a coupon of 6% paid semiannually. The exchange rate is 0.6600. The semiannual coupon payments are $ 3,960,000 and repayment of principal is $ 132 million. If the exchange rate of AUD / USD falls, buying U.S. dollars to make interest payments and principal repayment cost the company more dollars AUD.La Australian company decides to change fixed payments in USD in AUD fixed payments. The three-year swap rate is 6% per year, and the three-year rate of AUD for the swap is 6.5% año.Así that by hiring a currency swap, the Australian company will eliminate the risk of the currency because it will receive a rate of 6% and pay a fixed rate of 6.5%.

Currency swaps are also used to arbitrate comparative advantages in several markets. Arbitrage opportunities occur because lenders need more premium credit for borrowers with low credit scores who are trying to raise money in weak currencies, unlike if they were raising money borrowers in stronger currencies. Each part of the borrowed funds would swap their best markets, hire a currency swap and share the arbitrage opportunity.