Ⅱ Foreign Exchange Swap

A. Definition

Foreign Exchange Swap—an agreement to trade currencies at one date and then reverse the tradeat a later date.

The swap combines activity in both spot andforward markets.

These agreements are frequently used by banksto hedge against foreign exchange risk.

Swaps account for 47% of the volume oftrading activity in FEM (refer to Table 12.2).

B. Foreign Exchange Swap Example

C. Currency Swap

A currency swap involves exchanging principal and fixed interest payments on a loan inone currency for principal and fixed interest payments on a similar loan inanother currency.

The two specified principal amounts are setso as to be approximately equal to one another, given the exchangerate at the time the swap is initiated.

D. Example: Currency Swap

E. Benefits of a swap

1. Lower transaction costs of cross-currencycash management.

2. Reduce foreign exchange risk for financingtransactions.

3. Allow firm to acquire financing for whichit has a comparative advantage.