Foreign Currency Swaps

The word “swap” means to exchange. So, if two companies swap machines, they are trading those machines for each other. In the context of interest rate and foreign currency swaps, two companies are choosing to exchange the interest that they are paying (or receiving) or to exchange the currency that they are paying or receiving.

Foreign Currency Swaps

A foreign currency swap is similar to an interest rate swap in that two companies are exchanging future cash flows. In the case of a foreign currency swap, two companies agree to exchange (swap) both the principal payments and interest payments of a loan that is denominated in another currency.

For example, a U.S. company that issues Eurobonds in Europe that are denominated in euros can enter into a currency swap with a European company that has issued U.S. dollar denominated bonds. By swapping the principal and interest payments, both companies eliminate the exchange rate risk associated with issuing bonds denominated in a foreign currency.

A foreign currency swap is different from an interest rate swap in that in a foreign currency swap both the principal and interest are swapped, while in an interest rate swap, only the interest payments are swapped.