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Why is there a need to use currency swap, rather than forward contracts, currency futures or options? Is currency swap designed for hedging int or forex? Thanks.
Currency swaps are done for rather different reasons.
If I am in the UK but intend to (for example) buy a factory in the US, then it would make sense for me to borrow in $’s.
Similarly if a US company wants to invest in the UK, they might want to borrow in £’s.I am in the UK and I can borrow in $’s, but I will probably have to pay more interest that someone in the US who borrows $’s (because they will have a better credit rating for $ borrowing).
The person in the US can borrow £’s, but they will probably be charged more interest than I would be charged, because I am in the UK and they are not.So…….it might save us both money if I borrow £’s and the US person borrows $’s, and then we pay each others interest.
That way, we end up paying interested in the currency we want to, and potentially we might both end up saving money.
This is the purpose of taking int rate advantage (sounds like int rate swap). I see from Wikipedia, you can either swp int rate, or purely swap principal. May I know what is the purpose, pls?
By the way, what do ‘swap in’ and ‘swap out’ stand for, pls?
Thank you.It is like an interest rate swap.
Swapping the principal or swapping the interest as well depends on whether or not you want the interest to be in your own currency or in the foreign currency.
That would depend on whether or not you had income in the foreign currency that you wanted to hedge against the risk by having the interest expense in the foreign currency.
When you swap anything, something is coming in to you and in return something is going out from you.
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Can you please tell me the difference between currency swap and forex swap?
Sir,
Is there a way to use forex swaps to hedge against adverse currency movements?
For example – I live in Russia and have long-term morgage loan payble in US$, now US$ appreciated against Russian Ruble by more than 2 times. That means that I have to pay more than double for interest expence and for the loan principle if denominated in Rissian Rubles.
If I recieve income in roubles it could be a big trouble. Is there a way to hedge against such adverse forex movements using swaps?
Fortunately that is not my case but I am thinking about real-life practical application of swaps. The reason why people take morgage loans in russia in US$ is because interest expense is twice cheaper if it is borrowed in dollars.
The main reason (certainly for the exam) for a currency swap is to reduce the interest payable.
What you are suggesting is more matching. It makes sense to create an expense in the same foreign currency in which you have income.
So if you have income in US$ then although it may be strong at the moment, there is obviously a risk that the exchange rate may fall and the rouble equivalent therefore fall. You can hedge against this risk by taking a loan in US$ so that the interest expense is in US$. So in that way as the $ goes up and down, both the income and the expense go up and down together.
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