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SIR I JUST WANTED TO UNDERSTAND IT AS I AM HAVING DIFFICULTY ANSWERING THE MCQS
HOW CURRENCY SWAP HELPS IN HEDGING FOREIGN EXCHANGE RISK, THE INTEREST PAYMENT ARE SWAPPED OVER THE LIFE OF BORROWING BUT :
FOR EXAMPLE A UK COMPANY SWAPPING WITH US COMPANY,THEN THE UK COMPANY WILL HAVE TO PAY INTEREST IN DOLLARS AND US COMPANY WILL HAVE TO PAY IN POUNDS MY DOUBT WAS
DO THEY PRE DECIDE THE RATE AT WHICH THEY WILL SWAP THE INTEREST OVER THE LIFE OF LOAN?
OR IT IS JUST THAT THE UK COMPANY WILL HAVE INCOME FROM US INVESTMENT WHICH IT WILL USE TO PAY THE $INTEREST?
I WATCHED THE LECTURE BUT JUST HAVING DIFFICULTY UNDERSTANDING THIS
ALSO SIR ONE MORE DOUBT
IS IT COMPULSORY IN A CURRENCY SWAP TO SWAP INTEREST ALSO OR THEY CAN DECIDE NOT TO, LIKE IF THE UK COMPANY INVESTING IN US INVESTMENTS INCURS A LOSS, IT MAY NOT BE ABLE TO USE THE EARNINGS TO PAY THE US$ INTEREST?Why are you posting questions in the AFM forum now?
You have been asking in the FM forum until a few days agoIn a currency swap, the two parties involved agree to exchange interest payments in different currencies over the life of the borrowing. In the example you provided, if a UK company swaps with a US company, the UK company will have to pay interest in dollars, and the US company will have to pay interest in pounds. The rate at which they swap the interest payments is typically pre-decided and agreed upon by both parties. This allows each company to have a fixed interest rate in their own currency, reducing the foreign exchange risk associated with fluctuating exchange rates.
Regarding your second question, it is generally compulsory to swap interest payments in a currency swap. The purpose of a currency swap is to manage both foreign exchange risk and interest rate risk. By swapping interest payments, the parties involved can benefit from lower interest rates in the currency they are borrowing in. However, it is possible for the parties to negotiate and customise the terms of the currency swap, including the option to exclude interest payments. In such cases, the terms of the swap would be agreed upon by both parties based on their specific needs and circumstances.
sir what if the exchange rate is not pre decided, can currency swap still be used to hedge foreign exchange risk?
Why do you need to know this for the FM exam?
Currency swaps are primarily used to obtain lower interest rates rather than to hedge against exchange rate risk. However, in certain cases, currency swaps can be used to hedge foreign exchange risk even if the exchange rate is not pre-decided.
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