What is a Currency Swap?

Currency Swap Definition. A Currency Swap is an agreement between two parties to exchange principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest payments on an equal loan in another currency. The parties to the contract exchange the principal of two different currencies immediately, so that each party has the use of the different currency. They also make interest payments to each other on the principal during the contract term. In many cases, one of the parties pays a fixed interest rate and the other pays a floating interest rate, but both could pay fixed or floating rates. When the contract ends, the parties re-exchange the principal amount of the swap. For example, two companies in different countries may need to acquire currency in the opposite denomination. The two companies could arrange to swap currencies by establishing an interest rate, an agreed-upon amount, and a common maturity date for the exchange. Currency swap maturities are negotiable for at least 10 years, making them a very flexible method of foreign exchange. Currency swaps originally were used to get around exchange controls and to give each party access to enough foreign currency to make purchases in foreign markets. Increasingly, parties arrange currency swaps as a way to enter new capital markets or to provide predictable revenue streams in another currency, typically as a hedge against currency risk exposure.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.