What is a currency swap?
A currency swap, or cross-currency swap, is where two parties – such as banks, companies or even countries agree to swap the interest and sometimes the principle of a loan in one currency for the same loan, but in a different currency. They are mainly used to hedge currency and interest-rate exposure.
Where have you heard about currency swaps?
High profile swaps are often widely covered in the media. In early 2017, for example, it was reported that the Egyptian government was considering signing a currency swap with Russia. As Russia is one of Egypt’s largest trading partners, Egypt hoped the currency swap would improve trade and boost foreign currency liquidity in the cash-poor state.
What you need to know about currency swaps.
The pricing of currency swaps is usually calculated in terms of a number of points plus or minus the London Inter Bank Offered Rate (LIBOR). While swap activity is chiefly associated with hedging, swaps can be used also to try and get more favourable loan rates in a different country through another party than the organisation or country would get by themselves.
For example, you have two businesses. One is a UK business looking to expand into the US and one is a US business looking to expand into the UK. If they both take out loans in the countries they're keen to expand into, then the interest rates may be high for both. Instead, they could both take out loans in their own countries and currencies at a more reasonable rate and swap them.
There are variations on the exchange of interest rates when swapping currencies: floating rate to floating rate; fixed rate to fixed rate; or floating rate to fixed rate. Interest rate payments are usually calculated quarterly and exchanged twice a year.
Find out more about currency swaps.
There are different kinds of currency swaps, such as exchange of principle, exchange of interest rates or both.