hedging instrument to insure against material collateral mismatches and devaluation. Hedging example one For instance, a US-based company needing to borrow Swiss francs, and a Swiss-based company needing to borrow a similar present value in US dollars, could both reduce their exposure to exchange rate fluctuations by arranging either of the following: If the companies have already borrowed in the currencies each needs the principal in, then exposure is reduced by swapping cash flows only, so that each company's finance cost is in that company's domestic currency. Alternatively, the companies could borrow in their own domestic currencies (and may well each have comparative advantage when doing so), and then get the principal in the currency they desire with a principal-only swap. Hedging example two Suppose the British Petroleum Company plans to issue five-year bonds worth £100 million at 7.5% interest, but actually needs an equivalent amount in dollars, (current $/£ rate is ), to finance its new refining facility in the U.S. Also, suppose that the Piper Shoe Company, a U. S. company, plans to issue in bonds at 10%, with a maturity of five years, but it really needs £100 million to set up its distribution center in London. To meet each other's needs, suppose that both companies go to a swap bank that sets up the following agreements: Agreement 1: The British Petroleum Company will issue 5-year £100 million bonds paying 7.5% interest. It will then deliver the £100 million to the swap bank who will pass it on to the U.S. Piper Company to finance the construction of its British distribution center. The Piper Company will issue 5-year bonds paying 10% interest. The Piper Company will then pass the $150 million to swap bank that will pass it on to the British Petroleum Company who will use the funds to finance the construction of its U.S. refinery. Agreement 2: The British company, with its U.S. asset (refinery), will pay the 10% interest on () to the swap bank who will pass it on to the American company so it can pay its U.S. bondholders. The American company, with its British asset (distribution center), will pay the 7.5% interest on £100 million (.075 = ), to the swap bank who will pass it on to the British company so it can pay its British bondholders. Agreement 3: At maturity, the British company will pay to the swap bank