what is a foreign currency swap 
a foreign currency swap is an agreement between two foreign parties to swap interest payments on a loan made in one currency for interest payments on a loan made in another currency a foreign currency swap can involve exchanging principal as well this would be exchanged back when the agreement ends usually though a swap involves notional principal that s just used to calculate interest and isn t actually exchanged understanding foreign currency swapsone purpose of engaging in a currency swap is to procure loans in foreign currency at more favorable interest rates than might be available borrowing directly in a foreign market during the financial crisis in 2008 the federal reserve allowed several developing countries that faced liquidity problems the option of a currency swap for borrowing purposes 1in a transaction arranged by investment banking firm salomon brothers the world bank entered into the very first currency swap in 1981 with ibm ibm swapped german deutsche marks and swiss francs to the world bank for u s dollars 2foreign currency swaps can be arranged for loans with maturities as long as 10 years currency swaps differ from interest rate swaps in that they can also involve principal exchanges in a foreign currency swap each party to the agreement pays interest on the the other s loan principal amounts throughout the length of the agreement when the swap is over if principal amounts were exchanged they are exchanged once more at the agreed upon rate which would avoid transaction risk or the spot rate currency swaps have been tied to the london interbank offered rate libor libor is the average interest rate that international banks use when borrowing from one another it has been used as a benchmark for other international borrowers however in 2023 the secured overnight financing rate sofr will officially replace libor for benchmarking purposes in fact as of the end of 2021 no new transactions in u s dollars use libor although it will continue to quote rates for the benefit of already existing agreements 3types of swapsthere are two main types of currency swaps the fixed for fixed rate currency swap involves exchanging fixed interest payments in one currency for fixed interest payments in another in the fixed for floating rate swap fixed interest payments in one currency are exchanged for floating interest payments in another in this type of swap the principal amount of the underlying loan is not exchanged foreign currency swaps are a way of getting capital where it needs to go so that economic activity can thrive theses swaps provide governments and businesses access to potentially lower cost borrowing they also can help them protect their investments from the effects of exchange rate risk reasons for using currency swapsa common reason to employ a currency swap is to secure cheaper debt for example say that european company a borrows 120 million from u s company b concurrently u s company a borrows 100 million euros from european company a the exchange between them is based on a 1 2 spot rate indexed to libor the two companies make the deal because it allows them to borrow the respective currencies at a favorable rate if a currency swap deal involves the exchange of principal that principal will be exchanged again at the maturity of the agreement in addition some institutions use currency swaps to reduce exposure to anticipated fluctuations in exchange rates for instance companies are exposed to exchange rate risks when they conduct business internationally therefore it can behoove them to hedge those risks by essentially taking opposite and simultaneous positions in the currency u s company a and swiss company b can take a position in each other s currencies swiss francs and usd respectively via a currency swap for hedging purposes then they can unfold the swap later when the hedge is no longer needed if they suffered a loss due to fluctuating exchange rates affecting their business activity the profit on the swap can offset that 