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Currency Swaps

 

  • Currency swap involves exchanging principal and interest payment in one currency with the principal and interest payments in other currency
  • In this case the principal needs to be specified and it is exchanged in the beginning as well as the end of the swap
  • Consider a currency swap between party 1 and 2. In this case Party 1 is in US and can borrow in USD and party 2 is in Australia and can borrow competitively in AUDs at 6%. Party 1 borrows $385,000 at 4% and exchanges the principal with party2 for 350,000 AUDs (which it borrows in Australia). The principal is exchanged back at the end of the life of the swap and the life of the swap is 5 years

  

  • What is the net payout for party 1 and party 2?

Example

 

Solution

 


Questions

  • Which of the following statements is correct when comparing an Interest rate Swap with a Currency Swap?
  1. At maturity there is no exchange of principal between the counterparties in IRS and there is an exchange of principal in Currency Swaps.
  2. At maturity there is no exchange of principal between the counterparties in Currency Swaps and there is an exchange of principal in IRS.
  3. The counterparty in an IRS needs to consider fluctuation in exchange rates, while currency swap counterparties are only exposed to fluctuations in interest rates.
  4. Currency swaps counterparties are exposed to less counterparty credit risk due to offsetting effect of currency risk and interest rate risk embedded within the transaction.





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