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Currency swap explained

I need to understand what a currency swap is for a university assignment but I cannot make sense of it. Could you help? 

I don’t blame you for scratching your head on these products. A currency swap agreement between two parties is based on two currencies. It’s used so a loan in one currency can be equated to the net present value of a loan in another currency. They are often called over-the-counter derivatives and are used by sophisticated money market players. One kind of currency swap might only involve the principal of a loan which would be paid by another party in the future, called the “counterparty”, at an agreed exchange rate now. A currency swap like this over a longer period can be quite an effective way to make sure you don’t lend money and lose out when the exchange rate falls.

Currency swaps were first used in the 1970s in the United Kingdom to get around foreign exchange controls. Then a UK company paid extra to borrow in Greenbacks. So a US company wanting to borrow in pounds was found and a currency swap was created. The goal was to reduce the impact of a big change in exchange rates. 

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Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

 

Published on: Thursday, October 21, 2010

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