currency swap
Currency Swap, it is a combination of two opposite currency-exchange transactions for the same amount with different dates of value date. With regard to swap the date of execution of more close of the transaction is called the value date and the date of execution of the more remote by the term of the reverse of the transaction - the end date of the swap Maturity.
If the near-by date, currency exchange transaction is a purchase of the currency, and the more remote the sale of currency, such a swap is called the Buy and Sell Swap. If the first, by the transaction for the sale of foreign currency, and the reverse she transaction is a purchase of the currency, the swap will be called the Sell and Buy the Swap.
As a rule, foreign exchange swap is carried out with one counterparty, that is, both foreign currency exchange operations are carried out with one and the same Bank. It is so-called Pure Swap. It is, however, called the swap space a combination of two opposite currency exchange transactions with different dates of value date on the same amount, made with different banks is Engineered Swap.
The maturity can be divided currency swap into three types:
•the standard rate swaps (on the spot) - here the nearest value date - spot, far on the terms of a forward;
•short one-day swaps (up to the spot) - here, both the date of the transactions, part of the swap, fall on a date with the spot. For example one the deal is in the format of spot-tom, and the second on the second day after conclusion of the transaction (spot);
•Forward rate swaps (after the spot) - they are characterized by a combination of two transactions outright, when more close by the term of the transaction is on terms of forward (value date later than the spot), and the reverse her a transaction is concluded on the terms of a later attack.
Currency swaps, in spite of the fact that according to the form they represent a currency-exchange operations, by their content are related to the operations of the money market.
Let's consider an example of a currency swap.
The American company has a subsidiary in Germany. For implementation of 5-year investment project it needs 30 million. The Euro. The exchange rate prevailing on the spot market amounts to EUR/USD 1,3350. The company has the ability to issue bonds in the United States for the amount of 40,05 million. The United States with a fixed interest rate of 8%.
An alternative would be to issue bonds denominated in Euros, with a fixed rate of 6% +1% (risk premium).
Suppose in Germany there is a company with a subsidiary in the United States, which is in need of a similar volume of investments. It can either issue bonds for 30 million. The Euro with a fixed interest rate of 6%, or on 40,05 million. The United States at 8%+1% (risk premium) in the United States.
In any case, both companies are faced with significant foreign exchange risk, which will be subject to interest payments during the whole period of bonds ' circulation, as well as the principal amount of the loan at the expiration of 5 years.
In this case the Bank can arrange currency swap agreements for these two companies, having received for this Commission. In this case, the Bank closes a long position on the purchase of foreign currency for both companies and reduces costs for payment of interests for both sides. This is the consequence of the fact that each company takes the loans in the national currency at a low percentage (without risk premium).
Thus, each company receives a relative advantage.
The principal amount of the loan will be transferred through the Bank:
•40,05 million. The us American company a subsidiary of the German company;
•30 million. Euro German company a subsidiary of the American company.
Interest payments will be repaid as follows:
•a subsidiary of the American company annually pays 30*0,06=1.8 million. Euro parent company, which transmits the funds to the Bank, which, in turn, pays them a German company for repayment of the loan in Euro;
•a subsidiary of the German company annually pays 40,05*0,08=3,204 million. The U.S. parent company, which transmits the funds to the Bank, which transfers them American company for repayment of the loan in USD. The U.S..
