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What is the concept of currency swaps (FX swaps)?
Currency swap is an agreement between the parties to exchange principal amounts of different currencies at a predetermined rate on a future date.
The two types of currency swaps are as follows −
Fixed to fixed − Exchange of fixed interest payments in one currency on loan equivalent in other currency.
Fixed to floating − Fixed rate obligations in one currency are exchanged for floating rate obligations in other currency.
The stages included in the currency swaps are as follows −
Foreign exchange market is spotted.
Exchanging of interest payments during swap term is carried out.
On maturity principle is re-exchanged.
Principal is usually exchanged in any of the below ways −
At the start.
At the end.
In between starting and ending.
Neither at starting and nor at ending.
The benefits of currency swaps are mentioned below −
Company raises funds in one currency and saves in another currency.
Can switch their loans between currencies.
Flexibility in risk hedge.
Companies can undo their faulty decisions.
Can lock exchange rates for longer periods.
Can restructure company liabilities.
Raise funds at less cost.
Degree of liquidity is high.
Early termination depends on agreement between parties.
Used to hedge.
Currency swaps can be done at any time of transaction life.
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