Page 156 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 9: Interest Rate and Currency Swaps

11. In an extendible swap, the fixed rate payer gets the right to extend the swap maturity date. Notes
12. The interest rate swap involves the exchange of principal amounts.

9.5 Currency Swaps

A currency swap is a contract to exchange interest payments in one currency for those denominated
in another currency. The currency swap developed from back-to-back loans and parallel loans
and also functions virtually in the same manner. At present, the currency swap market, although
older than the interest rate market, is smaller and less sophisticated.
A standard currency swap entails the exchange of debt denominated in one currency for debt
denominated in another currency. Consider an example. Assume that a US multinational company
wants to issue a yen denominated bond so that it can make payments with yen inflows generated
by a Japanese subsidiary. Also, suppose there exists a Japanese multinational that wants to issue
dollar denominated debt. The US multinational could issue dollar debt while the Japanese
multinational issues yen debt. The US MNC would then provide yen payment, both principal
and interest to Japanese MNC in exchange for dollar payment. The swap of currencies allows the
two MNCs to make payments to their respective debt holders without having to repatriate
foreign exchange.
Thus, both the multinationals have reduced their exposures through the swap transactions.
Figure 9.5 illustrates this currency swap.

Figure 9.5: Currency Swaps

9.5.1 Various Forms of Currency Swaps

The various forms of currency swaps are discussed below:
1. Cross-currency Fixed-to-fixed Swap: The motivation for this type of swap is that each of
the two counterparties have access to cheap funds in different countries. Each counterparty
can raise funds in the country in which they have advantage and enter into a swap whereby
the payments are transformed into the currency that they prefer.

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