The foreign exchange stop is a special financialA tool that is used by both banks and institutional investors and international companies. Despite the fact that all types of swaps - currency, stock and interest - work roughly the same way, the former have certain characteristics.
Such an operation as a currency swap, alwaysinvolves the participation of two market participants who want to make an exchange to obtain the desired currency with the maximum benefit. To illustrate the essence of the currency swap, consider the following conditional example.
Let some English company (company A) wishEnter the US market, and the American corporation (B) - increase the geography of its sales in the UK. Usually loans and loans that banks give out to non-resident companies are characterized by higher interest rates than those granted to local firms. For example, firm A can issue a loan in US dollars at 10% per annum, and company B - a loan in GBP at 9%. At the same time, rates for local companies are much lower - 5% and 4% respectively. Firms A and B can enter into a mutually beneficial agreement, under which each organization will receive a loan in its local currency at a local bank at more favorable rates, and then the loan will be "swapped" through a mechanism known as a currency swap.
Let's say that the British pound and the dollarare exchanged in the Forex market at the rate of 1.60 USD for 1.00 GBP, and each firm needs the same amount. In this case, American firm B will receive 100 million pounds, and company A - 160 million dollars. Of course, they will have to compensate their partner's interest payments, but the swap technology enables both firms to reduce their expenses for repaying the loan by almost half.
For the sake of simplicity, the roleA swap dealer that acts as an intermediary between transaction participants. The dealer's participation will slightly increase the cost of the loan for both partners, but nevertheless the costs will be much greater if the parties do not turn to swap technology. The amount of interest that a dealer adds to the cost of a loan is usually not too large and is in the range of ten basic points.
It should also be noted that this type of operation is a currency-interest swap. In this case, the parties exchange interest payments aimed at repaying foreign currency loans.
Let's note some key moments thanks to which currency transactions of a swap differ from other kinds of similar operations.
In contrast to the swap, which is based on income, andinterest rate swap, a currency swap assumes a preliminary, and then a final exchange, of the loan commitment agreed in advance. In our example, the companies exchanged $ 160 million for £ 100 million at the beginning of the operation, and at the end of the contract they have to make a final exchange - there is a return of the amounts to the relevant parties. At this point, both partners are at risk, because the original exchange rate of the dollar and pound (1.60: 1) has probably already changed.
In addition, for most swap operationscharacteristic nettingovanie. This term means the netting of cash. In a swap transaction of aggregate income, for example, the yield on an index can be exchanged for income on a certain security. The income of one party to the transaction is netting against the income of the other participant at a predetermined specific date, and only one payment is made. At the same time, periodic payments that are associated with currency swaps are not subject to netting. Both partners undertake to make appropriate payments on the agreed dates.
Thus, a currency swap is an instrument withwith which two main goals are achieved. On the one hand, they reduce the cost of obtaining loans in foreign currency (as in the example above), and on the other hand, they allow you to hedge the risks that are associated with sharp changes in the exchange rate in the Forex market.