Currency swap

A currency swap is an agreement between two parties to exchange principal and interest payments in two different currencies over an agreed period. At the start of the agreement, the two parties typically exchange an agreed amount of one currency for the equivalent amount of another, then make periodic interest payments to each other in their respective currencies, before exchanging the original principal amounts back at the end of the agreement, often at the same exchange rate used at the start.

Multinational companies use currency swaps to manage the mismatch that comes from earning revenue in one currency while having debt or expenses denominated in another. A US company that has issued bonds in dollars but generates most of its cash flow in euros, for example, can use a currency swap to convert its dollar interest and principal obligations into euro obligations that better match the currency it earns, reducing the risk that a shift in the exchange rate erodes its ability to service that debt.

Currency swaps differ from a simple foreign exchange forward in that they typically run for years rather than months and involve ongoing interest payments throughout the life of the agreement, not just a single exchange at maturity. Banks and large corporations are the main users, and the swap market functions as an important channel through which companies raise financing in whichever market offers the best terms, then swap the proceeds into the currency they need.