Currency Swap

A Currency Swap is a derivative contract where parties exchange principal and interest payments in different currencies, effectively borrowing in one currency while lending in another. Unlike FX forwards, currency swaps involve multiple cash flows over time. For example, a U.S. company might swap $100 million for €85 million with a European firm, then exchange fixed USD payments for fixed EUR payments over five years, finally re-exchanging principal at maturity. Cross-currency basis swaps exchange floating rates in both currencies plus a basis spread reflecting funding differences. Companies use currency swaps to hedge foreign currency debt, access better rates in foreign markets, or convert foreign revenues. Central banks use swap lines for crisis liquidity provision – the Fed maintains permanent swap lines with major central banks. The cross-currency basis became significantly negative during crises, reflecting dollar funding stress. Currency swaps require considering both interest rate risk and foreign exchange risk. Valuation involves multiple discount curves and exchange rate assumptions. Credit risk is higher than interest rate swaps due to principal exchange.