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Currency swap

(chinadaily.com.cn)
Updated: 2006-10-18 10:40

A currency swap means an arrangement in which two parties exchange specific amounts of different currencies initially, and a series of interest payments on the initial cash flows are exchanged.

Often, one party will pay a fixed interest rate, while another will pay a floating exchange rate (though there may also be fixed-fixed and floating-floating arrangements). At the maturity of the swap, the principal amounts are exchanged back. Unlike an interest rate swap, the principal and interest are both exchanged in full in a currency swap.

An interest rate swap is a contract to exchange cash flow streams that might be associated with some fixed income obligations, say swapping the cash flows of a fixed rate loan for those of a floating rate loan. A currency swap is exactly the same thing except, with an interest rate swap, the cash flow streams are in the same currency. With a currency swap, they are in different currencies.

That difference has a practical consequence. With an interest rate swap, cash flows occurring on concurrent dates are netted. With a currency swap, the cash flows are in different currencies, so they can't net. Full principal and interest payments are exchanged without any form of netting.