A cross-currency swap is an agreement between 2 parties to exchange currencies at the spot rate. Cross-currency swaps are often made by financial institutions or large multinational corporations to access funds in foreign currencies at favorable rates.
Why is a cross-currency basis swap useful?
Cross-currency basis swaps are often used by financial institutions and corporations to:
Obtain foreign currency to pay for overseas assets.
Suppose Company A is a Canadian company that wants to build a factory in Europe and needs 10 million euros. To get a loan in euros from a European bank would come with high interest rates.
Company B is a German company that needs Canadian dollars to acquire high-tech equipment from a Canadian company. Similar to Company A, Company B will pay a high premium to borrow Canadian dollars from a Canadian financial institution to pay for the equipment.
The solution is simple — Company A and Company B agree to get loans with lower interest rates in their own countries and their home currencies and then swap them between each other at spot rates. When the time comes to pay off the loan, these two companies swap currencies once again at the same exchange rate as when the first swap was made.
Compare foreign exchange brokers
Cross-currency swaps are typically reserved for large companies. But that doesn’t mean you can’t speculate on currency exchanges or hedge against a potential Canadian dollar decline. Forex brokers let you open an account, exchange currencies and make a profit whenever your currency appreciates against the one you sold.
Are there any drawbacks?
In a cross-currency basis swap, you’re exposed to credit risk, because the other party could default, and interest rate risk, given that interest rates fluctuate.
Cross-currency swaps are designed to help companies access foreign currency at better terms and interest rates. Individuals can speculate or profit from currency exchanges with forex trading.
Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.
Kliment Dukovski is a credit cards and investments writer. He's written over 600 articles to help readers find and compare the best credit cards. Kliment has also written on money transfers, home loans and more. Previously, he ghostwrote guides and articles on foreign exchange, stock market trading and cryptocurrencies.
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