A cross-currency swap is an agreement between two 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 swap useful?
Cross-currency basis swaps are often used by financial institutions and corporations to:
Obtain foreign currency to pay for overseas assets.
Hedge against currency fluctuations.
Acquire foreign currency bonds as investments.
Raise foreign money through bonds.
Cross-currency swaps: An example
Suppose Company A is a US 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 US dollars to acquire high-tech equipment from a US company. Similar to Company A, Company B will pay a high premium to borrow US dollars from a US 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 US dollar decline. Forex brokers let you open an account, exchange currencies and make a profit whenever your currency appreciates against the one you sold.
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Cross currency swap pros and cons
Companies get foreign currency at lower interest rates.
Can eliminate foreign currency exposure by locking current exchange rates.
Transaction is executed over-the-counter (OTC), meaning it can be customized.
Credit risk as the counterparty could default and fail to complete the exchange.
Interest rates fluctuate and can negatively affect the cross currency swap deal.
Bottom line
A cross-currency swap is an agreement between two parties to exchange currencies at the spot rate.
Cross-currency swaps are mostly used by multinational companies and institutions, and they are designed to help them access foreign currency at better terms and interest rates.
Individual investors can speculate on currency fluctuations via the forex market.
Frequently asked questions
Currency swap and cross currency swap refer to the same financial derivative.
One company borrows money in its own currency, while a foreign company borrows money in a second currency. Both parties swap their currencies.
Kliment Dukovski is a personal finance writer at Finder, specializing in investments and cryptocurrency. He's written more than 700 articles to help readers compare the best trading platforms, understand complex investment terms and find the best credit cards for their needs. His expert commentary has been featured in such digital publications as Fox Business, MSN Money and MediaFeed. He’s also well-versed in money transfers, home loans and more — breaking down these topics into simple concepts anyone can understand. In another life, Kliment ghostwrote guides and articles on foreign exchange, stock market trading and cryptocurrencies.
Good foreign exchange robots can simplify how you trade in foreign currencies and they can also work in maximizing profits, but relying on them is not a good idea.
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