When two parties agree to swap principal and interest on a loan made in one currency for a principal and interest payments of a loan of equal value on another currency, such an agreement is known as FX swap or foreign currency swap.
The primary purpose of swap is to acquire debt in a foreign currency at more favorable interest rates than if borrowing directly in a foreign market.
In a currency swap:
- Each party of the agreement continues paying interest on the swapped principal throughout the loan
- When finally, the swap agreement is ended, principal amounts are exchanged once more at a pre-agreed rate or the spot rate.
Two main types of currency swaps
Fixed-for-fixed currency swap; exchanging fixed interest payments in one currency for fixed interest payments in another.
Fixed-for-floating; Fixed interest payments in one currency are exchanged for floating interest payments in another.