Often, the popular form of currency sweaces lies between two central banks. The main objective of the exchange swap by a central bank such as the RBI is to obtain the foreign currency from the foreign issuer on pre-determined terms (such as the exchange rate and currency volume) for the swap. In addition to supporting the domestic money market and the foreign exchange market, another main objective of the foreign exchange swap is to maintain the value of foreign exchange reserves with the central bank. Think of a company that holds the U.S. dollar and needs sterling to finance a new operation in the UK. Meanwhile, a British company needs U.S. dollars to invest in the United States. They are looking through their banks and agreeing that they both get the money they want without having to go to a foreign bank to get a loan, which would probably lead to higher interest rates and increase their debt. Currency swaps should not appear on a company`s balance sheet when a credit would. A foreign exchange swap consists of two flows (legs) of fixed or floating interest payments denominated in two currencies. Interest payments are made on pre-set dates.
If the swap counterparties have previously agreed on the exchange of equity, these amounts must also be exchanged at the same exchange rate on the maturity date. The strength of a currency depends on a number of factors such as the rate of inflation, the prevailing interest rates in its home country or the stability of the government, to name a few. The value of a country`s currency generally depends on supply and demand. Each currency is influenced by different factors. These include the rate of inflation, economic growth, domestic political stability and interest rates, to name a few. Many newer countries use their central banks to raise their currencies and fall into a narrow range, and can attach it to a leading international currency, such as the euro or the pound sterling. New nations often have the value of their monetary value relative to that of the euro. Swaps can take years depending on the individual agreement, so the spot market exchange rate between the two currencies involved can change dramatically over the course of trading. This is one of the reasons why institutions use currency swets.
They know exactly how much money they will receive and will have to pay back in the future. If they have to borrow money from a given currency and expect that currency to strengthen significantly in the coming years, a swap will help limit their repayment costs of that borrowed currency. A foreign exchange swap contract (also known as a cross-currency swap contract) is a derivative contract between two parties, which involves the exchange of interest payments, as well as the exchange of principal amountsPrincipal PaymentA principal is a payment on the initial amount of a loan owed. In other words, a principal payment is a payment for a loan that reduces the balance of the loan instead of applying the interest payment that is calculated on the loan. in some cases, denominated in different currencies. Although currency exchange contracts generally involve the exchange of equity, some swaps may only require the transfer of interest payments.