“Currency swaps are financial instruments that involve the exchange of one currency for another currency, with an agreement to reverse the exchange at a future date. They are used to manage currency risk, reduce funding costs, and access foreign currency funding.
In a currency swap, two parties agree to exchange principal and interest payments in different currencies. The exchange rate is agreed upon at the time the contract is entered into, and the parties agree to reverse the exchange at a future date.
For example, Company A, based in the United States, may want to borrow Japanese yen to finance a project in Japan, while Company B, based in Japan, may want to borrow US dollars to finance a project in the US. Instead of each company borrowing in their own currency and incurring foreign exchange risk, they could enter into a currency swap agreement where they agree to exchange the principal and interest payments in their respective currencies.
Currency swaps can be customized to meet the specific needs of the parties involved, including the amount of the exchange, the exchange rate, and the duration of the swap. They can also be structured to include a fixed or floating interest rate, and can be used to hedge against interest rate risk as well as currency risk.
Overall, currency swaps are a useful financial instrument for managing currency risk and accessing foreign currency funding. However, they also carry risks and require careful consideration and management of counterparty risk and market volatility.”
Sourced from Chat GPT, assessed by Sean Lee