Currency Swaps
Currency Swaps – What Does It Mean In The Business World ?
Currency Swaps Concept
Currency swaps are exchanges of currencies between two countries when they are in need of the other currency. The interest rates on the principle are decided between the two lending countries. The agreement is usually very flexible and companies have sufficient time to pay back the borrowed amount. Currency swaps eliminate the risk of exchange rate fluctuations and hence are extensively followed by several countries.
Currency swaps happen all the time when international monetary transactions are involved. Every country has a different currency and compares differently with another currency. So, when a businessperson in one country lends a businessperson in another country, the currency is converted. These conversions are called currency swaps. When companies prepare balance sheets, it is not necessary to mention currencies swaps and each country makes the entry in their respective currencies in their balance books. Both principle and interest are swapped in international transactions and both of these are recorded in currency swaps. The maturity dates for these loans can vary between one year and ten years.
How does currency exchange work ?
The concept of currency swaps is pretty simple and can be explained clearly with an example. Suppose a company in Europe holds EUR 1 million but is in need to USD$800,000 for investing. So, the company currency swaps its one million euros for $800,000. You can either do the exchange with a bank or with a company in the United States that is in need of Euros. In either case, the European company will receive its requirement. The maturity period for currency swaps will be set between the two exchangers.
Various types in which currency is swapped
There are different ways in which currency will be swapped between two entities. You can either currency swap your money in exchange of foreign currency with a bank or with another company that can give you money in the currency of your requirement. This process is very when a company has branches spread all over the world and needs to exchange money within the company. You can also indulge in currency swaps for different rates of interest. For example, an American company can exchange with a European company on 1% interest that it pays to the European company on principle while the European company pays 5% to the American company as interest. When the currency swaps period matures, each of the companies return the principle amount to each other.