FOR : SKP

FROM : JVQ
RE : Currency Swap
DATE : September 2, 2019

Give me memo on what a currency swap is

Foreign Currency Swap

A foreign currency swap, also known as an FX swap, is an

agreement to exchange currency between two foreign parties.

The agreement consists of swapping principal and interest

payments on a loan made in one currency for principal and interest
payments of a loan of equal value in another currency over a fixed
period of time at pre-determined exchange and interest rates. One party
borrows currency from a second party as it simultaneously lends another
currency to that party.1

The purpose of engaging in a currency swap is usually to procure

loans in foreign currency at more favorable interest rates than if borrowing
directly in a foreign market, 2 or for hedging 3 and managing possible
losses from volatile price movements over time.

Example

1. A Philippine company can take out a loan in the Philippines in

Philippine Peso (PHP) at the rate of 6%. To finance an expansion
project in China, this Filipino company requires a loan in Chinese
Yuan (¥) where the interest rate is at 10%.

2. At the same time, a Chinese company wishes to finance an

expansion project in the Philippines, but the interest rate is at 9%
when obtaining a loan in PHP, compared to a 7% interest rate when
such loan will be obtained in ¥.

1
How does currency swaps work, Mitchell, retrieved from: https://www.investopedia.com/ask/answers/042315/how-
do-currency-swaps-work.asp, on September 1, 2019
2
Additional Info: The World Bank first introduced currency swaps in 1981 in an effort to obtain German marks and
Swiss francs. This type of swap can be done on loans with maturities as long as 10 years.
3
Hedging is a management strategy used in limiting or offsetting probability of loss from fluctuations in the prices of
commodities, currencies, or securities.
1
 3. Both parties can enter into a currency swap agreement –

 The Philippine company can borrow PHP at local rate of 6% from

a Philippine bank and lend it to the Chinese company in the
Philippines at 6% (or at an agreed rate that is lower than 9%)
instead of a foreign loan interest rate of 9% if availed by the
Chinese company from a Philippine bank. The PHP may now be
used by the Chinese company for its expansion in the Philippines.

 The Chinese company can borrow ¥ at 7% and lend it to the

Filipino company at the same rate of 7% (or at an agreed rate
lower than 10%), as opposed to a 10% interest rate if ¥ will be
obtained by the Filipino company. The ¥ may now be used by the
Filipino company to finance its expansion in China.

For your information