What is designing a currency swap using comparative advantage?

Expert Solution

Currency Swap - Exchange of currency obligations with another party to eliminate the currency risk.

Example - I stay in US and have some obligations to pay in Euro due in one year. I know one party from European country who has some obligations to pay in USD due in one year. Assume we both have equal obligations as per current exchange rate.

Individually we both have risk of currency exchange. Assume today I can buy 9 Euro in $10 but in future what if I can buy only 7 Euro in $10. So I am exposed with currency risk similarly the counterpart is having the risk of fluctuations in currency. To eliminate such risk we both enter in agreement that I will pay their USD obligation and they will pay may Euro obligations. By doing this we both eliminated currency fluctuations risk.

Now consider these obligations associated with some rate of interest. So such swaps also give comparative advantage in Currency Interest Rate Swap.

jeff jeffy answered 5 months ago

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