Question

Is a currency swap contract a debt obligation that involves a borrower and a lender? Why or Why not?

Answer 1

Yes, a currency swap contract is in a way a debt obligation that involves a borrower and a lender.

A currency swap contract is essentially an arrangement wherein two counterparties agree to exchange notional principal and future interest payments in different currencies so as to gain an exposure to the desired currencies. These payments can be based on fixed/floating interest rates Thus, each party owes to the other party an amount depending on interest rates of the base currency, interest rates of the price currency and the prevalent spot exchange rates at the time of exchange.

For example - A party exchanges a Floating-rate debt in one currency for a fixed-rate debt in another currency of his choice. This is effectively a debt obligation for both the parties involved.

Generally, there is no netting of the cash flows involved as compared to an interest rate swap. Thus, the notional amounts and interest payments are swapped at agreed upon dates

Mechanism: At swap initiation, the parties will exchange the notional principals. If the interest payments are agreed upon quarterly, then both parties will pay quarterly interest rates in the agreed upon currency.

At the end of the swap, the original notional principals will be exchanged again.