Question

Define currency and interest swap and provide an example of a 3- period currency and interest swap between two parties.

Answer 1

CURRENCY SWAP

currency swap is an interest rate derivative. Currency swap is a transaction where two parties exchange principal and interest in different currencies. Here the parties will use different currencies and there is an exchange of these currecy will initiated. The parties involved in currency swaps are generally financial institutions that either act on their own or as an agent for a non-financial corporation. One counterparty agrees to receive one set of cash flows while paying the other another set of cash flows.

one party receives $10 million British pounds (UK), while the other receives $14 million U.S. dollars (USD). This implies a GBP/USD exchange rate of 1.4. At the end of the agreement, they will swap again using the same exchange rate, closing out the deal for 3 months.

INTEREST SWAP

Interest rate swaps involve exchanging interest payments. Here the parties are exchanging the interest payments. The future interest payment is exchanged in interest rate swaps.For exchanging the future interest payment the other party will get a principal amount. These kind of swaps can be fixed or floating.

Party A agrees to make payments to Party B based on a fixed interest rate, and Party B agrees to make payments to Party A based on a floating interest rate. ... A agrees to B at 1.5% per month on the $1,000,000 notional amount. Here A got the principal amount and he wants to ay interet at the rate of 1.55% per month in coming 3 months.

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