Question

Using your own hypothetical examples, critically evaluate any two reasons why investors may use plain vanilla currency swaps. Write out and explain the swaps you have designed.

Answer 1

Plain Vanilla currency swap is handy in the following case:
Company A which is incorporated in US wants to open up a business in India. Company B which is incorporated in India wants to do business in US. If company A goes to borrow in India it will have to face high borrowing rate of interest and similarly if company B borrows in US, it will face a higher rate of interest due to uncertainty. If you borrow from your home country, you are benefitted from your relations.

In this case, company A can borrow US dollars and company B can borrow Indian rupees and enter into a swap where they exchange this borrowed amount - the "notional principal" with each other. So if Company A borrowed US dollar 1 million, it will swap this to company B and in return get INR 75 million (if the exchange rate is US$1 = INR 75)
Hence, company A and B can get the amounts they require and pay interest to their banks in their home currency

Therefore the benefit is lower interest rate faced by each firm also the uncertainty of the exchange rate is removed.