Currency Swap

Unlike an interest rate swap, a currency swap usually involves exchanging the principal amounts at the start and again at the end, at an exchange rate fixed when the contract is agreed. In between, each party pays interest in the currency it received.

For example, a US company needs euros to fund a factory in Germany, while a European company needs dollars for a US expansion. They agree a currency swap: the US company gives dollars and receives euros, and the European company does the opposite. Each pays interest to the other in the currency it received, and at the end they swap the principal back at the original exchange rate.

Companies use currency swaps to borrow more cheaply in foreign currencies, since they may get better rates borrowing at home and then swapping, and to protect against exchange rate movements on foreign debts or investments.

Central banks also arrange currency swap lines with each other, allowing them to provide foreign currency to their banks during periods of financial stress. These were used extensively during the 2008 financial crisis and in 2020 to ease shortages of US dollars around the world.