Each entity has a different access and different needs in the international financial markets. Companies receive more favorable credit ratings in their country of domicile than in the country in which they need to raise capital. Investors are likely to demand a lower return from a domestic company, which they are more familiar with than from a foreign company. In some cases a company may be unable to raise capital in a certain currency. Currency swaps are also used to lower the risk of currency exposure or to change returns on investment into another, more favorable currency. Therefore, currency swaps are used to exchange assets or capital in one currency for another for the purpose of financial management.
A currency swap transaction involves an exchange of a major currency against the U.S. dollar. In order to swap two other non- U.S. currencies, a dealer may need to arrange two separate swaps. Although, any currency can be used in swaps, many counter-parties are unable to exchange their currencies due to a lack of demand. Since currency swaps involve die exchange of two or more types of currencies, the actual exchange of principals takes place at the commencement and the termination of the swaps. On certain occasions, the exchange occurs only at the inception of the swap depending on the nature of the swap. The exchange of principals is necessary because of the fluctuation of currencies. Also, counter parties may need to utilize the respective exchanged currencies. Principals and interest payments are exchanged based on the spot rate agreed at the inception of the swaps.… Read the rest