Cross currency swaps are agreements between counterparties to exchange interest and principal payments in different currencies. Like a forward, a cross currency swap consists of the exchange of principal amounts (based on today's spot rate) and interest payments between counterparties.It is considered to be a foreign exchange transaction and is not required by law to be shown on the balance sheet.
In a currency swap, these streams of cash flows consist of a stream of interest and principal payments in one currency exchanged for a stream, of interest and principal payments of the same maturity in another currency. Because of the exchange and re-exchange of notional principal amounts, the currency swap generates a larger credit exposure than the interest rate swap.
Cross-currency swaps can be used to transform the currency denomination of assets and liabilities. they are effective tools for managing foreign currency risk. They can create currency match within its portfolio and minimize exposures. Firms can use them to hedge foreign currency debts and foreign net investments.
Currency swaps were originally done to get around exchange controls and hedge the risk on currency rate movements. It also helps in Reducing costs and risks associated with
Currency swaps give companies extra flexibility to exploit their comparative advantage in their respective borrowing markets. Currency swaps allow companies to exploit advantages across a matrix of currencies and maturities.
Currency swaps are often combined with interest rate swaps. For example, one company would seek to swap a cash flow for their fixed rate debt denominated in US dollars for a floating-rate debt denominated in Euro. This is especially common in Europe where companies shop for the cheapest debt regardless of its denomination and then seek to exchange it for the debt in desired currency.