Currency Swap

Let’s say you’re the head of a U.S. company that wants to expand into Canada for the first time ever. You find a Canadian company that's looking to expand into the United States.

What you might find is that the Canadian banks don’t want to lend you money, just as the U.S. banks might not want to lend the Canadian company money. Both of you might end up with significant interest rates due to concerns about you both skipping out on the tab if things go south. Hypothetically, let's say that both companies would face 8% interest rates if they tried to borrow money outside of their own countries.

Well, here’s where things get shady…er…innovative. You can borrow in the U.S. for 4% interest, and the firm in Canada can borrow there for 3.5%. You both take out loans, and then you swap them with one another at a constant exchange rate. This way, you both secure the funding you need at a lower interest rate than you’d have acquired otherwise.

When the swap matures, both companies will swap back the principal amounts at a pre-agreed exchange rate, or at the spot rate, depending on the original terms.

Banks, global companies, and institutional investors are always trying to reduce their risks when dealing with transactions across borders. Currency swaps like this protect against fluctuations in interest rates.