Currency Swap
Categories: Forex, Banking, International, Econ
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.
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finance a la shmoop what is inflation-adjusted hyper currency and
commodity no no no no no I said frozen concentrated orange juice right there
that's better commodities that's what this is frozen [milk shake]
concentrated orange juice yeah it's the same whether you buy it here at Uncle [canned orange juice]
cheapies fruit barn or from Amazon or from Safeway it's a total commodity and [barn, Amazon website, Safeway building]
when inflation hits the fan yeah like that then commodity prices are usually [inflation hits ceiling fan]
the first to react commodities you know things like oil and electricity and [oil ships, light bulbs]
roundup weed killer and the price of generic picture frames on Amazon you [weed killer, picture frames on Amazon]
know those things all right well why does commodity pricing even matter well
let's talk about inflation for a sec inflation measures the rate at which
prices of goods and services are rising and they generally rise over time the
greater the level of inflation the lower the purchasing power of your currency
well in a world of inflation taking off going up up up and the Fed raising rates [house floating up with balloons]
hoping to tamp it down down down well equities or stocks and debt or bonds [house floating down]
will get crushed while commodities should just keep going on up up up in [air balloons rising]
lockstep with inflation rates because they're basically a store of cash and
you can turn them into cash so quickly and they don't really change that way in
essence commodities are a good balance to an investment portfolio highly
exposed to oh say the stock market well what else acts this way real estate yeah
it's kind of a commodity or at least it behaves like one in the grips of [air balloons rising]
inflation oil yep gold yep what about currencies commodity well yes and no [oil rig, gold ingots, paper money]
currencies react to other currencies generally on a relative basis but they
behave very much like commodities so then if you turbocharged inflation well [different world currencies]
yes you get then hyperinflation in most times the US dollar has been considered [house rocketing out of orbit]
a relatively stable bet like think Latin American debt in a historical frame that
is the countries were swimming in debt payable in their own currency in the [world map]
1980s and much to the chagrin of the Western countries who loaned them [bags of money in western countries]
billions and billions of dollars those latin-american countries decided to run
the Xerox machine all through the night and weekend printing more and more money [money being printed]
so hyperinflation would be created and the 18 kajillion dollars owed by
Venezuela would feel instead like only a few million bucks to that country and
while the West learned a big lesson about loaning people
irresponsible with her own currency oh and there was that other little one
lesson that the West learned about punitive war reparation rules check out [world map]
1930s vimar germany's hyperinflation currency issues this wheelbarrow full of [wheelbarrow full of money]
german marks yeah at the time this picture was taken it bought a loaf of
bread and only like two glasses of juice juice juice [two orange jews turn into orange juice]