Quanto Swap

An episode of Star Trek: The Next Generation, where Picard gets too close to an energy nebula while on a space walk and switches places with a bizarro version of himself from a different timeline. The bizarro version, named Quanto, tries to kiss Troy and gets punched by Riker.

Er, okay...let's get back on track. Here and now (meaning not in the 24th Century), a "quanto swap" refers to a type of interest rate swap. However, like crossing over the dimensional plane through an energy nebula, the quanto swap involves a switcheroo. This time, it's foreign currencies.

Basically, it acts like a regular swap. One party trades the proceeds from one interest-bearing investment for the proceeds of another one. Often, its used to trade cash generated by a floating rate and a fixed-rate investment. However, in the quanto case, the investments in question are cross-currency ones. One half of the swap will be in one currency (say, dollars), the other half in another (say, euros). However, and here's the trick: the deal is settled in a single currency at a fixed exchange rate. So one side of the swap involves interest paid on a dollar-denominated debt. The other side has a euro-denominated investment. But both sides settle in dollars. The exchange rate is fixed when the contract is signed.

For the investor on the dollar side of the equation, they get exposure to a European investment...but they don't have to worry about fluctuating exchange rates.