Currency swap

What it means

A currency swap is a derivative in which two parties exchange amounts in different currencies and swap them back later at a pre-agreed rate. In long-term currency swaps the parties also exchange interest payments in the respective currencies during the life of the contract.

The simplest form is an FX swap, which combines an immediate exchange of currencies with an opposite forward transaction at a future date. A company might, for example, exchange euros for the dollars it needs for a payment today and swap them back in three months at a rate known today.

A long-term cross-currency swap resembles an interest rate swap, but in addition to interest the parties also exchange principal amounts in different currencies. It is used mainly by larger companies and banks to convert debt from one currency into another without refinancing the loan.

How it works in practice

A company with a foreign currency loan but income in euros can use a currency swap to turn its repayments into euro payments, eliminating currency risk for the life of the loan. Likewise, a company with dollar income can use a swap to secure a known amount in euros.

Short-term FX swaps are used in liquidity management when a company temporarily needs another currency. For example, it needs dollars today for a supplier prepayment and will receive dollars from a customer in a month; the swap covers that period without exchange rate risk.

In the books, derivatives are measured at fair value with changes recognised in profit or loss, unless the company applies special hedge accounting. Under IFRS 9 and Slovak rules alike, that requires documenting the relationship between the hedging instrument and the hedged item.

What to watch out for

A currency swap is a commitment for its whole term. If plans change, for example the company repays the loan early or the foreign currency income does not arrive, terminating the swap early can cost a significant amount depending on its market value. The contract should be tailored to the company's actual cash flows.

Derivatives are complex and banks offer them as investment services, for which they must assess suitability for the client. A company should understand how the swap's value changes, what collateral may be required and what happens if exchange rates move sharply, and should not use a derivative to speculate unless that is its intention.