Currency Swap
A swap in which two parties exchange principal and interest payments denominated in different currencies.
What is Currency Swap?
A currency swap is a derivative agreement in which two counterparties exchange principal amounts in different currencies at inception, make periodic interest payments in the other party's currency over the swap's life, and re-exchange the original principal amounts at maturity at the original exchange rate. This differs from a currency forward, which involves only a single future exchange. Currency swaps allow multinational corporations to raise funding in one currency and synthetically convert it to another, often at more attractive rates than borrowing directly in the target market. Central banks also use bilateral currency swap lines to provide liquidity in foreign currencies during financial stress.
Example
A Japanese corporation wants to borrow US dollars to fund its American subsidiary but can borrow more cheaply in yen. It enters a currency swap with a US bank: the Japanese firm issues ¥10 billion in yen bonds, swaps the proceeds for $100 million at today's rate, and makes USD interest payments to the bank for five years. At maturity, it returns the $100 million and receives ¥10 billion back.
Source: BIS — Currency Swap Lines