Cross Currency Swap
A cross-currency swap (CCS) is a type of financial contract in which two parties agree to exchange interest and principal payments denominated in different currencies. The purpose of a CCS is typically to manage the risk associated with fluctuating exchange rates between the currencies.
The parties to a CCS agree to a fixed rate or floating rate in one currency, and to a floating rate in another currency. These rates are typically based on benchmark interest rates, such as LIBOR or EURIBOR. At the outset of the contract, the parties exchange the principal amounts in each currency at the prevailing exchange rate.
During the life of the contract, each party makes periodic interest payments to the other based on the agreed-upon rates. These payments are typically made semi-annually, but the frequency can vary depending on the terms of the contract.
At the end of the contract, the parties exchange the principal amounts again at the prevailing exchange rate. The goal of the CCS is to hedge against exchange rate risk, allowing each party to manage its exposure to fluctuations in currency values.
Cross-currency swaps are widely used by corporations, financial institutions, and governments to manage currency risk associated with international trade and investment. They are also used by investors to earn a return on foreign currency investments, and by speculators to bet on exchange rate movements.
It is important to note that CCS contracts are typically complex and customized to meet the specific needs of the parties involved. As such, they are generally traded over-the-counter (OTC) rather than on organized exchanges, and require a high level of expertise to structure and execute.