Union Currency Swaps
It is an agreement between two parties to exchange obligations in different currencies at the beginning, during the tenure and at the end of the transaction. At the start, initial principal is exchanged, though not obligatory. Periodic interest payments (either fixed or floating) are exchanged throughout the life of the contract. The principal is exchanged invariably on termination at the exchange rate decided at the start of the transaction.
By means of currency swap, the counterparties can hedge their exchange rate and interest rate risk and also reduce the cost of funding.
In a currency swap operation, also known as a cross currency swap, the parties involved agree under contract to exchange the following: the principal amount of a loan in one currency and the interest applicable on it during a specified period of time for a corresponding amount and applicable interest in a second currency.
In a typical currency swap transaction, the first party borrows a specified amount of foreign currency from the counterparty at the foreign exchange rate in effect. At the same time, it lends a corresponding amount to the counterparty in the currency that it holds. For the duration of the contract, each participant pays interest to the other in the currency of the principal that it received. Upon the expiration of the contract at a later date, both parties make repayment of the principal to one another.
Currency swaps are often used to exchange fixed-interest rate payments on debt for floating-rate payments; that is, debt in which payments can vary with the upward or downward movement of interest rates. However, they can also be used for fixed rate-for-fixed rate and floating rate-for-floating rate transactions.
The benefits for a participant in such an operation may include obtaining financing at a lower interest rate than available in the local market, and locking in a predetermined exchange rate for servicing a debt obligation in a foreign currency.