Dual Currency Swap

What Is a Dual Currency Swap?

A dual currency swap is a type of derivative transaction that permits investors to hedge the currency risks associated with dual currency bonds. A dual currency bond is a sort of debt instrument where the coupon payment is named in one currency and the principal amount in another, which can open the holder to exchange rate risk.

A dual currency swap includes concurring ahead of time to exchange either the principal or the interest payments from the dual currency bonds in a specific currency at predetermined exchange rates.

Dual currency swaps can assist companies with giving dual currency bonds by making them less presented to the risks associated with being paid in foreign currencies. Essentially, from the bond financial backer's viewpoint, dual currency swaps can reduce the risk of purchasing bonds designated in foreign currencies.

Understanding Dual Currency Swaps

The purpose of a dual currency swap is to make it simpler to buy and sell bonds named in various currencies. A company, for instance, could benefit from making its bonds available to foreign investors to access a bigger pool of capital or to appreciate better terms. Then again, investors could find the bonds of a foreign company more alluring than those available in their nation of origin. To oblige this market demand, companies and investors can utilize dual currency bonds, which are a type of bond where the interest and principal payments are made in two distinct currencies.

Albeit dual currency bonds can make it more straightforward for companies and investors to buy and sell bonds globally, they really do present their own unique risks. Besides the fact that these investors need to concern themselves with the typical risks of bond investment, for example, the creditworthiness of the issuer, however they must likewise execute in a foreign currency whose value could vacillate to their impediment during the term of the bond.

Dual currency swaps are a type of derivative product wherein the buyer and seller of a dual currency bond concur ahead of time to pay the principal and interest parts of the bond in a specific currency at predetermined exchange rates. This flexibility includes some major disadvantages, which is the price, or premium, of the swap agreement.

Dual currency bonds can make it simpler for investors and companies to globally buy and sell bonds.

Illustration of a Dual Currency Swap

Eurocorp is an European company wishing to borrow $50 million USD to build a factory in the United States. In the mean time, Americorp, an American company, wishes to borrow $50 million USD worth of euros to build a factory in Europe.

Both of these companies issue bonds to raise the capital they need. They then, at that point, orchestrate a dual currency swap between them, to reduce their separate currency risks. Under the terms of the dual currency swap, Eurocorp and Americorp swap the principal and interest rate repayment obligations associated with their bond issuances. In addition, they concur ahead of time to utilize specific exchange rates, with the goal that they are less presented to possibly adverse developments in the foreign exchange market. Significantly, the swap agreement is structured so that its maturity date lines up with the maturity date of the two companies' bonds.

Under the terms of their swap agreement, Eurocorp conveys $50 million USD to Americorp and receives an equivalent amount of euros in return. Eurocorp then, at that point, pays interest designated in euros to Americorp and receives an equivalent amount of interest named in USD.

As a result of this transaction, Eurocorp can service the interest payments on their initial bond issuance utilizing the USD interest payments that they receive from their swap agreement with Americorp. Moreover, Americorp can service its bond interest payments utilizing the euros received from its swap agreement with Eurocorp.

When the maturity date for the companies' bonds comes due, they reverse the exchange of principal that happened toward the beginning of their swap agreement and return that principal to their bond investors. Eventually, the two companies benefited from the swap agreement since it enabled them to reduce their exposure to currency risks.

Features

• A dual currency swap is a derivatives transaction that permits the gatherings required to reduce their exposure to foreign exchange risk.
• It is ordinarily utilized as a supplement to dual currency bond transactions.
• Dual currency swaps include trading the principal and interest repayment obligations associated with a dual currency bond. The timing and terms of the dual currency swap would be structured to offset, or hedge, the bond's currency risk.