Although a relatively recent invention, currency swaps have quickly become a vital and widely used financial instrument. Given the steady increase in globalization, understanding the potential benefits of using currency swaps is essential to any modern multinational business. Currency swapping works just as the name implies – different national currencies are swapped between two parties for an agreed amount of time. Investopeia.com defines a currency swap as “two notional principals [of different currencies] that are exchanged at the beginning and at the end of the agreement” (Cavallaro, 2011).
Typically, the reason to engage in a currency swap with another company is because a company may have a comparative advantage in getting a loan in one currency, typically their domestic currency, though they might desire the funds to be in a foreign currency. If they can find a counterpart who also has a comparative advantage in getting financing in their domestic currency, both companies can benefit though a currency swap.
To illustrate this, imagine that a well-know U.S. based corporation wants to expand its operations in Europe. Perhaps it will receive more attractive financing in the U.S. based on its reputation and contacts than in Europe; so the company can get a loan from a U.S. bank at a relatively low rate and then simply swap the dollars for Euros with a European company which needs USD and likewise has an advantage in financing options in its domestic currency (McCaffrey, 2007). Another reason a currency swap might be beneficial to a company is to hedge against currency fluctuations. Consider a U.S. firm that is seeking to hedge some of its euro exposure by borrowing in euros; by arranging a currency swap with a European com...
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...t of deregulation and integration of national capital markets and extreme interest rate and currency volatility…” (Shapiro, 2006, p. 312)
Figure 1 (Bank for International Settlements, 2007) (BANK FOR INTERNATIONAL SETTLEMENTS, 1999) (Bank for International Settlements, 2005)
Works Cited
Cavallaro, M. (2011, June 7). Hedging With Currency Swaps. Retrieved September 9, 2011, from Investopedia.com: http://www.investopedia.com/articles/forex/11/hedging-with-currency-swaps.asp#axzz1XRYSf5wt
McCaffrey, M. (2007, April 27). An Introduction To Swaps. Retrieved September 9, 2011, from Investopedia.com: http://www.investopedia.com/articles/optioninvestor/07/swaps.asp#axzz1XP2LnDyM
Shapiro, A. (2006). Multinational financial management (8th ed.). John Wiley & Sons.
Walmsle, J. (1992). Foreign Exchange and Money Markets Guide, The. New York: John Wiley & Sons, Inc.
The coins made in gold, silver and bronze were traded during Roman Empire and the shortage of coins created a barrier for money circulation. However with the establishment of paper money, a sophisticated banking, global clearing system and electronic money, the global financial system evolved with a worldwide framework of legal agreements. In the Global Financial market, foreign currencies issued by the world, countries are traded by the buyers and sellers using currency exchange rates. Now a day, it is very common practices of companies in one country to raise capital in a foreign country by listing their stocks on major foreign exchanges given the growth of equity markets are becoming more globalized (SNHU, 2015).
Money Market Hedge - Jaguar could borrow USD, convert the proceeds into GBP using spot rate, and use the revenues generated in US market to pay back the USD principle and interests in the future. Borrowing in US dollars would provide a "natural" hedge against Jaguar’s dollar revenue stream. However, Jaguar might not get a favorable interest rate in its USD loans, which might inflate the costs of the money market hedge. What’s more, unpredictable fluctuation of Jaguar’s revenue streams in US might hurt its ability to pay back debts and therefore become a potential threat to Jaguar’s financial situation.
see, foreign exchange hedging was an area of key importance for AIFS given the level of currency
Harris, Larry (2003). Trading and Exchanges: Market Microstructure for Practitioners. Oxford University Press. p. 290.
Kiss, Elinda Fishman. "Chapter 14 Optimum Currency Area: Euro as a Practical Paradigm." Ed. Dilip K. Ghosh and Mohamed Ariff. Global Financial Markets: Issues and Strategies. Westport, CT: Praeger, 2004. N. pag. Print.
Rob, Dixon, and Holmes Phil. Capital market; Stock exchanges; Foreign exchange market; Futures market. London: Chapman and Hall, 1992.
Globalization has led to an increase in multinational companies that produce different types of goods. Although these multinational corporations have been reaping substantial benefits as a result of market expansion, they face a greater risk of losing their international revenues as a result of fluctuations in exchange rates. Changes in the exchange rate between the countries expose the home company to various risks such as transaction exposure, translation, and economic exposure. As a result, the value of the firm is affected by fluctuation in the exchange rate. To effectively manage the exposures, companies use various hedging strategies such as the use of forwards contracts.
When considering the currency exposure that would need to be managed by Roraima, three aspects must be considered. Transaction exposure, translation exposure and economic exposure. Transaction exposure would be when dealings would be “affected by fluctuations in foreign exchange rate values” (306). Translation exposure would occur when these exchange rate differences show up differently on the financial statements. And lastly, the economic exposure refers to a situation in which the projected “earning power is affected by changes in exchange rates” (307). Economic exposure is the concept that best reflects the overall process of managing foreign exchange risk because it deals with the long-term effects of a global strategy and earning power. The firm would have to be alert to changes in exchange rates enabling them to project their costs and
Wang, Jing 2008, ‘Why Are Exchange Rates So Difficult To Predict’, Economic Letter, Vol. 3, no. 6.
The expanding global market has created both staggering wealth for some and the promise of it for others. Business is more competitive than ever before, and every business, financial or product-based, regardless of size or international presence is obligated to operate as efficiently as possible. A major factor in that efficient operation is to take advantage of every opportunity to maximize profits. Many multinational organizations have used derivatives for years in financial risk management activities. These same actions that can protect multinational organizations against interest rate futures and currency fluctuations can be used to create profits for those same organizations.
Howells, Peter., Bain, Keith 2000, Financial Markets and Institutions, 3rd edn, Henry King Ltd., Great Britain.
The adoption of an appropriate or adequate exchange rate regime is most times perceived as a complex and technical process. Several nations around the globe have adopted the floating...
Foreign exchange translation exposure results when an MNC translates each subsidiary’s financial data to its home currency for consolidated financial reporting. Foreign exchange translation risk arises from investments in the following countries: United States, United Kingdom, Switzerland, Hungary, Turkey, Poland, Australia, New Zealand, India and Egypt. The functional currencies of the subsidiaries in these countries are different from the Euro
The foreign exchange market is one of important mechanism in the international business because foreign exchange is an intermediary for all nations in term of the growth of the economy. There are many functions of foreign exchange market in the global economy. In the international business, it uses the foreign exchange markets in four ways. First, the pay...
Machiraju, H. R. , 2002. International Financial Markets And India. 1st ed. New Delhi: New Age International.