But ramesh learns from a company that American businessman Alex needs 7 Rupien Crore. Now Ramesh and Alex sign a swea-currency under which Ramesh 7 Crore gives Alex and Alex a million dollars. The value of the agreed amount for both is equal to the exchange rate of 1-Rs. 70. Currency Swp literally means “currency swp.” Under the agreement, two countries, two companies and two people exchange their countries so that their financial needs can be met without financial loss. A currency swp is considered a foreign currency transaction and it is not legal for an entity to display that transaction on its balance sheet. In the currency exchange agreement, the interest rate that two countries have offered can be both fixed and variable. For example, Ramesh and Alex, through currency swpes, have both met their financial needs by avoiding the uncertainty of exchange rate fluctuations. The agreement means that India can import up to $75 billion from Japan and will have the option to pay it in Indian rupees. Japan will have a similar facility, that is, Japan will also be able to import goods of this value from India by paying in yen. 3. It offers flexibility to companies that wish to hedge the risk associated with a given currency. Suppose Company A is headquartered in the United States and Company B is headquartered in England.
Company A must take out a loan that must be denominated in sterling and Company B to a loan denominated in U.S. dollars. These two companies can enter into a swap to take advantage of the fact that each company has better rates in its respective countries. Both companies could benefit from interest savings by combining privileged access to their own markets. An interest rate swap includes the exchange of cash flow related to interest payments at the declared nominal amount. There is no fictitious exchange at the beginning of the contract, so the fictitious amount is the same for both sides of the currency and is delineated in the same currency. The main exchange is redundant. Instead of borrowing 10% in real terms, Company A must meet the 5% interest payments that Company B receives as part of its agreement with Brazilian banks. Company A has effectively succeeded in replacing a 10% loan with a 5% loan. Similarly, Company B is no longer obliged to borrow 9% of funds from U.S.
institutions, but recognizes the 4% cost of credit borne by its counterparty. In this scenario, Company B did succeed in reducing its cost of debt by more than half. Instead of borrowing from international banks, the two companies borrow domestically and lend to each other at a lower interest rate. The following graph shows the general characteristics of currency sweaces. A fixed interest rate is exchanged for a variable rate or vice versa. Interest rates and currency swets differ in terms of the interest paid on the principal and the currency used for the payment. 2. Continuation of interest payments over the life of the swap – this represents a series of foreign exchange futures contracts during the term of the swap contract. The contract is generally set at the same exchange rate as the cash rate used at the beginning of the swap. On the day of the deal expiry, Ramesh will return $1 million to Alex and Alex will also return Rs 7 crore to Ramesh.