DESCRIPTION Similar to an Interest Rate Swap but where each leg of the swap is denominated in a different currency.

A Cross Currency Swap therefore has two principal amounts, one for each currency. Normally, the exchange rate used to determine the two principals is the then prevailing spot rate although for delayed start transactions, the parties can either agree to use the forward FX rate or agree to set the rate two business days prior to the start of the deal. With an Interest Rate Swap there is no exchange of principal at either the start or end of the transaction as both principal amounts are the same and therefore net out. For a Cross Currency Swap it is essential that the parties agree to exchange principal amounts at maturity. The exchange of principal at the start is optional (see Corporate example below). Like all Swaps, a Cross Currency Swap can be replicated using on-balance-sheet instruments, in this case loan and deposits in different currencies. This explains the necessity for principal exchanges at maturity as all loans and deposits also require repayment at maturity. While the corporate or investor counterparty can elect not to exchange principal at the start, the bank needs to. This initial exchange can be replicated by the bank by entering into a spot exchange transaction at the same rate quoted in the Cross Currency Swap. Loosely speaking, all foreign exchange forwards can be described as Cross Currency Swaps as they are agreements to exchange two streams of cashflows (in this case a stream of one!) in different currencies. Many banks manage Long Term Foreign Exchange Forwards as part of the Cross Currency Swap business given the similarities. Like all FX Forwards, the Cross Currency Swap exposes the user to foreign exchange risk. The swap leg the party agrees to pay is a liability in one currency, and the swap leg they have agreed to receive, is an asset in the other currency. One of the major market users for Cross Currency Swaps are Debt issuers, particularly in the Euro-markets where issuers sell bonds in the "cheapest" currency and swap their exposure to their desired currency (see Pricing). A Cross Currency Swap where both legs are floating rate is part of the Basis Swap product family. Cross Currency Swaps are also known as a CIRCA (a Currency and Interest Rate Conversion Agreement). A Cross Currency Swap is an agreement between two parties to exchange interest payments denominated in two different currencies for a specified term. One interest payment is typically calculated using a floating rate index such as USD LIBOR. The other interest payment is based upon a fixed rate or another floating rate index denominated in a different currency.

Example 1
The firm has a loan in dollars which was arranged 3 years ago and which is currently on a floating-rate basis. In the 3 years since then, the business has grown and is now exporting into Europe and receiving foreign currency from France. Managing the risk on the foreign exchange is becoming more and more difficult. The firm are also aware of the interest-rate risk on the loan.

The product
A Cross-Currency Interest-Rate Swap can solve both of these problems at once. This swap allows the firm to switch its loan and interest repayments from one currency into another. It also allows the firm to switch the interest rate from floating to fixed or from fixed to floating. This means the firm can switch a floating-rate dollar loan into a fixed- or floating-rate French Franc loan. The firm will pay floating dollar rate on the original loan but through the Cross-Currency Interest Rate Swap it will receive floating LIBOR. The firm must pay a fixed (or floating) rate in French Francs of an equal amount. The product is particularly useful if you have a loan in dollars and you receive a lot of foreign currency from abroad. The firm can then use this foreign currency to repay its loan.

The solution
The firm have borrowed $1 million which the firm will repay over 3 years. The firm decide to do a Cross-Currency Interest-Rate Swap with a bank. The French Franc and dollar exchange rate is 5 Francs to one Dollar. Under the terms of the swap, banks will do a foreign exchange deal that day so that the firm sells to the bank 1 Million Dollars and banks sell to the firm 5 million French Francs. Banks will pay the firm a floating interest rate on the $1 dollars for 3 years. Banks will pay you $1 million in dollars back at the end of the period. In return the bank will pay a fixed (or floating) interest rate on the French Franc loan of 5 million for 3 years. The firm will pay the bank 5 million Francs back at the end of the swap period. In doing this the firm creates a French Franc loan and it can use the French Francs from its exports to pay off the loan. This gets rid of the problem of managing its foreign exchange risk. And if the firm chooses a fixed interest rate on the French Franc loan it can also get rid of any possible interest-rate risk.