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Swap; Currency Swap; Foreign Exchange Swap; Forex
If a U.S. based company invoices foreign customers in a foreign currency and accepts payment in that foreign currency, unless the seller performs some form of FX hedging at some point foreign exchange related risks will have a negative impact on the seller's profit margin.
One of the best ways to mitigate the risk associated with a seller making a sale denominated in a foreign currency is by using a Currency Swap. A Swap is an agreement between two parties to exchange two currencies at a certain exchange rate on a specific date in the future. Here is an example of a Swap transaction in the foreign exchange market: A bank is about to extend a loan enters into two foreign exchange contracts. One saspot contract, to buy foreign currency now.forward contract to sell the currency later with the same counter-party.
The two rates differ based on the difference in prevailing interest rates in the two currencies. This allows the lender to charge the prevailing interest rate for the currency in which the loan is denominated while paying the prevailing interest rate for the funds used. This is a fundamental principle of the forward foreign exchange market; if it were not the case, there would be a huge opportunity to profit by borrowing and lending in different currencies.
Edited by Michael C. Dennis. Mr. Dennis is a consultant specializing in improving the quote to cash process.