May 18, 2011

Commodity Stocks Tips Term of the Day 18 May Cross Currency Swap


The term cross currency swap means an agreement between two parties to exchange interest payments and principal on loans denominated in two different currencies. In a cross currency swap, a loan's interest payments and principal in one currency would be exchanged for an equally valued loan and interest payments in a different currency. This helps one to cross over to currencies as per their purpose of trade.

The main reason that why companies prefer the use of cross-currency swaps is mainly to take advantage of other comparative advantages. This can be explained by following example, as say if a U.S. company is in need to acquire some yen, and a Japanese company is in need to acquire some U.S. dollars, then these two companies could perform a swap. The Japanese company likely has better access to Japanese debt markets and could get more favorable terms on a yen loan than if the U.S. company went in directly to the Japanese debt market itself, and vice versa in the U.S. for the Japanese company.

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