Currency Swap Arrangements

Recently, the RBI decided to address the liquidity deficit in the banking system by bond purchases & a $10B dollar/rupee buy/sell forex swap. 𝐁𝐮𝐭 𝐰𝐡𝐚𝐭 𝐢𝐬 𝐚 𝐟𝐨𝐫𝐞𝐱 𝐬𝐰𝐚𝐩?   A financial agreement where two parties exchange currencies today & agree to reverse the transaction at a future date at a pre-determined rate   Let's consider the RBI's example:  ✔️ RBI is planning to enter into the dollar/rupee buy/sell forex swap for 3 years ✔️ RBI will buy $10B from banks today, giving them ₹86,950 crore (at 1 USD = 86.95 INR) ✔️ For the sake of this example, let's consider a pre-agreed swap rate for 2027 is set at 1 USD = 88 INR (i.e., banks will return ₹88,000 crore to RBI in exchange for $10B) ✔️ After 3 years, banks must return the rupees, and the RBI will return the $10B   The USD/INR rate will not necessarily be at 1 USD = 88 INR 𝐒𝐜𝐞𝐧𝐚𝐫𝐢𝐨 𝟏: 𝐑𝐮𝐩𝐞𝐞 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐞𝐬 (𝟏 𝐔𝐒𝐃 = 𝟗𝟎 𝐈𝐍𝐑 𝐢𝐧 𝟐𝟎𝟐𝟕) - Banks need ₹90,000 crore to buy back $10B at market rates - But they only need to return ₹88,000 crore to RBI as per the swap - Banks 𝐠𝐚𝐢𝐧 ₹𝟐,𝟎𝟎𝟎 𝐜𝐫𝐨𝐫𝐞 because they are buying back dollars cheaper than the market price 𝐒𝐜𝐞𝐧𝐚𝐫𝐢𝐨 𝟐: 𝐑𝐮𝐩𝐞𝐞 𝐀𝐩𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐞𝐬 (𝟏 𝐔𝐒𝐃 = 𝟖𝟓 𝐈𝐍𝐑 𝐢𝐧 𝟐𝟎𝟐𝟕) - Banks need only ₹85,000 crore to buy back $10B at market rates - But they are locked into returning ₹88,000 crore to RBI as per the swap - Banks 𝐥𝐨𝐬𝐞 ₹𝟑,𝟎𝟎𝟎 𝐜𝐫𝐨𝐫𝐞 since they are buying back dollars at a higher-than-market price   𝐖𝐡𝐲 𝐝𝐨 𝐛𝐚𝐧𝐤𝐬 𝐩𝐚𝐫𝐭𝐢𝐜𝐢𝐩𝐚𝐭𝐞? ✔️ Instant Liquidity – Banks get ₹86,950 crore today, which addresses the liquidity deficit issue in our example. They can lend or invest ✔️Potential Forex Gains – If INR weakens beyond the pre-agreed swap rate, they profit ✔️ Interest Rate Arbitrage – If banks invest the rupees in high-yield instruments, they can earn extra returns over 3 years   Banks borrow ₹86,950 crore today, but their final cost depends on where USD/INR stands in 3 years compared to the pre-agreed swap rate (₹88). If INR weakens, they win; if it strengthens, they lose.

Cross-currency swaps. You removed the headline FX risk. You kept the basis, the MTM, and the collateral call nobody modelled. A cross-currency swap lets you borrow in one currency and service the debt in another. The coupon payments swap. The principal swaps back at maturity at the original rate. On paper, the FX risk disappears. What does not disappear is the basis. That is where many get surprised, not at inception, but 2 years in when the all-in cost looks nothing like the term sheet. Five things you need to understand before you enter a cross-currency swap. 1. What a cross-currency swap actually is. Two parties exchange principal in different currencies at inception. Throughout the life of the trade, they exchange coupon payments in those respective currencies. At maturity, the principal is re-exchanged at the original spot rate. The FX exposure on the underlying bond or loan is neutralised. What changes hands at every coupon date is the interest differential, and the basis layered on top of it. 2. The basis: the cost gets under-modelled. Cross-currency basis is a spread on top of the interest rate differential. It reflects supply and demand dynamics in the swap market, not interest rate fundamentals. It is real, it moves, and it is almost never modelled properly at the start of a programme. AUD/USD basis has historically traded between -40bps and +10bps. The rate on the term sheet is not the all-in cost. It is the starting point. 3. The MTM trap. Cross-currency swaps are marked to market daily. As rates and FX move, the NPV shifts. For a corporate or fund with liability-driven mandates, this creates P&L volatility that has nothing to do with the underlying exposure being hedged. It is not a cash loss until the trade is unwound, but it hits the balance sheet, can trigger collateral calls, and will eventually appear in front of an audit committee that was not briefed on it at inception. 4. Collateral and CSA optionality. If the CCS is collateralised under a CSA, variation margin moves with the MTM. The CSA currency, threshold amounts, and eligible collateral types all affect the true economic cost of the hedge in ways that are difficult to price upfront. If you are posting collateral in a currency that is not your functional currency, you have introduced a secondary FX exposure. 5. Where CCS breaks. Basis blowout during stress is the primary failure mode. In 2008 and March 2020, cross-currency basis moved to levels that made the economic cost of the hedge materially worse than the rate differential benefit it was designed to capture. For long-dated structures running five to ten years, you are carrying meaningful basis risk for the full tenor. Cross-currency swaps are the right instrument for genuine currency-liability mismatches. The problems come from treating basis, MTM volatility, and CSA optionality as footnotes rather than as core components of the cost analysis. parabellumadvisors.com CCS

🇺🇸🌎💵 Central banks worldwide are quietly preparing contingency plans as doubts grow over the reliability of dollar swap lines, the financial lifelines that have stabilised global markets since 2008. With Fed Chair Jay Powell set to leave in 2026 and Trump pushing the Fed to cut rates despite early inflation signals, these once-sacred agreements face unprecedented uncertainty. During the 2008 crisis, the Fed activated $583B in swap lines for non-US central banks. Another $450B flowed during Covid-19, preventing global financial contagion. These arrangements let foreign central banks access dollars when their commercial banks face funding shortages, addressing the core issue that only the Fed can print the world's reserve currency. Since then, US Vice President JD Vance has said he "hate[s] bailing Europe out," while Treasury Secretary Scott Bessent views finance, military, trade, and technology as deeply linked. As a result, future swap line access may come with political conditions. Would Denmark get dollar support without concessions on Greenland? Does the Pentagon's review of the submarine pact with Britain and Australia suggest allied agreements no longer enjoy automatic protection? European Central Bank officials remain publicly confident, yet the ECB recently asked banks to report dollar exposure vulnerabilities. Think tank CEPR has proposed a mutual pact in which 14 central banks use their combined $1.9T in dollar holdings to support each other if Fed swap lines vanish. Central banks are already taking defensive measures, increasing gold purchases and negotiating alternative arrangements with China. Bruno Colmant notes that stablecoins represent a further fundamental shift in dollar creation, bypassing traditional central bank swaps. Private American companies now issue dollar-backed tokens by buying US Treasury bills, effectively forcing foreign holders to finance US debt directly rather than through central bank channels. This ties to Izabella Kaminska's multilateral vision fund idea, which Sec. Bessent publicly supports. In his and Trump’s view, Japan, Korea, and European allies should invest their capital surplus in US manufacturing while America provides military protection and technology transfers. As Izabella notes, the setup resembles a reverse Marshall Plan, turning decades of trade surpluses into equity stakes in American industry. Weakening swap line reliability and rising stablecoin adoption could accelerate dollar system fragmentation. Treasury-backed stablecoins may prove safer than traditional bank deposits tied to central bank swaps, creating incentives for systemic change. Nixon’s 1971 exit from Bretton Woods caused monetary chaos but ultimately strengthened the dollar. Today’s shifts could prove equally disruptive, forcing central banks to choose between dollar dependence and monetary sovereignty. -- More analysis on monetary transformation in the NL Euro Stable Watch, which I co-edit with Marieke Flament 💶

When the news broke that the UAE Central Bank had quietly asked the Fed for a dollar swap line, I was, frankly, puzzled. A central bank with $300bn in reserves and $2tn in sovereign wealth assets standing behind it does not, on the face of it, need to borrow dollars from anyone. It looked structurally odd. I asked around. The answers were unsatisfying. So I went down several rabbit holes - you know how nerdish I can get, and this essay is no different. The first crack came from Brad Setser at the CFR and from Bessent himself. The UAE's reserves are not an access problem. They are a problem of liquidation impact. Selling $50bn from Abu Dhabi Inc or the CB UAE into a stressed market would itself break the Treasury market. So a swap line is the elegant non-disruptive option. That answer is correct. It is also incomplete. Because what I had missed, and what now strikes me as mindbogglingly brilliant, is that the CB UAE has been quietly assembling a four-layer monetary architecture over five years. First, a dollar peg at 3.6725, anchored by Abu Dhabi Inc. and CB UAE $2tn balance sheet. Second, eight outbound dirham swap agreements (China, Turkey, Egypt, Ethiopia, Bahrain, with Saudi Arabia and India in active negotiation), creating a regional non-dollar settlement layer that rests on a dollar foundation. Third, the AE Coin and the Payment Token Services Regulation, which has, since July 2025, locked foreign-currency stablecoins (USDT, USDC, the lot) out of domestic UAE payments. The AE Coin Consortium (IHC, ADQ, BankFab, UAE) is now building the institutional version. Fourth, the Digital Dirham and mBridge, completing the sovereign-to-retail CBDC stack. The inbound Fed swap request is the missing capstone. Dollar liquidity in extremis, slotted into a system that already has everything else. And here is the strategic move that hasn't been noticed: the request itself is the prize, even if never granted. The signalling. The leverage (UAE officials told The Wall Street Journal they "may need to settle oil transactions in renminbi or other currencies"). The optionality. Those exist whether the FOMC approves or not. The UAE wins by asking. This is state-level architecture that very few jurisdictions can match. Not reactive moves but a deliberate, optionalised construction that quietly, unfussily, hedges every plausible dollar liquidity outcome. Colour me extremely impressed. Are there other state-level architectures we're not reading this carefully? The essay here - https://lnkd.in/dGSpJw4f #CentralBanking #SwapLines #UAE #Dirham #AECoin #DigitalDirham #ADGM #Stablecoins #FederalReserve #FamilyOffice #TheInformedAllocator

Ethiopia is now in active talks with China to convert a portion of the $5.38 billion debt it owes Beijing from U.S. dollar–denominated terms into yuan, following a blueprint set recently by Kenya. As reported by Bloomberg, Ethiopia’s central bank governor, Eyob Tekalign, met with representatives from The Export-Import Bank of China and the People's Bank of China in Beijing to explore a currency-swap restructuring. This move has multiple implications. At one level, it signals China’s continued push for its currency’s greater role in global finance—and in particular, in development finance for African economies. At another level, it reflects Ethiopia’s search for greater flexibility amid debt pressures and currency volatility. By shifting liability from dollars to yuan, Ethiopia may aim to mitigate exposure to dollar fluctuations and potentially secure more favorable terms. Yet it also exposes the country to new risks tied to yuan valuations and China’s monetary policy. For policymakers and business leaders, this development is a reminder that the conventional dominance of the dollar in international lending is not immutable. Emerging markets and creditor nations are experimenting with alternative frameworks and instruments to rebalance risk, influence, and currency strategy. As the global economy continues to evolve, we might increasingly see hybrid debt structures, local currency lending, and more multipolar reserve currency dynamics. This isn’t just about one bilateral debt deal — it speaks to how nations are rethinking financial sovereignty, currency exposure, and development finance architecture for the years ahead. https://lnkd.in/gm26xWe7

💱 What is a Currency Swap? A currency swap is a financial derivative contract in which two parties exchange principal and interest payments in different currencies The swap typically involves: 1️⃣ Initial exchange of principal amounts in different currencies 2️⃣ Periodic exchange of interest payments (which can be fixed or floating) 3️⃣ Final re-exchange of the principal amounts at the end of the swap term 🔁 Purpose of a Currency Swap Currency swaps are used by: 🔅 Corporates: To hedge against foreign currency debt 🔅 Governments: To manage foreign reserves or funding costs 🔅 Investors and banks: To gain access to cheaper foreign funding or exposure Imagine 💡 1️⃣ A Sri Lankan company (Company A) has a loan in USD but earns in LKR 2️⃣ A U.S. company (Company B) has a loan in LKR (perhaps via a local subsidiary) but earns in USD They can enter a currency swap to exchange their obligations and reduce foreign exchange risk 🔄 Step-by-Step: How a Currency Swap Works 👥 Parties: Company A (Sri Lanka): Needs USD Company B (USA): Needs LKR Step 1️⃣ : Initial Principal Exchange 🔹 Company A gives LKR 32 million (at LKR 320/USD) 🔹Company B gives USD 100,000 This allows each party to access the currency they need without going to the forex market Step 2️⃣ : Periodic Interest Payments (e.g., annually) Let’s assume a 3-year swap: 🔹 Company A pays interest on USD 100,000 at 5% annually → USD 5,000 🔹 Company B pays interest on LKR 32 million at 12% annually → LKR 3.84 million Each party pays interest in the currency it originally received. Step 3️⃣ : Final Re-exchange of Principal At the end of 3 years: 🔹 Company A returns USD 100,000 🔹 Company B returns LKR 32 million This protects both companies from exchange rate volatility during the contract period 🧠Currency swaps are a useful tool for multinational companies to manage foreign currency liabilities, reduce financing costs, and hedge long-term FX risk But they must be entered with clear legal agreements and understanding of counterparties #RiskManagement #CorporateFinance #FinancialStrategy #TreasuryManagement #DerivativeMarkets #CurrencyTrading #HedgingStrategies #ForeignExchangeRisk #OptionsTrading #FinancialMarkets #CFRM #SL02

Steps to Price a Currency Swap 📊📊📊 🎯 1. Understand the Currency Swap Structure A currency swap involves exchanging principal and interest payments in one currency for those in another. Typically, one side pays a fixed interest rate, and the other pays a floating rate, although fixed-fixed structures are also common. 🎯 2. Gather Inputs - Principal amounts for both currencies. - Fixed and floating interest rates for each currency. - Spot exchange rate and, if necessary, forward rates for the currency pair. - Discount rates from the respective yield curves of the currencies. - Swap tenor and payment frequency (e.g., quarterly, semi-annual). 🎯 3. Calculate Fixed Leg Cash Flows Determine the periodic fixed interest payments in the fixed-rate currency. Discount these payments to the present using the discount factors from the yield curve. Fixed Payment = Notional Amount × Fixed Rate × Day Count Fraction 🎯 4. Calculate Floating Leg Cash Flows Identify the floating interest rate for each period (typically tied to benchmarks like LIBOR or SOFR). Calculate periodic floating interest payments and discount them to the present. Include the notional repayment at the end of the swap if applicable. Floating Payment = Notional Amount × Floating Rate × Day Count Fraction 🎯 5. Incorporate Spot and Forward Rates Spot rates are used to convert initial or current cash flows between currencies. Forward rates may be used to value cash flows expected in the future, as they account for the time value of money and interest rate differentials between the currencies. 🎯 6. Convert Cash Flows to a Common Currency Use the spot rate or forward rates to convert the cash flows of one currency into another. 🎯 7. Net the Present Values Calculate the difference between the present value of the fixed and floating legs, ensuring all values are in the same currency. 🎯 8. Include Principal Exchange (if applicable) If the swap involves exchanging principals at the start and/or end, include these amounts in the valuation. Note: 📊📊 🎯 Spot Rate: Used for initial principal exchanges and converting immediate cash flows into the counter currency. 🎯 Forward Rate: Used to value future cash flows, as it accounts for the interest rate differential between the two currencies over time. It is derived from spot rates and interest rates for both currencies. #CurrencySwap #InterestRates #SpotRate #ForwardRate #QuantFinance #FixedIncome #Derivatives #SwapValuation #FinancialModeling #RiskManagement

𝗖𝘂𝗿𝗿𝗲𝗻𝗰𝘆 𝗦𝘄𝗮𝗽𝘀 𝗶𝗻 𝗦𝗶𝗺𝗽𝗹𝗲 𝗧𝗲𝗿𝗺𝘀 Currency swaps are essential derivative instruments for companies and investors operating in international markets. They allow the conversion of payment flows from one currency to another while benefiting from preferential interest rates. When a company borrows in a foreign currency, it is often exposed to exchange rate fluctuations and to potentially higher interest rates compared to borrowing in its local currency. A currency swap can help optimize costs by leveraging comparative advantages in different interest rate environments. Take two companies, A (AAA-rated) and B (BBB-rated), both needing to borrow €10M for five years. A prefers a floating-rate loan but can borrow at 4% fixed or EURIBOR + 30 bps. B prefers a fixed-rate loan but faces 5.2% fixed or EURIBOR + 100 bps. The fixed-rate spread is 1.2% (5.2% - 4.0%), while the floating-rate spread is only 0.7% (EURIBOR + 100 - EURIBOR + 30). This means B has a relative advantage in floating-rate borrowing, while A benefits more in the fixed-rate market, creating an opportunity for a swap to lower costs for both. 𝗘𝘅𝗮𝗺𝗽𝗹𝗲: A European Company Seeking to Borrow in USD A direct loan in USD would cost the company 6% annual interest. However, it can borrow in EUR at a rate of 3%. Using a EUR/USD currency swap, it can convert its EUR-denominated loan into a USD liability, benefiting from the lower EUR interest rate and securing a fixed exchange rate for future USD payments. 𝟮. 𝗛𝗼𝘄 𝗮 𝗖𝘂𝗿𝗿𝗲𝗻𝗰𝘆 𝗦𝘄𝗮𝗽 𝗪𝗼𝗿𝗸𝘀: 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄s A currency swap is a contract in which two parties exchange interest payments and/or principal amounts in different currencies. 𝗞𝗲𝘆 𝗙𝗲𝗮𝘁𝘂𝗿𝗲𝘀: 𝗘𝘅𝗰𝗵𝗮𝗻𝗴𝗲 𝗼𝗳 𝗻𝗼𝘁𝗶𝗼𝗻𝗮𝗹 𝗮𝗺𝗼𝘂𝗻𝘁𝘀: At the beginning of the swap, the parties exchange a principal amount in their respective currencies. At maturity, they return these notional amounts. 𝗘𝘅𝗰𝗵𝗮𝗻𝗴𝗲 𝗼𝗳 𝗶𝗻𝘁𝗲𝗿𝗲𝘀𝘁 𝗽𝗮𝘆𝗺𝗲𝗻𝘁𝘀: Each party pays an interest rate in the currency they borrow and receives an interest rate in the other currency. 𝗙𝗶𝘅𝗲𝗱 𝗼𝗿 𝗳𝗹𝗼𝗮𝘁𝗶𝗻𝗴 𝗶𝗻𝘁𝗲𝗿𝗲𝘀𝘁 𝗿𝗮𝘁𝗲𝘀: Swaps can be fixed-to-fixed or fixed-to-floating. Suppose a European company needs $100 million for a project. Instead of borrowing directly in USD, it opts for a currency swap. 𝗦𝘁𝗲𝗽𝘀 𝗼𝗳 𝘁𝗵𝗲 𝗦𝘄𝗮𝗽: 1. The company borrows €90 million (equivalent to $100 million at an exchange rate of 1 EUR = 1.11 USD). 2. It immediately exchanges the euros for dollars through a currency swap. 3. The company pays interest in USD at an agreed rate while receiving interest payments in EUR. 4. At maturity, the two parties re-exchange the notional amounts, and the company recovers its euros to repay the original loan. This strategy enables the company to benefit from a lower EUR interest rate while securing its USD payment obligations at a known exchange rate. #CurrencySwaps #FXMarkets #RiskManagement

Matching currency cash flows in a currency swap can avoid or reduce the risk of foreign exchange fluctuations. It is the practice where a company aligns its foreign currency inflows with its foreign currency outflows. This mismatch can expose the company to exchange rate risk. Example - if the foreign currency weakens relative to the home currency, the company might not have enough of the foreign currency to cover its expenses. A currency swap can be used to address this risk by allowing the company to swap its future cash inflows in one currency for cash outflows in another currency that match its obligations. Let’s consider Company A, a U.S.-based company, which has a revenue stream in euros (EUR) but needs to pay a loan in U.S. dollars (USD). Company A’s situation: Revenue: Company A generates 10 million Euros annually from European operations. Loan: The company has a $12 million loan to repay in the U.S. (in USD). Company A’s problem is that it earns euros (EUR) but has expenses (loan repayments) in US dollars (USD). If the exchange rate between EUR and USD fluctuates, it could end up with insufficient euros to meet its loan obligations in USD, or it might face higher costs if the EUR weakens against the USD. To match the currency cash flows, Company A could enter into a currency swap with another company or financial institution. Let’s assume the swap terms are: -> Company A receives 10 million Euros, while the counterparty receives $12 million. Company A agrees to swap its 10 million Euros with $12 million at the start of the swap. This exchange ensures that Company A has the required dollars to service its loan payments. -> Company A will make periodic interest payments on the $12 million loan in USD, while the counterparty will make interest payments on the 10 million Euros loan in EUR. So here, the company A pays a fixed interest rate of 5% on the $12 million in USD. The counterparty pays a fixed interest rate of 4% on the 10 million in EUR. These interest payments are made periodically (annually/ semi-annually depending on the terms), and the currency of the payments is based on the currency the cash flows are denominated in (USD for Company A’s side and EUR for the counterparty). At the end of the swap’s term (let’s assume 5 years), Company A will repay the $12 million principal, while the counterparty will repay 10 million Euros. This ensures that Company A has euros available (through the swap) to cover the loan repayment in euros when the time comes, and it will also receive USD back when the principal is exchanged at the end of the swap. Company A gets benefitted: Before the swap: Company A had mismatched currency cash flows, earning euros but needing to pay USD. After the swap: Company A has effectively matched its revenue stream (EUR) to its debt repayment (USD). The swap structure ensures that it has the right amount of currency to meet its obligations. #CCR #counterpartycreditrisk