Foreign Currency Swaps

A currency swap involves the exchange of principal and/ or interest payments on a loan or asset in one currency for principal and/ or interest payments on an equivalent loan or asset in another currency. The rate is based on a prevailing spot or predetermined forward rate (for forward start swaps) and agreed upon at the time of the transaction.

For example, a customer in India with a long-term USD borrowing is typically exposed to exchange rate risk between the USD and the INR as well as USD interest rate risk. The company can eliminate the risk by entering into a USD/ INR currency swap with a bank (as per the prevailing regulations).

The customer receives from the bank USD floating interest rate payments and USD principal amortisations. Simultaneously, the customer pays the bank fixed interest rate in INR and the equivalent INR principal amortisations at an exchange rate based on a spot rate (or forward rate) prevailing at the time of the transaction and locked in for the entire tenure of the swap.

The client has the option of covering only interest payments, only principal repayments at maturity, or interest payments and principal repayments (amortisation).

For example:

• Client hedges interest payments and principal repayments
• Client hedges only interest payments

Clients don’t prefer these swaps as exchange rate risk on the principal is greater than the exchange rate risk on the interest portion only.

The client also has the option of hedging only the principal.

In this arrangement, the bank agrees to pay on maturity an agreed principal in one currency to the client at the current rate of exchange. In return, the client agrees to pay in another currency the equivalent amount of the principal on maturity as well as a fixed rate of interest on the principal amount at agreed intervals.

For more details, write to us at derivatives@hdfcbank.com