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.