A currency swap, also called a cross-currency swap, is a contract to exchange payment streams denominated in different currencies. Each leg has its own principal amount and interest terms; principal exchanges may also be agreed. A company can use one to transform foreign-currency borrowing into payments in the currency of its revenues, provided the swap matches the debt's amounts and dates.
The practical task is to track what currency must be delivered, how much, and when. A favourable coupon rate does not by itself make the swap cheap: exchange rates, funding terms and the value of both payment streams matter.
Two currencies, two ledgers
Consider a synthetic fixed-for-fixed contract lasting exactly one year. Party A initially pays EUR 100 and receives USD 120. The agreed principals are re-exchanged at maturity. There is one interest payment then, with a full-year accrual fraction of 1: A pays 2% on the USD principal and receives 3% on the EUR principal. There are no interim payments, principal resets or fees in this example.
| Time | A's EUR cash flow | A's USD cash flow |
|---|---|---|
| Start | −100 | +120 |
| One year: interest | +3 | −2.40 |
| One year: principal | +100 | −120 |
| One year: total | +103 | −122.40 |
The interest amounts are EUR and USD . At maturity, the original principals return in the opposite directions to the initial exchange. Party B has the opposite sign in each currency on each date.
Illustrative one-year contract, viewed by Party A. Principal re-exchange and one annual coupon are stipulated; amounts are currency units, not millions.
The ratio of the initial principals is 1.20 USD per EUR. That fixes the principal amounts for this contract; it does not require the future market exchange rate to stay at 1.20. Nor does the example establish that these coupon terms would make a new swap fairly priced.
A common mistake is to subtract 122.40 from 103 and call the result a net payment. These amounts have different units. If the maturity spot rate is USD per EUR, the USD equivalent of the maturity exchange alone is
At an illustrative , that equals USD 1.20. It is not the trade's profit: assessing the whole transaction also requires the initial flows, funding or investment cash flows, timing and any costs. Actual settlement remains EUR 103 against USD 122.40 unless the contract provides otherwise.
What the swap changes
Suppose A owes a EUR loan whose final payment is EUR 103. The swap's EUR receipt can cover that obligation, while its initial EUR payment can be supplied by the loan proceeds. A receives USD 120 initially and owes USD 122.40 at maturity through the swap. Together, the matched loan and swap create USD funding cash flows.
That cancellation is only as good as the match. An amortising loan, different coupon dates, floating-rate resets or early repayment can leave residual basis risk. For the broader mechanics, the Swaps lesson in the Finance Primer explains payment legs, netting and collateral; the full lesson requires a free signed-in account, with a public preview available.
Currency swap versus FX swap
An FX swap combines a near-date currency exchange with an opposite far-date exchange at an agreed rate. Its financing cost is embedded in the difference between those exchanges; it does not have a separate periodic coupon stream. A currency swap explicitly exchanges interest streams as well as any agreed principal flows. Tenor alone is not a reliable definition: the one-year example above is intentionally short and has only one coupon date. The BIS describes the near/far structure and the additional interest streams.
Actual currency swaps can be fixed-for-fixed, fixed-for-floating or floating-for-floating. A cross-currency basis swap exchanges floating-rate legs in different currencies, with a quoted spread on a specified leg. Read the benchmark, spread sign and payer direction together; a basis quote is not a universal measure of which party wins. The BIS explanation of cross-currency basis uses historical LIBOR examples, rather than prescribing today's benchmark terms.
Some contracts reset a principal amount as FX moves, generating additional cash flows. The RBA's explanation of resetting principal shows why the fixed-principal ledger above must not be applied to every cross-currency swap. Collateral and close-out terms also matter: a hedge can reduce a firm's currency mismatch while still creating collateral calls, settlement exposure and counterparty credit risk.
Sources
- John C. Hull, Options, Futures, and Other Derivatives, 9th Global Edition, Pearson, 2018, §§7.9–7.10, pp. 190–196: principal and coupon mechanics; valuation of the two currency legs.
- BIS, Annual Economic Report 2025, “The FX swap market as linchpin”: near/far FX exchanges and currency-swap interest streams.
- BIS, “CIP, FX swaps, cross-currency swaps and the factors that move the basis”: basis mechanics, using historical reference rates.
- RBA, “OTC Derivatives Reforms and the Australian Cross-currency Swap Market”, 2013, especially footnote 5: principal resets and collateral. Historical market and regulatory observations are not asserted as current rules.