Currency swaps effectively involve the exchange of debt from one currency to another. Currency swaps can provide a hedge against exchange rate movements for longer periods than the forward market and can be a means of obtaining finance new countries.
Advantage
1) Swaps are easy to arrange and are flexible since they can be arranged in any size and are reversible.
2) Transactions costs are low,only amounting to legal fees,since there is no commission or premium to be paid.
3) The parties can obtain the currency they require without subjecting themselves to the uncertains of the foreign exchange markets.
4) The company can gain access to debt finance in another country and currency where it is little known, and consequently has a poorer credit rating,than in its home country.It can therefore take advantage of lower interest rates than it could obtain if it arranged the currency loan itself. 5)Currency swaps may be used to restructure the currency base of the company's liabilities.This may be important where the company's is trading overseas and receiving revenues in foreign currencies, but its borrowings are denominated in the currency of its home contry.Currency swaps therefore provide a means of reducing exchange rate exposure.
Disadvantage
1) There is the risk of one of the parties defaulting.
2) There is the risk that interest rates and exchange rates could move in such a way that the net payments arising as a result of the swap are higher than they would have been had swap not been undertake.
3)If the bank takes on a temporary role in the financing during the arrangement of the swap,it runs the risk that rates could move during the delay involved in completing the tranctions.
