Level III Core · Swaps, Forwards, and Futures Strategies

Currency Swap Strategies and Cross-Currency Exposure

Updated 9 October 2026 · Fact-checked

A currency swap is an agreement to exchange principal and interest payments in two currencies. You use it to convert a liability or asset from one currency into another. To solve a question, identify the exposure, choose the swap leg you pay and receive, then compute the cash flows at each date.

Understand Currency Swaps and Cross-Currency Exposure

A currency swap exchanges cash flows in one currency for cash flows in another. Each side pays interest on its own notional. Most swaps also exchange the notional at the start and return it at maturity, at the rate agreed on day one.

The key difference from an interest rate swap is the principal. In a plain interest rate swap, both legs use the same currency, so notionals are not exchanged and only the net interest moves. In a currency swap the two notionals are in different currencies. Their values differ, so they are usually exchanged at start and end, and interest is not netted because the legs are in different currencies.

Think of a currency swap as a pair of loans. You lend one currency and borrow another, and each side pays interest on what it borrowed. This view makes conversion easy. If you owe foreign currency debt, you receive the foreign currency in the swap to fund your debt payments and pay your home currency. You have then turned the liability into a home currency liability.

The same logic works for assets. If you hold a foreign bond and want home currency exposure, you pay foreign currency (matching the bond's coupons and principal) and receive home currency. Each leg can be fixed or floating, so a swap can also change the interest rate basis at the same time as the currency.

At Level III, tie the swap to the client's goal. A manager may hedge a currency exposure, change the currency mix of a portfolio, or borrow cheaply in one market and swap into the currency needed. Swaps suit long horizons, where a single forward would not cover many cash flows.

Key rules to remember

Notional conversion at initiation: Foreign notional = Domestic notional ÷ spot rate (domestic per foreign); Domestic notional = Foreign notional × spot rate; Fixes the amount exchanged at start and returned at maturity. Check the quote direction first.
Periodic interest on each leg: Interest = notional × rate × (days ÷ day-count basis); Each leg uses its own notional, rate and day count. For annual periods, interest = notional × rate.
Converting a liability: Receive the currency of the existing debt, pay the currency you want; Receipts cover debt service. What you pay becomes your new liability.
Converting an asset: Pay the currency of the existing asset, receive the currency you want; The asset's income funds the payments. What you receive becomes your new asset exposure.
Value of a currency swap to a party: Value = PV of currency A leg received (converted at spot) − PV of currency B leg paid; Discount each leg at its own currency's rates, then convert at the current spot rate.

How to solve Currency Swaps and Cross-Currency Exposure questions

Use this method for any question on converting exposure with a currency swap.

1Write down the existing exposure: which currency, asset or liability, fixed or floating, and its cash flow dates.
2State the target: the currency and rate type the client wants, linked to the client's objective and constraints.
3Pick the swap legs. For a liability, receive the debt currency and pay the target currency. For an asset, pay the asset currency and receive the target.
4Compute the notionals from the spot rate. Check the quote direction so you multiply or divide correctly.
5List cash flows at start, each interest date and maturity. Show the notional exchange and interest on each leg.
6Net the swap against the original position to find the resulting cash flows and any leftover risk, such as a rate mismatch or counterparty credit risk.
7State the answer in the form the command word asks, with units, and justify in one or two short sentences.

Quickest way: Receive what you owe, pay what you want

When to use it: Use this when asked which side of a currency swap to take, or what the converted exposure is.

Liability: receive the currency of the debt, pay the target currency.
Asset: pay the currency of the asset, receive the target currency.
Match the swap notional and rate to the original position so the receipts cancel the original flows.
What is left is the paid leg, which is your new exposure.

Common mistakes in Currency Swaps and Cross-Currency Exposure

Netting interest across the two legs as in an interest rate swap.
Students carry over the interest rate swap habit.
Fix: Interest is in two currencies, so show each leg separately. Only same-currency flows can offset.
Forgetting the exchange of notionals at start and end.
Interest rate swaps have no principal exchange.
Fix: Always list the initial exchange and the final return of principal at the agreed rate.
Taking the wrong side when converting a liability or asset.
The pay and receive direction feels reversed.
Fix: Liability: receive what you owe. Asset: pay what the asset gives you.
Multiplying or dividing by the spot rate in the wrong direction.
The quote direction is not checked.
Fix: Write the quote as domestic per foreign. Then foreign = domestic ÷ rate, and domestic = foreign × rate.
Using the spot rate for the final principal return.
Students assume the rate updates.
Fix: The final exchange uses the rate agreed at initiation, not the future spot rate.
Ignoring counterparty credit risk and leftover rate risk.
The conversion looks complete once the currency is matched.
Fix: Add one line on credit risk, and on any fixed versus floating mismatch.

Worked examples

Example 1

A European company (home currency EUR) has issued a USD 50,000,000 five-year bond paying a 6% annual coupon. Spot is 1.10 USD per EUR. It enters a currency swap to convert the bond into EUR fixed at 4%. The swap's USD leg is set at 6% fixed on USD 50,000,000 to match the bond coupon. Show the initial exchange, annual swap interest flows and the final exchange.

Show the solution

Liability is in USD, so the company receives USD and pays EUR in the swap.
The swap's USD leg is set at 6% fixed to match the bond coupon, so the USD received each year equals the coupon owed.
EUR notional = 50,000,000 ÷ 1.10 = EUR 45,454,545 (rounded).
Start: the company receives USD 50,000,000 of bond proceeds, delivers them to the swap counterparty and receives EUR 45,454,545.
Each year: receive USD 50,000,000 × 6% = USD 3,000,000, which pays the bond coupon.
Each year: pay EUR 45,454,545 × 4% = EUR 1,818,182 (rounded).
Maturity: receive USD 50,000,000 to repay the bond principal and pay EUR 45,454,545.

Answer: At start the company receives EUR 45,454,545 in exchange for the USD 50,000,000 bond proceeds. It then pays EUR 1,818,182 a year and EUR 45,454,545 at maturity. The USD received at 6% matches the bond's flows, so the liability is now a 4% fixed EUR liability.

Example 2

A US-based portfolio (home currency USD) plans to buy a GBP 20,000,000 fixed-rate bond with a 5% annual coupon. Spot is 1.25 USD per GBP. The manager wants USD exposure and uses a swap in which it pays GBP fixed and receives USD fixed. The swap rates are given: the GBP fixed rate is 5% and the USD fixed rate is 3.5%. State the legs and the cash flows at start, in the first year and at maturity.

Show the solution

This is an asset in GBP. At start the manager pays USD and receives GBP to buy the bond. Over the life of the swap and at maturity the manager pays GBP and receives USD.
USD notional = 20,000,000 × 1.25 = USD 25,000,000.
Start: the portfolio pays USD 25,000,000 to the swap counterparty and receives GBP 20,000,000. The GBP 20,000,000 funds the purchase of the bond.
Each year, pay GBP: 20,000,000 × 5% = GBP 1,000,000, funded by the bond coupon.
Each year, receive USD: 25,000,000 × 3.5% = USD 875,000.
At maturity, pay GBP 20,000,000 (from bond principal) and receive USD 25,000,000.

Answer: At start the portfolio pays USD 25,000,000 and receives GBP 20,000,000, which buys the bond. Each year it receives USD 875,000 and pays GBP 1,000,000, funded by the bond coupon. At maturity it pays GBP 20,000,000 from the bond principal and receives USD 25,000,000. The bond is effectively a 3.5% USD asset.

Exam tips

Draw a small arrow diagram of the two legs. It prevents pay and receive errors and takes seconds.
Read the command word. 'Calculate' needs the number, 'Justify' needs a reason tied to the client's objective.
Check the quote convention before any conversion. This is the most common loss of marks.
For asset or liability conversion, add one risk comment: counterparty credit risk or a rate basis mismatch.
Compare with a forward: a swap covers many dates in one contract, while a forward covers one date.

Currency Swaps and Cross-Currency Exposure in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Currency Swaps and Cross-Currency Exposure: frequently asked questions

What is the difference between a currency swap and an interest rate swap?

An interest rate swap uses one currency, so notionals are usually not exchanged and net interest is paid. A currency swap involves two currencies, so notionals are usually exchanged at start and end. Interest on each leg is paid in its own currency.

How do I convert a liability using a currency swap?

Receive the currency of the existing debt and pay the currency you want. The receipts fund the debt payments. What you pay becomes your new liability.

Why are notionals exchanged in a currency swap?

The two notionals are in different currencies and are not equal in value in general. Exchanging them at the agreed rate fixes the conversion for the whole life of the swap. It also lets each party use the principal to fund or repay its position.

Can a currency swap also change fixed to floating?

Yes. Each leg can be fixed or floating, so you can change the currency and the rate basis in one contract. State both changes clearly in your answer.