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ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against forex risk

A UK company needs to borrow US$10 million for five years and can raise sterling at a favourable fixed rate in the UK market. A bank offers to arrange a currency swap. What is the principal reason the company would use a currency swap here?

The company would use a currency swap to borrow in sterling, where it gets better terms, and exchange the obligations into dollars. This gives it the dollar funding it needs at lower cost and fixes the exchange exposure, while principal is still re-exchanged at maturity.

  1. ATo obtain dollar funding indirectly while benefiting from its comparative advantage in the sterling marketCorrect
  2. BTo remove all credit risk from the borrowing
  3. CTo convert a variable-rate liability into a fixed-rate liability in the same currency only
  4. DTo avoid ever having to repay the principal amount

Explanation

A currency swap lets a firm borrow where it has a comparative advantage (sterling) and swap into the currency it needs (dollars), usually reducing cost and hedging long-term exchange risk. It does not remove credit risk, is not restricted to a single currency, and principal is still re-exchanged at maturity.

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