How do you use a back-to-back loan?

By Chizoba Morah AAA
A:

Back-to-back loans or parallel loans are a financial move used by companies to curb foreign exchange rate risk or currency risk. They are loan arrangements where companies loan each other money in their own currency. For example, if a U.S. company is engaged in a back-to-back loan arrangement with a Mexican company, the U.S. company borrows pesos from that company, while the same company borrows dollars from the U.S. company.

Usually, if a company needs money in another currency, the company heads to the currency market to trade for it. The issue with trading currency is that a currency with high fluctuations can result in great loss for the company. A back-to-back loan is very convenient for a company that needs money in a currency that is very unstable. When companies engage in back-to-back loans, they usually agree on a fixed spot exchange rate, usually the current one. This eliminates the risk associated with the volatility of exchange rates because the companies are repaying their loans based on the agreed upon fixed rate.

This is how back-to-back loans work: To avoid currency or exchange risk, companies look for other companies in another country and engage in back-to-back loaning. For example, if U.S company X, has a subsidiary in Japan, Y, that needs one thousand yen, company X will look for a Japanese company with a subsidiary in the U.S., Z, that needs one thousand dollars. A back-to-back loan occurs when company X loans Z $1000 and the Japanese company loans Y, ¥1000. The two companies usually agree on the duration of the loan and at the end of the loan term, they swap currencies again. Back-to-back loans are rarely used today but they still remain an option for companies seeking to borrow foreign currency.

For more on exchange risk, see Foreign Exchange Risk.

This question was answered by Chizoba Morah.

RELATED FAQS

  1. What is an asset?

    An asset is anything of value that can be converted into cash. Assets are owned by individuals, businesses and governments. ...
  2. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ...
  3. What's the difference between weighted average accounting and FIFO/LILO accounting ...

    The main difference between weighted average cost accounting, LIFO, and FIFO methods of accounting is the difference in which ...
  4. What is the difference between LIBOR, LIBID and LIMEAN?

    LIBOR, LIBID and LIMEAN are all reference rates used to benchmark short-term interest rates. The London Interbank Offered ...
RELATED TERMS
  1. Expanded Accounting Equation

    The expanded accounting equation is derived from the accounting ...
  2. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  3. Billing Cycle

    The interval of time during which bills are prepared for goods ...
  4. Amortization

    1. The paying off of debt in regular installments over a period ...
  5. Price-To-Cash-Flow Ratio

    The ratio of a stock’s price to its cash flow per share. The ...
  6. Contra Liability Account

    A liability account that is debited in order to offset a credit ...
comments powered by Disqus
Related Articles
  1. Reading The Balance Sheet
    Investing Basics

    Reading The Balance Sheet

  2. What Is Opportunity Cost And Why Does ...
    Economics

    What Is Opportunity Cost And Why Does ...

  3. Using Enterprise Value To Compare Companies
    Fundamental Analysis

    Using Enterprise Value To Compare Companies

  4. Credit Default Swaps: What Happens In ...
    Insurance

    Credit Default Swaps: What Happens In ...

  5. A Clear Look At EBITDA
    Markets

    A Clear Look At EBITDA

Trading Center