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. How does transfer pricing help business?

    Explore several ways that transfer pricing helps businesses. Transfer pricing can often help streamline accounting and business ...
  2. How do I calculate my effective tax rate using Excel?

    Find out how to calculate your effective tax rate using Microsoft Excel, what income tax rates to apply to your earned income ...
  3. How important are contingent liabilities in an audit?

    Read about the importance of contingent liabilities during an audit, why audits are necessary and how contingent liabilities ...
  4. How does quantifying fixed overhead volume variance show whether a company is profitable ...

    Find out why some fundamental analysts look at fixed overhead volume variance as an indicator of company profitability or ...
RELATED TERMS
  1. Operating Cost

    Expenses associated with administering a business on a day to ...
  2. Capital Expenditure (CAPEX)

    Funds used by a company to acquire or upgrade physical assets ...
  3. Accident Year Experience

    Premiums earned and losses incurred during a specific period ...
  4. Book Value Reduction

    Reducing the value at which an asset is carried on the books ...
  5. Inherent Risk

    The risk posed by an error or omission in a financial statement ...
  6. Deferred Tax Asset

    A deferred tax asset is an asset on a company's balance sheet ...

You May Also Like

Related Articles
  1. Fundamental Analysis

    Why Last In First Out Is Banned Under ...

  2. Budgeting

    Quickbooks vs. Quicken

  3. Fundamental Analysis

    The Best 5 Online Accounting Systems ...

  4. Investing Basics

    How To Calculate Goodwill

  5. Investing News

    Learn How To Invest Defensively From ...

Trading Center