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 are some examples of general and administrative expenses?

    In accounting, general and administrative expenses represent the necessary costs to maintain a company's daily operations ... Read Full Answer >>
  2. How do dividend distributions affect additional paid in capital?

    Whether a dividend distribution has any effect on additional paid-in capital depends solely on what type of dividend is issued: ... Read Full Answer >>
  3. Why can additional paid in capital never have a negative balance?

    The additional paid-in capital figure on a company's balance sheet can never be negative because companies do not pay investors ... Read Full Answer >>
  4. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. How can I find net margin by looking a company's financial statements?

    In finance and accounting, financial statements represent the fundamental means of analyzing a company's financial position, ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Calculating Return on Net Assets

    Return on net assets measures a company’s financial performance.
  2. Economics

    Understanding Cost of Revenue

    The cost of revenue is the total costs a business incurs to manufacture and deliver a product or service.
  3. Economics

    Explaining Carrying Cost of Inventory

    The carrying cost of inventory is the cost a business pays for holding goods in stock.
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  5. Investing

    How To Calculate Minority Interest

    Minority interest calculations require the use of minority shareholders’ percentage ownership of a subsidiary, after controlling interest is acquired.
  6. Economics

    Explaining Replacement Cost

    The replacement cost is the cost you’d have to pay to replace an asset with a similar asset at the present time and value.
  7. Economics

    How Does National Income Accounting Work?

    National income accounting is an economic term describing the system used by a country to gather data and determine aggregate economic activity.
  8. Fundamental Analysis

    Understanding the EBITDA/EV Multiple

    The EBITDA/EV multiple is a financial ratio that measures a company’s return on investment.
  9. Term

    What is Wealth Management?

    Wealth management combines financial and investment advice, accounting and tax services, and legal and estate planning.
  10. Personal Finance

    AR & Inventory Turnover Is Key For These Sectors

    Accounts receivable and inventory turnover are two important ratios in the current asset category. We will also discuss the key industries that benefit from a thorough understanding of these ...
RELATED TERMS
  1. Receivables Turnover Ratio

    An accounting measure used to quantify a firm's effectiveness ...
  2. International Financial Reporting Standards - IFRS

    A set of international accounting standards stating how particular ...
  3. Days Sales Outstanding - DSO

    A measure of the average number of days that a company takes ...
  4. Derivative

    A security with a price that is dependent upon or derived from ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  6. Surplus

    The amount of an asset or resource that exceeds the portion that ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!