DEFINITION of 'Quanto Swap'

A swap with varying combinations of interest rate, currency and equity swap features, where payments are based on the movement of two different countries' interest rates.

This is also referred to as a differential or "diff" swap.

BREAKING DOWN 'Quanto Swap'

Though they deal with two different currencies, payments are settled in the same currency. For example, a typical quanto swap would involve a U.S. investor paying six-month LIBOR in U.S. dollars (for a US$1 million loan), and receive payments in U.S. dollars at the six-month EURIBOR + 75 basis points.

Fixed-for-floating quanto swaps allow an investor to minimize foreign exchange risk. This is achieved by fixing both the exchange rate and interest rate at the same time. Floating-for-floating swaps have slightly higher risk, since each party is exposed to the spread between each country's currency interest rate.

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