What Is a Blue Chip Swap?

Blue chip swap describes a type of international asset trading in which an investor purchases a foreign asset, usually at a depreciated local price, and then trades that asset in a domestic trade, usually capitalizing on a depreciated exchange rate.

Blue chip swaps can be extremely profitable for some investors when there is an imbalance in exchange rates, or in an exchange rate at which the supply for currency meets the demand.

Understanding Blue Chip Swaps

A blue chip swap is when a domestic--U.S. for example--investor purchases a foreign asset, including bonds or currency, and then transfers the purchased asset toan offshore domestic bank branch. In most cases, the domestic investor works with a partner who transfers assets to the foreign branch on their behalf. The U.S. investor probably got a reduced price on the stock, plus he also took advantage of depreciated exchange rates, thus turning a profit in the transfer to U.S. dollars.

Others use blue chip swaps to legally move money in and out of countries such as Brazil and Argentina.

The term blue chip swap is used in the common and financial press to describe a type of international asset trading that was prominent in South America in the 1990s and early 2000s, particularly in Brazil and Argentina. This type of trade became popular when Argentina was experiencing hyperinflation, and established capital control laws. When Argentina got rid of their fixed exchange rate in early 2000, they tied their peso to the U.S. dollar. The exchange rate plummeted, which made it a perfect time for blue chip swaps.

Key Takeaways

  • A blue chip swap is a type of international trading in which an investor purchases a foreign asset, usually at a depreciated local price, and then trades that asset domestically, usually for a higher price.
  • Blue chip swaps generally capitalize on a depreciated exchange rate; so they can be very profitable when an imbalance in exchange rates exists.
  • Blue chip swaps were popular in South America in the 1990s and early 2000s, particularly in Brazil and Argentina.

History of Blue Chip Swaps in Argentina

Blue chip swaps initially became possible because off Brazilian and Argentinian capital control laws that reduced the amount of capital flow into the country. Although this law prohibited direct foreign investments in the countries' derivative markets, blue chip swaps allowed investments in derivatives to continue.

Such trades were unregulated for many years, but control regulations began to emerge that imposed minimum holding periods for bonds transferred abroad. Under Argentinian law, the seller of a bond is currently required to have it in stock for 72 hours or more.

This type of exchange became prominent in Argentina because of that nation's economic history of saving its wealth in U.S. dollars, in response to a long history of inflation crises in Argentina going back to the 1970s. These crises decreased confidence in the Argentinian peso, and initiated a particularly severe period of hyperinflation in Argentina between 1989 and 1990.

In response, Argentina implemented a fixed exchange rate in 1991. Sometimes referred to as the convertibility plan, this rate tied the Argentinian peso to the U.S. dollar in a one-to-one relationship. This plan increased interest rates and led to a recession that lasted into the early 2000s.

For the next decade, Argentina abandoned the fixed-rate plan in favor of a managed float plan that sent the exchange rate for the peso plummeting in relationship to the dollar and gave rise to the blue chip swap market. Although Argentina has imposed much stricter controls on exchange rate fluctuations since 2011, blue chip swaps continue to be profitable for traders.