What Is a Fixed-for-Fixed Swap?
A fixed-for-fixed swap refers to a type of foreign currency swap in which two parties exchange currencies with one another. In this agreement, both parties pay each other a fixed interest rate on the principal amount. A fixed-for-fixed swap can be used to take advantage of situations where interest rates in other countries are cheaper.
- A fixed-for-fixed swap is a foreign currency agreement in which two parties pay each other a fixed interest rate on the principal amount.
- In a fixed-for-fixed swap, one party uses its own currency to buy funds in the foreign currency.
- These kind of swaps allow entities to get loans at better rates than if they were to go to foreign capital markets.
How Fixed-for-Fixed Swaps Work
Foreign currency swaps take place between two foreign entities. The parties essentially swap principal and interest payments on a loan in one currency for those in another currency. One of the parties involved in the agreement borrows currency from another while lending a different currency to that party. Foreign currency swaps come in fixed-for-floating and fixed-for-fixed swaps.
The parties involved in a fixed-for-fixed swap—who are also called counterparties—enter into an agreement, paying each other interest at a fixed rate. So one party agrees to exchange fixed interest payments in one currency for interest at a fixed rate in another. This means one party uses its own currency to buy funds in the foreign currency.
In fixed-for-fixed swaps, one party uses its own currency to buy funds in the other party's currency.
Fixed-for-Fixed vs. Fixed-for-Floating Swaps
As noted above, there are two primary kinds of currency swaps—fixed-for-fixed and fixed-for-floating swaps. Fixed-for-floating swaps involve two parties where one swaps interest on a loan at a fixed rate, while the other one pays interest at a floating rate. Unlike the fixed-for-fixed swap, the principal portion on the fixed-for-floating swap is not exchanged. One of the main reasons parties enter into this agreement if the floating interest rate is lower than the fixed rate that's being paid.
Benefits of Fixed-for-Fixed Swaps
To understand how investors benefit from these types of arrangements, consider a situation in which each party has a comparative advantage to take out a loan at a certain rate and currency. For example, an American firm can take out a loan in the United States at a 7% interest rate, but requires a loan in yen to finance an expansion project in Japan, where the interest rate is 10%. At the same time, a Japanese firm wishes to finance an expansion project in the U.S., but the interest rate is 12%, compared to the 9% interest rate in Japan.
Each party can benefit from the other's interest rate through a fixed-for-fixed currency swap. In this case, the U.S. firm can borrow U.S. dollars for 7%, then lend the funds to the Japanese firm at 7%. The Japanese firm can borrow Japanese yen at 9%, then lend the funds to the U.S. firm for the same amount.