Hi All, I have a few questions about using foreign currency swap to hege the exchange rate risk. Would you please give me some advice. Thanks. 1. How can FX swap hedg exchange rate risk? Is it because both parties have agree in a predetermined exchange rates, therefore, the depreciation and appreication of the currency in the market would affect the value of the swap? 2. Is FX swap still has default risk and interest rate risk? Is there anyothere risk associate with it? Thanks Victor
1/ Exactly. Both parties exchange principals (in different currencies) at the inception and then exchange them again at the termination. However, at the termination, the exchange rate will have changed. 2/ Yes, both. Default risk because if the swap is valuable to you and the counterparty defaults, you lose. Interest rate risk because fx swaps are often fixed-for-fixed so if the rates move against you, you lose.