Overview

Cross currency swaps allow participants to exchange principal and interest payments in two different currencies. They are commonly used for hedging foreign exchange (FX) and interest rate exposures.

What Are Cross Currency Swaps?

A typical cross currency swap involves:

• Exchange of Principal: Notional amounts in each currency, often swapped back at maturity.

• Interest Payments: Each leg pays interest based on its respective currency’s benchmark rate (fixed or floating).

Pricing Methodology

• Discount Curve Construction We begin by building OIS-based discount curves for each currency, reflecting the cost of collateralized funding and the most up-to-date market expectations. Cross-currency basis spreads are then incorporated to adjust discount factors, capturing the incremental cost or benefit of switching between currencies.

• FX Alignment Cash flows in each currency are converted using the relevant exchange rate—either spot or agreed forward rates—reflecting the terms set out in the swap contract. This ensures each leg’s value can be consistently measured in a common reference currency.

• Cash Flow Projection Interest payments (fixed or floating) and notional exchanges are scheduled according to each currency’s standard conventions (e.g., day count, payment frequency, holidays). The timeline of these payments is established from the start date through maturity, including any interim exchange of principal if stipulated.

• Present Value Calculation Each leg’s projected cash flows are discounted back to the valuation date using the respective discount curve. By aligning the net present value (NPV) of both legs, we ensure the swap’s initial fair value is set to zero, matching typical market practice and allowing for direct comparisons with quoted swap rates.

Key Applications

• Foreign Currency Debt Hedging: Convert overseas funding back to home currency rates.

• Balance Sheet Management: Align multi-currency assets and liabilities.

• Risk Mitigation: Lock in exchange rates and interest costs, reducing FX and rate volatility.