Question

How could a U.S. firm with revenue related to sales to U.K. customers, and denominated in British pounds, use a foreign currency swap to reduce their foreign exchange risk?

Answer 1

The U.S firm can enter into the currency swap with a firm that wants to exchange its dollars with pounds for almost the same amount and the same period of time. The currency swap will work in the following way:

• The U.S firm will collect revenue in U.K in British Pounds.
• The other firm has (or will collect) money in Dollars.
• The condition is that the value (decided by a common exchange rate at the start of the swap) of both the revenues should be same.
• The U.S firm will give its Pounds to the other firm and will collect Dollars. In the same way, the other firm will collect Pounds.

Hence, Foreign exchange rate risk is reduced.

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