Currency swap as read from Wikipedia

[Eric]

Alan,

As read from Wikipedia, two out of three currency swaps (cs) involve interest payment. The third kind of cs with interest only does not involve principle return. So I think a better definition of cs is it does involve different currencies while interest swap is only for one single currency.

If at day one, Greece made the deal with Goldman was to transform the Euro debt to off-the-book Dollars. Then it means she did not really need the US Dollar (principle) in the future. Therefore, the requirement of different currency principle exchange was small. 

Eric

    

*****  http://en.wikipedia.org/wiki/Currency_swap *******

Currency swaps  are over-the-counter derivatives, and are closely related to interest rate swaps. However, unlike interest rate swaps, currency swaps can involve the exchange of the principal.^[1]

There are three different ways in which currency swaps can exchange loans:

The most simple currency swap structure is to exchange the principal only with the counterparty, at a rate agreed now, at some specified point in the future. Such an agreement performs a function equivalent to a forward contract or futures. The cost of finding a counterparty (either directly or through an intermediary), and drawing up an agreement with them, makes swaps more expensive than alternative derivatives (and thus rarely used) as a method to fix shorter term forward exchange rates. However for the longer term future, commonly up to 10 years, where spreads are wider for alternative derivatives, principal-only currency swaps are often used as a cost-effective way to fix forward rates. This type of currency swap is also known as an FX-swap.^[2]

Another currency swap structure is to combine the exchange of loan principal, as above, with an interest rate swap. In such a swap, interest cash flows are not netted before they are paid to the counterparty (as they would be in avanilla interest rate swap) because they are denominated in different currencies. As each party effectively borrows on the other's behalf, this type of swap is also known as a back-to-back loan.^[2]

Last here, but certainly not least important, is to swap only interest payment cash flows on loans of the same size and term. Again, as this is a currency swap, the exchanged cash flows are in different denominations and so are not netted. An example of such a swap is the exchange of fixed-rate US Dollar interest payments for floating-rate interest payments in Euro. This type of swap is also known as a cross-currency interest rate swap, or cross-currency swap.^[3]

[edit]History

Currency swaps were originally conceived in the 1970s to circumvent foreign exchange controls in the United Kingdom. At that time, UK companies had to pay a premium to borrow in US Dollars. To avoid this, UK companies set up back-to-back loan agreements with US companies wishing to borrow Sterling.^[4] While such restrictions on currency exchange have since become rare, savings are still available from back-to-back loans due to comparative advantage.

Cross-currency interest rate swaps were introduced by the World Bank in 1981 to obtain Swiss francs and German marks by exchanging cash flows with IBM. This deal was brokered by Salomon Brothers with a notional amount of $210 million dollars and a term of over ten years.^[5]

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