Fixed-for-Fixed Swaps

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 may be contrasted with a fixed-for-floating swap, where fixed interest payments in one currency are exchanged for floating interest payments in another. In a fixed-for floating swap, the principal amount of the underlying loan is not exchanged.

How Fixed-for-Fixed Swaps Work

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.

Foreign currency swaps — including fixed-for-fixed swaps — allow entities to get loans at better interest rates than if they were to go directly for financing in the foreign capital markets.

In fixed-for-fixed swaps, one party uses its own currency to buy funds in the other party's currency.

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.

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.