- Precisely how a dual currency swap works can be very complicated and vary from case to case, depending for example on whether both or only one party has issued or bought a bond. The general principle is that the two parties make exchanges between currencies with the money used in all three stages of the bond process: the original purchase, the coupon payments and the redemption. The rate used for each exchange can be fixed in advance and thus may differ from the prevailing currency market rate at each stage.
More complicated forms of a dual currency swap can involve an option: this means one party has the right to make an exchange at a particular stage, but is not obligated to do so.
- Both parties in a dual currency swap will come to the deal with the intention of reducing a risk. That risk is that the fact that the relevant bond uses two different currencies may mean that the real-terms cost of issuing or buying a bond is different from what is expected. In other words, the party knows the amount it will pay or be paid in the foreign currency, but won't know what this will translate to in its own domestic currency.
- Using a dual currency swap can give a company or investor greater certainty about the money it will pay or receive. This can make it easier to make financial plans and to give an accurate value to investments on the company's balance sheet.
- Using a dual currency swap is normally a form of hedging. This means arranging the deal so that it pays off in circumstances that mean a separate deal will have a larger but negative effect on the party. With a dual currency swap, the circumstances will be the movement of currency exchange rates.
The effect is that if things go badly in the main deal, the party will make some money back through the swap; similarly, if things go well on the main deal, the party will lose a little on the swap. In both cases, both the potential gains and losses are reduced. This reduces the risk for the company while allowing it to make deals involving larger sums of money, which may allow it to access better terms.