| Which of the following statements is/are correct with regard to currency swap agreements? |
| 1. It helps in increasing liquidity. |
| 2. They are considered to be loans provided by one country to another. |
| 3. They are risk free. |
| 4. Currency swaps are required to be documented on a company's balance sheet. |
| Select the correct answer using the codes given below. |
A) Only 1
B) 1, 2 and 3
C) 2, 3 and 4
D) All of these
Correct Answer: A
Solution :
[a] A currency swap is an exchange that occurs between two individuals or entities holding set currencies for a specified period of time after which, they will be exchanged back. This can occur between two or more parties. Upon the maturity of the exchange, each party returns to the other the original amount of currency traded. Due to laws of international accounting, currency swaps are not considered to be loans and are thus not required to be documented on a company's balance sheet. Instead of being considered a loan, currency swaps are treated as foreign exchange transactions with the maturity date closed as a forward contract, which is a simple agreement ensuring the date on which the amounts will be repaid. The first and foremost drawback can be that the other party may fail to meet the obligation during the period of swap or upon maturity. The parties exposed to the risk either one or both have chances to default on principal payment as well as interest. The other drawback could be devaluation in the domestic currency, which can happen when huge foreign debts are acquired. India has currency swap arrangement with Japan.
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