What does a currency swap involve?

A currency swap specifically involves exchanging currencies between two parties at predetermined exchange rates. In this arrangement, one party agrees to pay interest on the currency they receive from the other party, while simultaneously receiving interest on their own currency that they provide to the other party. This allows both parties to access the foreign currency they need while managing their risk related to currency fluctuations.

The mechanism of a currency swap often includes an initial exchange of principal amounts at the beginning of the swap, followed by periodic interest payments and a final exchange of the principal amounts at the end of the swap agreement, all based on the agreed-upon exchange rates. This arrangement can be advantageous for companies looking to hedge against exchange rate risk, facilitate international trade, or obtain access to cheaper borrowing costs in a foreign currency.

In contrast, the other choices do not accurately describe the nature of a currency swap. Exchanging debt securities relates to bond markets, buying and selling foreign stocks pertains to equity investments, and trading futures on currency exchange rates involves derivative instruments rather than direct currency exchanges.