A currency swap is a swap that involves the exchange of principal and interest in one currency for the same in another currency. It is considered a foreign exchange transaction and therefore is not required to be shown on the balance sheet.
Along with the initial exchange of a specific amount of one currency for a specific amount of another currency, currency swaps normally also include a series of recurring payments based on the cash flow performance of the two currencies, making them different from a simple currency exchange.
The recurring payments that compose the second phase of a currency swap normally make use of both fixed and variable rates of interest. One party will agree to pay a fixed interest rate, while the second party will pay interest based on a floating rate of exchange. However, currency swap agreements can also be arranged in which both parties make recurring payments based on a fixed rate or a floating exchange rate.
An example might be: A U.S. company that needed Swiss francs and a Swiss company that need U.S. dollars could arrange to swap currencies by establishing an interest rate, an agreed upon amount and a common maturity date for the exchange. Currency swap maturities are negotiable for at least 10 years, making them a flexible method of foreign exchange.