Swaps are transactions in which a firm simultaneously buys and sells two different currencies. Swaps are designed to avoid exchange controls, alleviate political risks, and overcome informational problems in capital markets. Although swaps are usually thought of as protection against transaction and translation risks, they are more frequently used as a means of transferring and/ or raising capital for investment purposes. In the latter case, interest rate and debt-equity swaps are usually used; these will be treated later in the chapter. What follows is a brief explanation of the use of swaps to transfer capital.
Spot and forward market swaps are usually employed to alleviate financial difficulties stemming from foreign exchange regulations. For example, suppose a U.S. MNC's subsidiary in Spain needs 10,000 Spanish pesetas to finance its production. To avoid exchange problems, the U.S. parent company will buy the 10,000 pesetas in the spot market and lend them to its affiliate or subsidiary for, say, three months at the going interest rate. At the same time, the parent will sell the same number of pesetas for delivery in three months (the duration of its loan to its affiliate). The parent company will receive dollars for the pesetas, and its short position will be covered with the pesetas it will collect from the repayment of the loan to its Spanish subsidiary. This way the parent receives its dollars and the Spanish subsidiary its pesetas without violation of any foreign exchange regulations.
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