Introduction
A bank or corporate may borrow in one currency even though its:
revenues;
assets;
cash flows; or
preferred liability
are in another currency.
This creates foreign-exchange risk.
The borrowing may also create interest-rate risk if its coupon is fixed or floating.
A currency swap can transform these exposures without necessarily replacing the original borrowing.
RBI currently defines a currency swap as an OTC derivative under which two counterparties exchange streams of interest payments and/or principal amounts in different currencies on specified dates over the life of the swap at a pre-agreed exchange rate.
The current 2026 IIBF CAIIB BFM syllabus specifically includes Interest Rate and Currency Swaps under Module C – Derivative Products.
The central idea is:
Original Liability + Currency Swap → Different Economic Currency/Interest Exposure
Learning Objectives
After studying this topic, you should be able to:
explain the structure of a currency swap;
distinguish a currency swap from an interest-rate swap and an FX swap;
understand principal and interest exchanges;
explain fixed-fixed and fixed-floating currency swaps;
analyse how a foreign-currency liability can be transformed;
identify basis, counterparty, settlement and rollover risks; and
solve CAIIB case studies by tracing each cash flow separately.
Basic Structure of a Currency Swap
A currency swap involves two different currencies.
For example, one counterparty may:
pay interest in USD; and
receive interest in INR.
Depending on the contract, principal amounts may also be exchanged:
at inception;
at maturity; or
according to other agreed terms.
This is different from a conventional single-currency interest-rate swap, where the same currency is used on both legs and the notional principal is normally not exchanged.
Currency Swap Cash-Flow Structure
A typical currency swap can involve three stages.
Stage 1: Initial Principal Exchange
The counterparties may exchange principal amounts in two currencies at an agreed exchange rate.
Stage 2: Periodic Interest Payments
Each party pays the agreed interest stream in one currency and receives the other currency's interest stream.
Stage 3: Re-Exchange of Principal
At maturity, the principals may be exchanged back according to the contractual terms.
The detailed structure varies by product.
Therefore, always read the case carefully before assuming that principal is exchanged at every stage.
Fixed-Fixed Currency Swap
In a fixed-fixed currency swap:
one party pays a fixed rate in Currency A; and
receives a fixed rate in Currency B.
This can convert:
Fixed Foreign-Currency Liability → Fixed Domestic-Currency Liability
or the reverse.
Fixed-Floating Currency Swap
In a fixed-floating currency swap:
one leg has a fixed interest rate;
the other leg has a floating interest rate; and
the two legs are denominated in different currencies.
This can transform both:
currency risk; and
interest-rate risk.
For example:
Fixed USD liability → Floating INR liability
may be created economically through an appropriately structured currency swap.
Floating-Floating Currency Swap
A swap may also involve floating rates in both currencies.
This can be useful where the purpose is primarily to change:
currency;
benchmark; or
funding basis
rather than move from fixed to floating.
Case 1: USD Borrowing but INR Revenues
An Indian company has borrowed in USD.
Its operating revenues are mainly in INR.
Risk
The company must service:
USD interest; and
USD principal
using INR revenues.
If USD appreciates against INR, the rupee cost of servicing the debt rises.
Possible Transformation
The borrower may enter a currency swap under which it:
receives USD cash flows; and
pays INR cash flows.
The USD receipts under the swap can offset the USD obligations on the original borrowing.
The company is then economically left with an INR payment obligation under the swap.
Result
Conceptually:
USD Loan: Pay USD
Currency Swap: Receive USD / Pay INR
=
Synthetic INR Liability
CAIIB Learning
A currency swap can transform the currency denomination of an economic liability without cancelling the original loan.
Case 2: Foreign-Currency Liability Converted to Rupee Liability
A resident company has a long-term foreign-currency liability.
Management wants to remove the foreign-exchange exposure.
Analysis
A suitable foreign-currency/INR swap can be used to transform the foreign-currency liability into a rupee liability, subject to the applicable regulatory and contractual framework.
RBI has specifically recognised currency swaps as instruments that may be used to transform foreign-currency liabilities into rupee liabilities in permitted cases.
CAIIB Learning
The original borrowing remains in foreign currency legally.
The swap changes the economic exposure.
Do not say that the swap automatically changes the original lender's loan contract.
Case 3: INR Liability Transformed into Foreign-Currency Liability
A company has an INR liability.
It has substantial foreign-currency earnings and wants its debt servicing to align with those foreign-currency cash flows.
Analysis
An appropriately permitted INR–foreign currency swap may convert the economic INR liability into a foreign-currency liability.
Conceptually:
INR Loan: Pay INR
Swap: Receive INR / Pay Foreign Currency
=
Synthetic Foreign-Currency Liability
Important Risk
If the company lacks a reliable foreign-currency income stream, this transformation can create substantial FX risk.
RBI's framework has historically required additional prudential consideration for transactions transforming rupee liabilities into foreign-currency liabilities, including suitability and the existence of natural hedges/economic exposures in relevant cases.
CAIIB Learning
A swap can remove FX risk or deliberately create FX exposure, depending on its direction.
Case 4: USD Fixed-Rate Loan to INR Floating Liability
A borrower has:
Fixed-rate USD debt
but wants:
Floating-rate INR exposure
Swap Structure
The currency swap may be arranged so that the borrower:
receives fixed USD;
pays floating INR.
Economic Result
The fixed USD receipt offsets the fixed USD liability.
The remaining economic payment becomes floating INR.
Therefore:
Fixed USD Liability + Receive Fixed USD / Pay Floating INR Swap
=
Synthetic Floating INR Liability
CAIIB Learning
Currency swaps can transform two dimensions simultaneously:
currency; and
interest-rate basis.
Case 5: INR Fixed Liability to USD Fixed Liability
A company has fixed-rate INR borrowing but substantial long-term USD revenues.
It wants debt servicing to match USD cash flows.
Possible Structure
The company may:
receive fixed INR under the swap;
pay fixed USD.
The INR receipt offsets the original INR interest obligation.
It is then economically left paying fixed USD.
CAIIB Learning
This may improve asset-liability matching where genuine USD cash flows exist.
However, if expected USD revenues disappear, the transformed liability can become risky.
Case 6: Exchange Rate Moves after Principal Is Swapped
Assume counterparties exchange principal amounts at the beginning of a currency swap using an agreed exchange rate.
Later, the market exchange rate changes significantly.
One party argues that the principal to be returned at maturity should now be recalculated using the new spot rate.
Analysis
Not necessarily.
The contractual re-exchange terms are determined by the swap agreement.
RBI's definition itself refers to exchanges at pre-agreed exchange rates.
The market movement changes the economic value of the swap, but it does not automatically rewrite the contracted principal exchange terms.
CAIIB Learning
Distinguish:
Contractual exchange amount
from
current market value of the swap
Case 7: Currency Swap vs Interest-Rate Swap
A company has USD floating-rate debt.
It wants to change only from:
USD Floating → USD Fixed
Correct Analysis
The company does not need to change currency.
A normal interest-rate swap may be sufficient.
It can:
receive USD floating;
pay USD fixed.
Currency Swap?
A currency swap would be unnecessary if no currency transformation is desired.
CAIIB Learning
Ask:
Is currency changing?
No → consider IRS.
Yes → currency/cross-currency swap may be required.
Case 8: Currency Swap vs Foreign-Exchange Swap
This is one of the most important CAIIB distinctions.
A treasury requires USD today and will reverse the transaction after three months.
It exchanges INR for USD now and agrees to reverse the currencies later.
Instrument
This is typically an FX swap, not the same as a long-term currency swap.
RBI defines an FX swap as an OTC transaction involving:
actual exchange of two currency principals on a near date; and
reverse exchange of those principals on a later date,
at rates agreed when the contract is entered.
Currency Swap
A currency swap can involve:
streams of interest payments;
principal exchanges; or
both
over a longer series of specified dates.
CAIIB Learning
FX Swap → Near leg + Far leg principal exchanges
Currency Swap → Ongoing interest/principal cash-flow transformation across currencies
Case 9: Currency Swap Removes FX Risk but Creates Counterparty Risk
A borrower successfully converts its USD exposure into INR using an OTC currency swap.
Management claims that the transaction is now risk-free.
Analysis
Incorrect.
The swap may reduce FX risk but still expose the borrower or bank to:
counterparty credit risk;
settlement risk;
basis risk;
liquidity risk;
collateral/margin risk;
legal risk; and
operational risk.
RBI's OTC derivatives framework requires governance, valuation and counterparty-risk controls for market-makers, while applicable non-centrally cleared derivatives may also fall under RBI margining requirements.
CAIIB Learning
Risk transformation ≠ risk elimination
Case 10: Floating Benchmarks Do Not Match
A borrower pays:
Foreign Benchmark A + spread
on its original loan.
Under the swap, it receives:
Foreign Benchmark B
Analysis
The two floating rates may not move together.
Therefore, the borrower retains:
Basis Risk
Even if both are in the same currency, a mismatch in benchmarks prevents perfect offset.
CAIIB Learning
A hedge must match more than currency.
Check:
benchmark;
reset frequency;
maturity;
day count;
principal;
cash-flow dates.
Case 11: Maturity of Swap Is Shorter than Loan
A borrower has a five-year USD liability.
It enters a three-year currency swap.
Analysis
The first three years may be hedged, but the final two years remain exposed.
When the swap matures, the borrower may need a replacement hedge.
This creates:
Rollover Risk
CAIIB Learning
Always compare:
Loan Maturity vs Swap Maturity
A correct currency direction with the wrong tenor does not create a complete hedge.
Case 12: Swap Notional Exceeds Underlying Borrowing
A borrower has USD 50 million debt but enters a swap for USD 70 million.
Analysis
USD 50 million may hedge the underlying liability.
The additional USD 20 million creates a separate net exposure.
This can convert a hedge into a partially speculative position.
CAIIB Learning
The hedge should be assessed for:
notional amount;
outstanding loan amount;
maturity; and
cash-flow profile.
Case 13: Amortising Loan but Bullet Swap
A foreign-currency loan amortises gradually over five years.
The currency swap uses the full original notional until maturity.
Analysis
As the loan principal falls, the swap notional remains high.
This can create:
Over-Hedging
An amortising swap structure may better match the declining underlying exposure.
CAIIB Learning
A hedge must match the cash-flow profile, not merely the original principal.
Case 14: Swap Cash Flow and Swap Market Value
A company receives a favourable net interest payment under its currency swap this quarter.
Management assumes the swap must therefore have positive total market value.
Analysis
Not necessarily.
A periodic cash flow is only one payment.
The market value depends on the present value of all remaining contractual cash flows in both currencies.
It is affected by:
exchange rates;
interest rates;
yield curves;
remaining maturity; and
contractual terms.
CAIIB Learning
Current Settlement ≠ Total Swap Value
Case 15: Natural Hedge Already Exists
A company has USD borrowing and stable USD export revenues.
Management proposes a currency swap to eliminate the USD liability completely.
Analysis
Before entering the swap, treasury should recognise that the company already has a natural hedge:
USD Revenues ↔ USD Debt Service
Transforming the debt into INR could actually increase the mismatch between:
assets/revenues; and
liabilities.
CAIIB Learning
Do not hedge an exposure in isolation.
Analyse the net economic exposure.
Case 16: Currency Swap Used to Match Asset and Liability Currencies
A bank has:
a long-term USD asset; but
INR funding.
The asset earns USD, while funding obligations are in INR.
Analysis
The bank has currency mismatch.
A suitable currency swap may transform the funding exposure so that the economic liability better matches the USD asset.
This can improve:
currency matching;
cash-flow alignment; and
balance-sheet risk management.
CAIIB Learning
Currency swaps are not limited to corporate loans.
They can support treasury and Asset-Liability Management by aligning currencies and interest-rate characteristics.
Main Risks in a Currency Swap
Exchange-Rate Risk
The swap is designed to transform currency exposure, but incorrect matching can create new FX risk.
Interest-Rate Risk
Fixed and floating legs react differently to changes in interest rates.
Counterparty Credit Risk
If the swap has positive value and the counterparty defaults, replacement loss may arise.
Settlement Risk
Principal exchanges can be large.
Failure during settlement can therefore create material exposure.
Basis Risk
Underlying and swap benchmarks may differ.
Liquidity Risk
The swap may be costly to unwind or replace.
Rollover Risk
A shorter swap than the underlying exposure may need to be renewed later.
Legal Risk
Documentation, enforceability and netting arrangements matter.
Operational Risk
Incorrect currency, rate, amount or settlement instruction can create significant losses.
Currency Swap vs IRS vs FX Swap
Basis | Currency Swap | Interest-Rate Swap | FX Swap |
|---|---|---|---|
Number of currencies | Two | Usually one | Two |
Interest streams | May be exchanged | Main feature | Normally not periodic swap interest streams |
Principal exchange | May occur | Normally not | Near and reverse far-leg exchange |
Main purpose | Currency + rate transformation | Interest-rate transformation | FX liquidity/funding and short-dated currency management |
Typical tenor | Often medium/long term | Medium/long term | Often shorter, though tenor can vary |
Key risk transformed | FX and/or interest-rate risk | Interest-rate risk | Short-term currency/funding exposure |
Practical Case-Study Method
For a CAIIB currency-swap case, use five questions.
1. What Is the Original Liability?
Identify:
currency;
fixed/floating rate;
principal;
maturity.
2. What Does the Party Receive under the Swap?
This leg should normally offset the original liability if the objective is transformation.
3. What Does the Party Pay under the Swap?
This becomes the new synthetic exposure.
4. Does the Swap Match the Underlying?
Check:
amount;
maturity;
benchmark;
payment dates; and
amortisation.
5. What Risks Remain?
Look for:
basis;
counterparty;
rollover;
settlement;
liquidity; and
operational risk.
Current Regulatory Context
RBI's Market-makers in OTC Derivatives Directions, 2021, effective from January 3, 2022, currently defines currency swaps and sets governance and conduct standards for permitted OTC derivative market-makers.
Foreign-exchange derivative transactions also operate under RBI's Master Direction – Risk Management and Inter-Bank Dealings, which is currently listed by RBI as updated to May 3, 2024.
Accordingly, actual currency-swap transactions must comply with the applicable:
FEMA framework;
user eligibility;
purpose;
exposure requirements;
documentation;
reporting;
suitability; and
risk-management rules.
For CAIIB case analysis, avoid assuming that every entity can freely enter every swap structure merely because the economic hedge appears sensible.
CAIIB Exam Focus
Currency swap involves different currencies.
It may exchange interest streams, principal amounts, or both.
IRS usually changes interest-rate exposure within the same currency.
Currency swap can change both currency and interest-rate exposure.
FX swap is different from a currency swap.
FX swap has a near-leg currency exchange and a reverse far-leg exchange.
Foreign-currency liability + receive foreign currency/pay INR swap can create a synthetic INR liability.
INR liability + receive INR/pay foreign currency swap can create a synthetic foreign-currency liability.
The original loan normally remains legally unchanged.
Principal exchange terms are governed by the swap contract, not automatically by the later spot exchange rate.
Notional and maturity should match the underlying exposure.
Amortising exposure with non-amortising swap can create over-hedging.
Currency swap can reduce FX risk but create counterparty, basis, settlement and liquidity risk.
Natural hedges must be considered before transforming currency exposure.
A periodic favourable swap payment does not automatically mean the whole swap has positive market value.
Common Exam Traps
Trap 1: Currency Swap and FX Swap Are the Same
Incorrect.
An FX swap primarily involves near and far exchanges of currency principals.
A currency swap can exchange interest and/or principal streams over its life.
Trap 2: Currency Swap and IRS Are the Same
Incorrect.
An IRS normally keeps the same currency; a currency swap uses different currencies.
Trap 3: Swap Automatically Changes the Original Loan Currency
Incorrect.
The legal borrowing normally remains unchanged. The economic exposure is transformed.
Trap 4: Currency Swap Eliminates Every Risk
Incorrect.
Counterparty, basis, settlement, liquidity and operational risks may remain.
Trap 5: Foreign-Currency Debt Should Always Be Converted to INR
Incorrect.
Foreign-currency revenues or assets may already provide a natural hedge.
Trap 6: Correct Currency Match Means Perfect Hedge
Incorrect.
Benchmark, maturity, amount and cash-flow dates can still differ.
Trap 7: Swap Maturity Shorter than Loan Maturity Is a Complete Hedge
Incorrect.
Unhedged residual tenor and rollover risk remain.
Trap 8: Swap Notional Larger than Loan Gives Extra Protection
Incorrect.
It can create over-hedging and a new speculative exposure.
Trap 9: Principal Must Be Exchanged in Every Currency Swap
Incorrect.
RBI's definition allows exchange of interest streams and/or principal amounts.
Trap 10: Current Spot Rate Automatically Determines Maturity Re-Exchange
Incorrect.
Contractual re-exchange follows the agreed swap terms.
Trap 11: One Profitable Swap Payment Means the Swap Has Positive Overall Value
Incorrect.
Total market value depends on all remaining discounted cash flows.
Trap 12: Currency Swap Only Manages FX Risk
Incorrect.
It can also transform fixed/floating interest-rate exposure.
Trap 13: Currency Swap Itself Provides the Original Borrowing
Incorrect.
The swap is a derivative. Funding and hedging are separate transactions.
Trap 14: Any Economically Sensible Currency Swap Is Automatically Permitted
Incorrect.
The transaction remains subject to applicable RBI/FEMA eligibility and regulatory requirements.
Memory Technique
Remember C-I-P:
C – Currency changes
I – Interest streams may change
P – Principal may also be exchanged
For exposure transformation:
Receive the old liability currency
Pay the desired new liability currency
And remember:
IRS = Rate Change
Currency Swap = Currency + Rate Transformation
FX Swap = Near Exchange + Reverse Far Exchange
The central CAIIB principle is:
A currency swap does not erase the original liability; it overlays opposite cash flows so that the economic exposure behaves like a liability in another currency or interest-rate form.