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In this example, at the time the cross-currency swap is instituted the interest rates in Japan are about 2.5% lower than in the U. Over the next 10 years, each party will pay the other interest.
For example, General Electric will pay 1% on ¥100 million quarterly, assuming interest rates stay the same.
If the agreement is for 10 years, at the end of the 10 years these companies will exchange the same amounts back to each other, usually at the same exchange rate.
The exchange rate in the market could be drastically different in 10 years, which could result in opportunity costs or gains.
They agree to use the 3-month LIBOR rates as their interest rate benchmarks. The notional amounts will be repaid in 10 years at the same exchange rate they locked the currency-swap in at.
The difference in interest rates is due to the economic conditions in each country.
For example, a US company, General Electric, is looking to acquire Japanese yen and a Japanese company, Hitachi, is looking to acquire U. dollars (USD), these two companies could perform a swap.
The Japanese company likely has better access to Japanese debt markets and could get more favorable terms on a yen loan than if the U. company went in directly to the Japanese debt market itself, and vice versa in the United States for the Japanese company.
That said, companies typically use these products to hedge or lock in rates or amounts of money, not speculate.
The companies may also agree to mark-to-market the notional amounts of the loan.