I didn’t know enough about FX swaps to comment personally, but Investopedia says this:
The top risk with foreign currency swaps is currency risk. Currency risk arises from fluctuations in exchange rates between two currencies involved in the swap. When companies or financial institutions enter into a swap, they agree to exchange cash flows in different currencies at future dates. If/when the exchange rate moves, one party may end up paying significantly more in its domestic currency than anticipated. For example, if a company swaps U.S. dollars for euros and the euro strengthens, the company will need to pay more in dollars to meet its euro obligations.
Another key risk is interest rate risk. Foreign currency swaps often involve exchanging fixed or floating interest payments on the notional amounts of the two currencies. If interest rates in one country rise unexpectedly, the party receiving fixed interest payments in that currency may miss out on higher interest income. If interest rates decline, the party paying floating rates could face higher-than-expected costs.
Counterparty risk is another risk. In any swap agreement, the parties involved rely on each other to fulfill their obligations. If one party defaults, the other party may face financial losses. To mitigate this risk, companies often perform thorough due diligence on their counterparties or utilize clearinghouses for swap agreements. As is the case with most financial instruments, this risk cannot be eliminated.
Last, the liquidity risk associated with foreign currency swaps is another factor to consider. These swaps typically have long maturities, and the liquidity of certain currencies can fluctuate over time. If market conditions change and a party wants to exit the swap early, they may find it difficult to find a willing counterparty, especially if they wish to trade or exchange out of their position.
Company A sells widgets for dollars made from raw materials bought in yen.
Company B sells woggles for yen made from raw materials bought in dollars.
Both companies can reduce their risk by agreeing to exchange yen for dollars at an agreed fixed value. No one is gambling. Everyone is reducing their risk.
Interest rates, some companies may have floating income they wish to swap for long term fixed, and others may have too much long term debt which has a volatile mtm value.
Counterparty risk, usually mitigated by diversification. Companies pool their specific risk for a lower, but more certain, general risk (and use clearing houses).
Liquidity risk. Only a problem if you need to sell something quickly. Here there are gamblers taking advantage. There’s no-one that naturally wants to take the other side of illiquid assets.
Not necessarily. Two companies in different countries can both reduce their risk by entering into an FX swap.
I didn’t know enough about FX swaps to comment personally, but Investopedia says this:
Company A sells widgets for dollars made from raw materials bought in yen.
Company B sells woggles for yen made from raw materials bought in dollars.
Both companies can reduce their risk by agreeing to exchange yen for dollars at an agreed fixed value. No one is gambling. Everyone is reducing their risk.
Interest rates, some companies may have floating income they wish to swap for long term fixed, and others may have too much long term debt which has a volatile mtm value.
Counterparty risk, usually mitigated by diversification. Companies pool their specific risk for a lower, but more certain, general risk (and use clearing houses).
Liquidity risk. Only a problem if you need to sell something quickly. Here there are gamblers taking advantage. There’s no-one that naturally wants to take the other side of illiquid assets.