Swap contract is a type of means to hedge risk for companies. Suppose there are two companies whose they want to hedge the interest rate for borrowing as they are afraid of the rate is gonna go up at the maturity date. Also different markets may have vary rates for borrowing, which that's why we would be mentioned comparative advantages.
swaps can be used for currency hedging as well. Let's take a example to illustrate.
Two companies A and B are offered fixed rates in Australian dollars and pounds. Provided company A wants to borrow sterling and B wants to borrow dollars
The difference between the in rate facing the two companies in dollars market is 2%(10%-8%) and the difference between the rate facing them in the currency of pounds market is 0.4%(12%-11.6%).
Therefore the net gain is 1.6% (2-0.4)%.
As the diagram has been set up, we may see company A can be 0.6% pa better than if went directly to dollar markets because 11.6% is higher than 11%. Whereas the company B can be better off of 0.6% as well because less expensive than went directly to sterling markets, which can be borrowed at 9.4% rather than 10%
Thus, the intermediary of financial institution can gain 0.4% in this case as the total gain is 1.6% and less the gains for two parties with 0.6% respectively.
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