Back To Back Loan Agreement
To alleviate these fears, companies XYZ and ABC are structuring a back-to-back loan, with XYZ company paying $1 million to ABC Bank and ABC Bank (with the guarantee as collateral) lending $1 million to XYZ to XYZ €1 million. The current exchange rate between the US dollar and the euro is 1:0.50 (i.e. $1 buys half a euro). One of the disadvantages of these agreements is asymmetrical liability – in the absence of a specific agreement, the other party can still be held responsible for repayment if one party is late in the loan.  Another disadvantage compared to foreign exchange swaps is that back-to-back credit operations are generally recorded as liabilities in the statements of banking institutions, thus increasing their capitalization requirements, while foreign exchange swaps were largely exempt from this requirement in the 2000s.  Only large companies with sufficient liquidity on the spot markets or countries whose currencies are traded on the markets of the future can participate in a back-to-back loan. Companies also reduce their currency risk with the back-to-back loan. Although our example includes two relatively stable currencies, back-to-back loans are most often unstable currencies (due to their high volatility, which makes companies in these countries more necessary to reduce their currency risk). This is how back-to-back loans work: to avoid currency or currency risks, companies look for other companies in another country and grant back-to-back loans. For example, if U.S.
company X has a subsidiary in Japan, Y, that needs 1,000 yen, company X is looking for a Japanese company with a subsidiary in the United States, Z, that needs 1,000 $US. In the case of a foreign exchange swap, the actual amount of capital is not taken into account, but used to calculate the interest payments paid to each party. . . .
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