What is a 'currency swap'?

A 'currency swap' is an agreement between two parties to exchange principal and interest payments in different currencies. In this arrangement, each party typically borrows a specific amount of money in their respective currencies. Throughout the duration of the agreement, they will exchange interest payments—often making them on a regular basis—based on the notional amounts borrowed. At the end of the swap agreement, the parties will also exchange the principal amounts back to one another.

This financial instrument allows companies and investors to manage their foreign currency risk and take advantage of different interest rates in different countries. Currency swaps can also be used for hedging purposes, where one party seeks to protect itself from fluctuations in exchange rates. By agreeing to these terms, both parties benefit from access to foreign currency at more favorable interest rates than they might receive through other means.

This understanding of a currency swap highlights its strategic importance in international finance, making option B the right choice.