Explain the functional currency and what is a presentation currency and why are they undertaken

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Question: Explain the foreign currency swaps and why are they undertaken? Explain the functional currency and what is a presentation currency.

A foreign currency swap is basically an agreement which is undertaken among two foreign parties for exchange of currency. It is also known as FX swap. In a foreign currency swap agreement, there is a swap in principal amount and interest payments involved on a loan of equivalent value in analternate currency. In a foreign currency swap, one party borrows certain currency from another party and simultaneously lends another currency to the same party.

The purpose of undertaking a currency swap is to procure loans in the respective foreign currency at more favourable rates of interest than that of direct borrowing from foreign markets. Each of the party pays interest on the swapped principal throughout the loan duration. Once the swap is over, the amount of principal is exchanged once more at a rate which is pre-agreed or uses spot rates.

The currency belonging to‘primary economic environment' is referred to as the functional currency. It is the currency of the region where the business runs. Usually, the functional currency is the local currency itself. Presentation currencyrefers to the currency in which the business entity reports financial statements. Such currency is often same as functional currency. However, it differs from the functional currency in certain situations. For example, if an entity is a ‘foreign owned subsidiary', It may be required to report financial statements in the currency used by its parent unit. In such case, the currency of the parent company is the Presentation currency while the currency of the foreign subsidiary is the functional currency.

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