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Parallel Loan

Introduction

Parallel loans also known as back to back loans are an agreement by which two companies in different countries borrow one another’s currency for a provided time frame, so as to minimize foreign exchange risk equally for both of them. It is also called back-to-back loans. For example a Malaysian firm, borrows dollars to invest in its US subsidiary and lends the same amount in Ringgit to the Malaysian subsidiary of a US firm. In each case, the parent organizations stay liable for financial loans made to their subsidiaries. A parallel loan is a form of exchange. We can say that the funds are to cross borders in the case. The Malaysian parent company will need to exchange its Ringgit into Dollars and send is across US to its subsidiary. At the same time the US parent company will have to exchange its Dollar for Ringgits and send it across to Malaysia to its subsidiaries. In both of these transactions, there is always an exchange risk exposure. Theoretically this option seems as a simple approach to reduce operating exposure. Its use is nevertheless not widespread as a result of not only difficulty finding a counter party to loan with and also the valid risk another partner would standard upon the loan with minimal alternatives. There are two types of back to back loans generally used in forex market, one is currency parallel loan and other is interest parallel loans.

Background

The concept of a parallel loan is definitely not new. There are many signs that the agreement was used since the 18the century, between the United Kingdom and other European countries to trade their domestic currency for business. The tranquility of exchanging one amount of currency to acquire an equivalent level of another currency assisted businesses to be reasonably competitive outside their own countries. Generally, if a company requires money in another currency, the company goes to the currency market to trade for it. The problem with trading currency is that a currency with higher fluctuations could lead to great loss for the company. A parallel loan is quite easy for a company which requires money in a currency which is very volatile. When companies are involved in parallel loans, they normally agree on a fixed spot swap rate, normally the current one. This gets rid of the risk related to the unpredictability of exchange rates as the companies are trying to repay their loans depending on the arranged fixed rate.

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