What is a quanto swap and when would a corporate use one?

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AcadiFi · Accepted Answer

A quanto swap settles cash flows tied to a foreign-currency rate but pays in the domestic currency at a fixed notional. There is no exchange of principals and no FX conversion at settlement. In contrast, a cross-currency swap actually exchanges principal in two currencies and uses floating rates in each currency's funding market.

Example: Tokyo-based Hinode Manufacturing wants exposure to US rates but prefers yen cash flows. They enter a 5-year quanto swap receiving 6-month USD SOFR applied to a notional of ¥2 billion, paying 6-month TONA on the same yen notional. Each reset, if USD SOFR is 5.10% and TONA is 0.75%, net receipt = (0.0510 - 0.0075) × ¥2B × 0.5 = ¥43.5M. The USD rate is used but converted to yen at the notional, without any currency actually trading hands.

Pricing a quanto requires a quanto drift adjustment. The USD rate paid in JPY must be adjusted by -ρ × σ_r × σ_fx × T, where ρ is correlation between USD rate and USDJPY. If ρ = 0.3, σ_r = 1.0%, σ_fx = 9.0%, T = 5: adjustment = -0.0135%, so the fair quanto rate is about 1.35 bp below the USD forward.

Corporates use quantos to express views on foreign rates without FX exposure.

What is a quanto swap and when would a corporate use one?

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