Parallel Loans: A Historical Approach to Currency Risk Management

Parallel loans were an early precursor to foreign exchange hedging. Two companies who required money in the domestic currency of each other would both take a loan then provide the money to each other. This helped reduce the risk exchange rates would cut into profits. It also presented beneficial tax arrangements.

Example

Company A operates in the Brazil and owns Bob's Coffee which needs to purchase chocolate from Switzerland. Company B operates in Switzerland and owns Jane's Chocolate which needs to purchase coffee from Brazil. Company A borrows money from a Brazilian bank and then lends the money to Jane's Chocolate. Company B borrows franc from a Swiss bank and loans the money to Bob's Coffee. When the loans mature, the parent companies each receive the funds in return and pay off their existing loans. The exchange does not occur at the bank level. 

Modern Application

These loans originated in the 1970s, but they have been replaced with the foreign currency market. Today, Company A and Company B would be more likely to purchase options in each other's currencies to hedge against fluctuations than to engage in a parallel loan structure.