Suppose a currency swap wherein two counterparties of comparable credit risk each borrow at the best rate obtainable, yet the nominal rate of one counterparty is greater than the other. After the primary principal exchange, is the counterparty i.e. required to make interest payments at the higher nominal rate at financial disadvantage to the other in the swap agreement? Describe your thinking.
Superficially, it may seem that the counterparty paying the higher nominal rate is at a disadvantage as it has borrowed at a lower rate. Though, if the forward rate is an unbiased predictor of the expected spot rate & if IRP holds, then the currency along with the higher nominal rate is expected to depreciate versus the other. In this case, the counterparty making the interest payments at the higher nominal rate is effectively making interest payments at the lower interest rate since the payment currency is depreciating in value versus the borrowing currency.