Glosario

Under-hedging is to the application of a lower-than-optimal optimal hedge ratio to hedge a given FX exposure. Under-hedging is common when forward points are ‘against’ a company, for example when a European firm sells in Emerging Markets currencies that trade at a forward discount to EUR. Risk managers are naturally reluctant to sell these currencies in forward markets, given the high cost of carry. Under-hedging, in such a situation, can be counter-productive. This is because currencies with a high cost of carry tend to be highly volatile and can cause severe losses. The solution is to use Currency Management Automation solutions to calculate a weighted-average rate of all individual pieces of exposure and to build a ‘tolerance’ (in % terms) around that benchmark rate. Then, ‘take-profit’ and ‘stop-loss’ orders are automatically set, allowing the firm to effectively delay the execution of the trades, and thus to take shorter-maturity hedges that create savings on the carry.

Unrealised FX gains or losses reflect the change in the value of foreign currency denominated sales/purchase transactions that are recorded in financial statements prior to the settlement of the invoices. For example, a U.S.-based company sells EUR 100,000 worth of motor vehicle parts to a European distributor. When the invoice was recognised, the spot EUR-USD rate was 1.10. As financial statements are drawn, the transaction hasn’t been settled still, and the exchange rate has moved to 1.15. The corresponding unrealised FX gain of USD 5,000 is recorded on the balance sheet under the owner’s equity section.