Glosario

A revolving credit is a financial arrangement in which a bank or other lending institution allows a business or individual to borrow funds for purchases or investments as they require them.Revolving credits work like credit cards. The lending bank guarantees the maximum amount that can be loaned to the customer. Whenever the customer draws on this credit, the amount that they borrow is subtracted from the maximum amount. Periodically, and normally at the end of each month, the customer is obliged to pay off their debt, plus the interest rate, and then they are free to borrow up to the maximum amount again.The business or individual pays a commitment fee to the lending institution for this kind of credit.If the borrower fails to repay the debt by the scheduled deadline, the lending institution applies interest rates to the unpaid amount. These can range from 10-30% and can create a considerable snowball of debt and a possible credit risk.

In FX management, risk diversification refers to foreign exchange risk being managed centrally on a portfolio basis. This approach allows the firm to manage FX exposures in several currency pairs by taking advantage of natural offsets and currency correlations existing within the portfolio. When it is considered practical, the remaining exposures are hedged with forward contracts. In general terms, the lower the correlation between changes in currency values, the higher the benefits of diversification and the lower the hedging requirements.

In FX risk management, a Risk Management Framework (RMF) is the structured process used to identify the sources of currency risk and to define the goals of a hedging program aimed at eliminating or minimising the impact of this risk. The Risk Management Framework should allow management to achieve the goals of a hedging program in a systematic way, meaning: (a) targets must be consistently accomplished over time; (b) the goals of the program must be clearly communicated across the enterprise in as much detail as possible. A Risk Management Framework takes into account a number of variables, starting with the firm’s pricing parameters. Budget-related programs also take into account the company’s sources of information, IT systems, degree of cash flow visibility, and key decision makers (their risk tolerance, their familiarity with different risk management styles, etc.) Thanks to Currency Management Automation solutions, a wide array of programs is available for firms to tackle the needs formulated in their Risk Management Framework.

The risk premium is the extra compensation —in terms of rates of return— required for holding assets that are considered riskier than AAA-rated government bonds. In FX markets, the risk premium is visible in the difference in interest rates between low-risk currencies such as USD, CFH and EUR, and riskier currencies such as TRY, BRL or RUB. Because of this risk premium, high-yielding currencies trade at a forward discount rate to safe currencies. The difference between forward and spot exchange rates, measured in ‘pips’, is known as forward points. By delaying hedging as much as possible, Currency Management Automation solutions allow firms to minimise the impact of unfavourable forward points.

Rolling hedging is part of a ‘family’ of hedging programs in which the foreign-currency exposure for the current budget —divided into months or quarters— is forecasted and hedged partly (or entirely) during the previous budget period. The process is continuously updated, as the following year’s exposure is planned and hedged during the current year. The hedge rate for a given period is the average of all the forward rates used to hedge the exposure of that particular period. While keeping the exposure under management constant, rolling hedging programs require continuous forecasts, as no budget is hedged in isolation—rather, each budget is hedged in connection to the previous one. While rolling hedging programs are relatively straightforward to implement and manage, Currency Management Automation solutions allow firms to run them in a fully automated manner, minimising operational risk and freeing up time for treasury teams to concentrate on more value-adding tasks. Also, Currency Management Automation makes it possible to combine rolling hedging programs with more dynamic programs based on hedging firm commitments instead of forecasts.

Rolling positions forward refers to the extension of an FX forward contract. It is achieved by closing out a soon-to-expire contract and opening another one at the current market price for the same currency pair with a longer-dated maturity. The resulting gains or losses on the expiring forward are charged or refunded by the liquidity provider to the company. For example, a company holds an EUR-USD forward contract covering a USD 1 million payment to a supplier. The contract expires in a few weeks, but the supplier delays delivery for three months, so the company wants to roll the contract over to cover these additional three months. Suppose the initial forward rate was 1.10 and the new forward rate is 1.12. The contract issuer will close the initial contract under which the company needs EUR 909,000 to buy USD 1 million. With the new forward rate of 1.12, the company will have to pay EUR 892,000 on the new maturity date. By rolling over the forward, the liquidity provider should refund the hedger with EUR 17,000.

A SWIFT payment is a cross-border payment processed through the Society for Worldwide Interbank Financial Telecommunication international payment network. This procedure is internationally recognised as the fastest and most secure system for sending financial messages internationally.The SWIFT international payment network sends more than 15 million payments every day and has not lost the documentation of a single transfer in its over 40-year history. Any failure to send funds to their payment destination is due to errors in the details included in the SWIFT payment.The vast majority of the world’s interbank network use SWIFT. Over 10,000 financial institutions worldwide operate in over 200 countries and territories with SWIFT.

The concept of sensitivity analysis in corporate finance refers to a technique used by businesses exposed to currency risk to test the resilience of a company or a business line to a range of variables in different likely scenarios.The main objective of this exercise is to assess the potential impact of variations in elements that are strategic for the business, like exchange rates, interest rates, oil or commodity prices.For instance, a eurozone business that gets 40% of its yearly turnover by selling their products in British pound in the UK market should be interested in assessing the potential impact on their margins of the variations on the EURGBP exchange rate.With that objective, the company could study the volatility ranges of the EURGBP in the last five years and identify the:smallest variation;average variation;largest variation.With those three numbers create three different models to analyse how sensitive is that business line to the different likely scenarios on the euro-pound exchange rate.

A set-and-forget hedging strategy, also known as static hedging, is a budget hedging program where a big hedge is taken at the start of the period and is not reactivated until this period is over. Set-and-forget or static hedging makes sense for businesses with a high degree of forecast accuracy, rarely adjusted and FX-driven pricing, whose customers accept the potential ‘cliff’ created by sharp intra-period currency moves. If forward points are in favour, so much the better.

In a business transaction, the settlement date is the date on which it is due for payment in cash. In the chronology of a typical transaction, the settlement date is the last stage. It is preceded by other stages: forecasting, pricing, contracting (SO/PO, sales order/payment order) and recording (AR/AP, accounts receivable/payable). In a FX forward contract, the settlement date, also known as the ‘value date’, maturity date’ or ‘delivery date’ is the date at which delivery and payment of the agreed-upon amounts take place.

A short currency is the creation of an offsetting short FX position with forward contracts, in order to neutralize any gain or loss on an original ‘long’ currency exposure by a corresponding foreign exchange loss or gain on the hedge. For example, a U.S.-based exporter sells EUR 100,000 of goods worth to a European customer is said to be ‘long’ EUR since EUR will be received from the sale. In order to hedge that position, the firm undertakes a short currency hedge by selling an equivalent amount of EUR in the forward market, with a value date matching the settlement of the business transaction.