Glosario

Translation risk is the possibility that the translation into a company’s assets, liabilities, revenues, expenses, gains and losses that are denominated in foreign currencies will result in foreign exchange gains and losses. Translation risk is also known as accounting risk. Unlike transaction risk, translation risk reflects paper gains and losses determined by the accounting rules that prevail in each country. It is retrospective because it is based on activities that occurred in the past.

Translation account exposure management refers to the methods used when a firm restates, in the currency in which a company presents its financial statements, of all assets, liabilities, revenues, expenses, gains and losses that are denominated in foreign currencies. This process of foreign currency translation results in accounting FX gains and losses. There are three main translation account exposure management methods available. With the current/noncurrent method, all the foreign exchange denominated current assets and liabilities are translated at the current exchange rate, while non-current assets and liabilities are translated at the historical exchange rate. With the monetary/nonmonetary method, monetary items such as cash, accounts receivable and payable, are translated at the current exchange rate, while nonmonetary items (inventory, fixed assets) are translated at the historical exchange rate. Finally, with the current rate method, all balance sheet and income statement items are translated at the current exchange rate. No matter what translation account exposure management method is used, the resulting FX gains and losses are paper only, and rarely affect cash flows.

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.

In a currency transaction, the value date (VD) is the date at which the trade is settled and one currency is exchanged against another. In a spot market transaction the most common value date is two days after the transaction was agreed If the value date is more than 48 hours away from the day the transaction was agreed, it is called a forward market transaction. It can be weeks, months or, in cases involving very liquid currencies such as USD and EUR, even years after the contract has been signed. In forward markets, the value date is freely agreed between the buyer and the seller. This is not the case with futures markets transactions, where the VD is standardised by the futures exchange.

A vanilla currency option is a financial derivative instrument that gives the buyer the right —but not the obligation— to buy (in a ‘call’ option), or to sell (in a ‘put’ option) the contracted currency at a set price or exchange rate (known as the ‘strike price’), on a predetermined expiration date. The seller of the option must fulfill the contract if the buyer so desires. The term ‘vanilla’ or ‘plain vanilla’ is used to signify that the contract has no other special features that would turn it into an ‘exotic’ option. When hedging regular foreign currency inflows and outflows, forward contracts are more widely used than options. However, vanilla currency options can be an efficient tool when contingent business events are hedged.

The weighted average exchange rate, for an accumulated FX exposure is an average of the exchange rates used in the valuation of each portion of the exposure, weighted by its size. For example, a company with USD as its functional currency has an exposure of EUR 100 valued at the exchange rate of EUR-USD 1.30, and an additional exposure of EUR 200 valued at EUR-USD 1.00. The corresponding weighted-average exchange rate, also known as WAER, is 1.10 = (100 x 1.3 + 200 x 1.0) / 300. The WAER is calculated for each currency pair. It allows companies to track their overall exposure as new pieces of exposure are incorporated, each at a different exchange rate. FX automation allows firms to instantaneously calculate both the WAER and their exposure in any currency pair, which turns out to be especially useful for firms with numerous small-size FX-denominated transactions.

Wire transfers, also called bank transfers or credit transfers are the transfers of funds sent by one person or entity to another using computer-based technology and without human intervention.Wire transfers provide a fast and reliable way to send money around the world, either using traditional banks or other Fintech alternatives like TransferWise for individuals or Kantox for businesses.The main advantage of wire transfers is their immediacy. Wire transfers do not need the funds to be physically transferred from one bank to the other. There is only information the moves through a network such as SWIFT globally, or FedWire in the U.S, with the instructions defining the recipient’s identity, bank account (if applicable), amount, value date and the destination.The receiving bank or institution makes the payment to the beneficiary and both institutions settle the payment in the back end afterwards.Wire transfers are thus quick. Banking wires take one day on average while transfers with alternative services like Western Union or MoneyGram may take minutes.Businesses processing significant amounts of daily wire transfers can improve process efficiency by integrating accounts payable automation solutions.

WM Reuters benchmark rates are spot and forward currency rates in the main currency pairs announced each day at 4pm London time. Made by taking an average of the exchange rate in currency trades 30 seconds before and after 4pm in the London market, these benchmark rates can be used by companies to reduce search and trading costs. Currencies are quoted with the widely used three-letter codes for currencies worldwide: USD, EUR, CHF, GBP, TRY, BRL, etc. Another widely used set of daily foreign exchange rates that are used as benchmarks is the euro foreign exchange reference rates (also known as the ECB reference rates), published daily by the European Central Bank on its website at around 4pm CET.