Glosario

A margin deposit refers to the funds held in security that is required as a protection against possible losses. Let us imagine a situation where a ‘short’ EUR forward position is initiated, on which a 5% margin is requested. The position is ‘long’ USD 100,000 and the forward rate is EUR-USD 1.1111. Measured in EUR, the initial margin requirement is EUR 4,500 = 100,000 x 0.9000 x 0.05. If the position shows losses, the margin deposit may need to be increased, depending on the severity of the loss.

Margin requirement is a financial concept related to the minimum amount in collateral that the issuer of a financial security requests from the buyer, to hedge against the risk of adverse price movements or the buyer defaulting.In the foreign exchange markets, businesses or individuals who wish to enter a currency forward contract in order to protect their exposure to exchange rate volatility are normally requested to deposit a minimum margin requirement.It acts as a surety against transactional default and provides other parties to a transaction with confidence that the counterparty will fulfil its contractual obligations.The margin requirement in currency exchange is normally in cash, deposited in a margin account. It is usually a percentage of the total amount to be transacted.Should the margin requirement change – as is regularly the case in currency transactions as exchange rates change continuously – there is a margin call, whereby the counterparty must deposit the shortfall in order to meet the new margin requirement.

Margin risk, in the context of FX risk management, refers to the impact of unexpected currency fluctuations on operating profit margins. A Europe-based exporter to the United States could see operating profit margins decrease in the event of a sharp EUR appreciation, as it would be forced to slash USD selling prices in order to maintain market share. A hard definition of margin risk management would be a stated policy of not having operating margin decrease by more than 5%, for example, due to the changes in exchange rates. Currency management, including pricing in foreign currencies and effective hedging programs, can go a long way in protecting a firm from FX-induced margin risk.

Mark-to-market is a valuation method aimed at providing a measurement based on current market conditions. Because mark-to-market is based on current market values, it gives a realistic picture of a company’s financial position. Originally introduced to assess the value of futures contracts, mark-to-market accounting has become prominently used in over-the-counter derivatives markets, including forward markets, where it is one of the main tools to calculate FX gains and losses. Mark-to-market has received criticism because in volatile times, it can provide results that do not accurately portray the true value of an asset or liability. If, for example, investor confidence in a certain market suddenly dissipates, leading to forced liquidations in the short-term, values could fall sharply, while not reflecting long-term valuation considerations.

In financial markets, the figure of a market maker defines any company with the power to set buy and sell prices of financial instruments or commodities. The U.S. Securities and Exchange Commission defines it as "a firm that stands ready to buy and sell a particular stock on a regular and continuous basis at a publicly quoted price".In practice, a market maker, also known as a liquidity provider, is a company or individual that quotes the bid and ask price of any commodity or financial product in order to make a profit from the bid/ask spread.In stock markets, market makers are the entities entitled to buy and sell stocks listed on an exchange, such as the London, New York or Tokyo stock exchanges.In the foreign exchange market, most trading firms and many commercial banks are market makers. They create a bid/ask spread between the price they pay for a specific currency and the price at which they sell that currency, in some cases applying significant surcharges.

In portfolio theory, market risk is created by events that affect all or most asset markets. Whereas firm-specific risk (which affects one or a group of firms) can be countered with a strategy of diversification, market risk cannot be diversified away. For this reason, market risk is also known as undiversifiable risk. The coronavirus pandemic, which affected the entire world in 2020, is a perfect example of ‘undiversifiable’ market risk.

In a currency forward transaction, the maturity date —also known as the ‘value date’— is the date at which the trade is settled and one currency is exchanged against another. The maturity date of a forward contract can be weeks, months or, in cases involving very liquid currencies such as USD and EUR, even years after the contract has been signed. The maturity date is freely agreed between the buyer and the seller. This is not the case with futures markets transactions, where the maturity date is standardised by the futures exchange.

Micro-hedging is a currency management strategy that consists of hedging each transaction as it occurs. Unlike in other strategies whereby users take protective action after reaching a certain nominal threshold, micro-hedging executes hedges to protect against individual exposures immediately.This strategy benefits companies with significant foreign exchange transaction volumes in low amounts, as is the case of e-commerce firms, travel agencies, tour operators and Adtech companies.For example, think of an online travel agency that books hundreds of hotel beds a day in multiple currencies. Instead of waiting for a certain nominal number of payables/receivables to come in before hedging, they may choose to hedge each transaction. This way, they protect their profit margins, revenue and obligations from the FX market at the very start of the exposure.Due to the continuous trading activity required, this strategy cannot be applied manually. It requires technological solutions that are able to automate currency trades, like Kantox’s Dynamic Hedging.

The minimum variance hedge ratio, also known as the optimal hedge ratio, is a formula to evaluate the correlation between the variance in the value of an asset or liability and that of the hedging instrument that is meant to protect it. The minimum variance ratio is used by businesses and investors who hedge their exposure with futures contracts. Since perfect hedging does not exist, in some cases treasurers need to calculate the minimum variance hedge ratio to find out the suboptimal number of contracts in order to offset their exposure to the potential changes in the value of their underlying asset or liability. A typical example of this is an airline who, because their business is exposed to variations in fuel prices, might want to protect their margins with futures contracts. As there is no jet fuel futures market, the company will have to look for suboptimal contracts, that is, the futures contracts with the highest correlation with the underlying asset – in this case, jet fuel.

In the process of translating foreign-currency denominated assets and liabilities into a firm’s functional currency, monetary assets and liabilities are items that represent a claim to receive, or an obligation to pay, a fixed amount of foreign currency units. Foreign-currency denominated cash balances, accounts payable and receivable, and long-term debt are examples of monetary assets and liabilities. By contrast, non monetary items are physical assets such as inventory and fixed assets. In the monetary/non monetary method of translation for the balance sheet, monetary items are translated at the current rate, while non monetary items are translated at historical rates.

Multi-currency accounts are bank accounts that allow holders to send and receive payments in multiple currencies. In practice, they mimic a structure featuring multiple bank accounts, but with a single account number. Multiple currency accounts empower businesses to make and receive payments in local and foreign currencies without needing to convert as a result of each transaction. Multiple currency accounts are particularly useful for e-commerce firms running stores in different currencies, and, more generally, for firms with international operations.

Multi-currency notional pooling consists in creating a master account with a bank in order to offset balances in different currencies and optimise cash and liquidity management. Companies with subsidiaries in different countries can implement multi-currency notional pooling strategies due to their efficiency as a method to manage multi‑currency balances. The advantages include: – A single liquidity position to address most cash-management issues. – Minimal cash transfer fees, as transfers between accounts are minimised. – Reduced foreign-exchange transactions: offsetting credit and debit balances through a multi-currency balance, the pool minimises the need for FX transactions and their costs.