Glossaire

A currency spot trade, or simply spot trade, is a foreign exchange transaction executed at the spot rate. If a dealer quotes spot USD-JPY as 106.30-35 and a corporate client sells one million JPY against USD at that rate to International Bank XYZ, the trade date (‘day 0’) is today, but the transaction usually settles in two business days (‘day 2’). On day 2, the company must wire the bank one million JPY and will receive USD 9,402.91 from the bank.

A currency swap is an exchange of debt-service obligations denominated in one currency for the service on an agreed-upon principal amount of debt denominated in another currency. By swapping their future cash-flow obligations, the counterparties are able to replace cash flows denominated in on currency with cash flows in a more desired currency. A company borrowing in GBP at a fixed interest rate can convert its debt into a fully hedged USD liability by exchanging flows with another company with the opposite need. At each payment date, the company will pay a fixed interest rate in USD and receive a fixed rate in GBP. Unlike interest rate swaps, where no exchange of principal takes place, currency swaps include the exchange of principal amounts at the start and at the end of the agreement. Depending on the nature of the corresponding interest rate payments —at a fixed or floating interest rate—, currency swaps can be arranged as ‘fixed-for-fixed’, ‘fixed-for-floating’ or ‘floating-for-floating’.

A currency swing is a large fluctuation in exchange rates, usually due to an unexpected market event. Sharp currency swings take place every now and then in currency markets. They are a normal feature of the flexible exchange rate system. They illustrate the need for adequate FX hedging programs to protect companies’ profit margins from sudden and unexpected FX moves. The implementation and management of these FX hedging programs may be quite burdensome for treasury teams that rely on manual execution and spreadsheets. However, Currency Management Automation solutions allows firms to run them smoothly, on a fully automated basis.

Currency volatility is the frequency and extent of changes in a currency’s value. It is measured by calculating the dispersion of exchange rate changes around the mean, expressed in terms of daily, weekly, monthly or annual standard deviations. The larger the number, the greater the volatility over a period of time. Episodes of currency volatility are a normal occurrence in a world of flexible exchange rates. During such episodes, companies with inadequate hedging programs in place are likely to feel the impact of proportional volatility in terms of their performance.

The current rate method is used in translation exposure management to restate —in the currency in which a company presents its financial statements— all assets, liabilities, revenues, expenses, gains and losses that are denominated in foreign currencies. With the current rate method, all balance sheet and income statement items are translated at the current exchange rate. For this reason, the current rate method is the simplest. The other main methods are the current/noncurrent method and the monetary/nonmonetary method. It should be noted that, no matter what translation account exposure management method is used, the resulting FX gains and losses are paper only, and rarely affect cash flows.

Daily foreign exchange rates are currency pair quotations supplied by dealers and/or bank providers through a handful of electronic quotation systems, such as Bloomberg, Reuters and others. Currencies are quoted with the widely used three-letter codes for currencies worldwide: USD, EUR, CHF, GBP, TRY, BRL, etc. Each day at 4pm London time, WM Reuters calculates ‘benchmark’ rates for spot and forward trading in the main currency pairs. 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. 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.

Decentralised Treasury is the system of financial management used by international companies with subsidiaries, in which funding activities, investment and foreign exchange decisions are made by local treasurers instead of one centrally located treasury team. From a foreign exchange risk management perspective, the main argument in favour of decentralised treasury is that it allows the firm to leverage valuable knowledge that only local treasurers can take advantage of. Detractors of decentralised treasury argue that it hinders exposure netting possibilities, thereby forcing the firm to execute unnecessary hedging.

Deflation is a decrease in the general price level as measured by a broad-based price index. Deflation is often the result of an overvalued currency that raises the cost of labour in relative terms. If, at the same time, the cost of capital is also high —due, for example, to weak and malfunctioning political institutions— the ensuing decline in corporate profits leads to low investment and high unemployment. In such a scenario, deflation wreaks havoc on the economy, as slow economic growth dents tax revenue, leading to a fiscal crisis and debt defaults. Deflation needs to be distinguished from disinflation, which is a decline in the (positive) rate of inflation over time.

The delivery date, also known as the value date or maturity date, is the final date by which the currency that was sold in a forward or futures contract must be delivered for the terms of the contract to be fulfilled. In a forward contract, the delivery date (and the underlying amount of currency) can be agreed upon by the parties. By contrast, both the delivery date and the underlying amount per contract are standardised in currency futures contracts. In an open forward contract, delivery can occur before the originally agreed upon delivery date. When both parties are legally obliged to exchange the funds precisely on the delivery date, the forward contract is said to be’ closed’ or ‘standard’.

A dirty float (also known as ‘managed float’) is an exchange rate regime in which the exchange rate is neither entirely free (or floating) nor fixed. Rather, the value of the currency is kept in a range against another currency (or against a basket of currencies) by central bank intervention. By far the most significant system of ‘dirty’ or ‘managed’ float in recent years is the Chinese currency regime. At the start of each trading day, China’s central bank sets a ‘reference rate’ against which the renminbi is allowed to rise or fall no more than 2 per cent against USD in onshore trading. A ‘managed float’ system gives the central the power to set a corridor for the exchange rate, in order to avoid situations of currency over- or under-valuation. In order to be credible, a ‘managed float’ system has to be managed by an autonomous or semi-autonomous central bank with a high level of FX reserves, strong credibility. Above all, the target corridor for the exchange rate should not be too far away from market-based levels.

The dollar offset method is one of the accounting procedures recognised by the International Accounting Standards Board (IASB) to test the effectiveness of a hedging relationship. At each reporting period, the fair value of the forecast transaction (hedged item) and the fair value of the hedging instrument are measured. The resulting differences are recognised in profit or loss (for the ineffective part of the hedge) or in other comprehensive income as a cash flow hedge reserve (for the effective part of the hedge).