Glossary

Created by Kantox, Dynamic Hedging is a Currency Management Automation software solution that eliminates all or most FX risk and enables managers to capture the growth opportunities that result from buying and selling in local currencies. By keeping FX risk at bay, Dynamic Hedging allows firms to take control of their own competitiveness.  Dynamic Hedging automates —in accordance with business rules defined by each company— the three phases of the hedging process: pre-trade (exposure collection and monitoring), trade (forward transaction execution), and post-trade (reporting management). For this reason, Dynamic Hedging is known as an ‘end-to-end’ solution.

Kantox’s Currency Management Automation solutions integrate Dynamic Hedging and allow companies to deploy the hedging programs that best responds to the needs of the business, taking into account the firm’s pricing parameters, degree of forecast accuracy, and situation in terms of forward points.

Whether a company desires to protect its budget from FX fluctuations with static, rolling or layered programs, or whether it aims at ‘microheding’ its many foreign currency-denominated transactions, Dynamic Hedging ensures that the firm systematically achieves its risk management goals.

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).

In FX forward markets, a drawdown refers to the act of performing an early draw, i.e. exchanging a portion of the total amount specified in a flexible FX forward contract before the expiration of the contract.The period in which the contract holder can activate such drawdowns, for example three months, is established in the contract terms. Flexible forward contracts are an effective method of hedging against currency risk, and allow the contract holder to make regular payments using the same exchange rate for a specific time period. They can therefore be useful for companies that make regular payments to an overseas supplier