Glossary

A flexible hedging strategy or program is the hedging of future FX-denominated cash flows that result from contractually binding transactions, whether or not the corresponding receivables/payables have been created. In a flexible hedging program, forwards are booked against SO/POs (sales orders/purchase orders) and/or AR/AP (accounts receivable/accounts payable). Flexible hedging strategies or programs call for constant vigilance, as new orders keep on arriving. Their effective implementation is carried out with the help of Currency Management Automation solutions that provide end-to-end automation. On the opposite side of the spectrum, static hedging —where a big hedge is taken at the start of the period and is not reactivated until this period is over— is implemented once. Flexible hedging strategies or programs are particularly well suited for companies with low forecast accuracy where an FX rate is systematically part of its pricing parameters. Whether their pricing is frequently updated (bed banks in the travel industry) or not (ecommerce companies), these firms are mostly compelled to hedge on a transaction-by-transaction basis.

A floating exchange rate regime lets currencies find their level in the foreign exchange market. Contrary to a fixed exchange rate regime, where a currency is pegged to another at a fixed rate, exchange rates in a floating exchange rate regime are determined by the interplay of supply and demand. The current floating exchange rate regime has been in place since the 1970s. Some governments intervene, through their central banks, to manage the value of their currency relative to others in order to avoid losing competitiveness. China’s exchange rate regime, for example, has undergone gradual reform since the move away from a fixed exchange rate in 2005. The renminbi has become more flexible over time but is still carefully managed, and depth and liquidity in the onshore FX market is relatively low compared to other countries with floating exchange rates. Gradually, China is allowing a greater role for market forces within the existing regime, and greater two-way flexibility of the exchange rate.

Foreign currency measurement is the accounting method used by an organisation to measure foreign transactions in their functional currency.International businesses that pay suppliers in foreign currencies and/or sell their products in overseas markets need to translate those costs and revenues into their functional currency in their financial statements.Since currencies fluctuate continuously, these companies are subject to transaction risks. The variations of the exchange rate in the different moments when foreign currencies are exchanged, generate differences in the amount of functional currency needed to pay suppliers (in the case of costs) or received from sales in overseas markets. These differentials are called transaction gains and losses and are included in the company's net income statements.

Foreign currency monetary items are FX-denominated assets and liabilities representing a claim to receive, or an obligation to pay, a fixed amount of foreign currency units. Examples of foreign currency monetary items are FX-denominated cash positions, accounts payable and receivable, and long-term debt. By contrast, non-monetary foreign currency items include inventory, fixed assets and long-term investments. The distinction between foreign currency monetary and non-monetary items is relevant in terms of the different techniques used in FX translation methods. 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.

A foreign 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. Because the foreign currency option has value, the buyer must pay the seller a premium in exchange for the right to exercise the option. An ‘American’ call or put option can be exercised at any time up to the expiration date; a ‘European’ option can be exercised only at maturity. When hedging regular foreign currency inflows and outflows, forward contracts are more widely used than foreign currency options. However, foreign currency options can be an efficient tool when contingent business events are hedged.

Foreign currency remeasurement is a procedure that restates the value of payables, receivables, and cash balances posted in a foreign currency to the company currency at period end. The key day for FX remeasurement is the last day of the period or fiscal year. Items are valued using the exchange rate valid on the key date and compared to the amounts that were originally posted.

‍

It is usually done by any organisation with monetary assets or liabilities (cash, receivables, payables, debt, etc) in currencies other than its functional currency, which brings FX remeasurement risk. If they want to reduce the volatility introduced by FX remeasurement, treasurers carry out balance-sheet hedging programmes. This will partially offset the accounting impact of foreign currency volatility from changes in the exchange rate between the value date and the period end date.

‍

Foreign currency risk or foreign exchange rate risk, also known as exchange rate risk, is the possibility that currency fluctuations can affect a firm’s expected future operating cash flows, i.e., its future revenues and costs. Exchange rate risk affects all companies with international operations. For companies desiring to take advantage of the growth opportunities from buying and selling in multiple currencies, effectively managing currency risk is an essential task. Foreign currency risk can be decomposed into: Pricing risk, between the moment a transaction is priced and settled Transaction risk, between the moment a transaction is agreed and settled Accounting risk, between the moment the invoice is created and settled The most effective tool to manage foreign currency risk is to deploy FX hedging programs —and combinations of hedging programs — that allow management to achieve the firm’s goals 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.

Foreign currency risk management is the process that allows firms to protect themselves from currency risk. This allows them to take control of their own competitiveness by capturing the growth opportunities resulting from buying and selling in multiple currencies. With FX risk under control, managers can focus on growing the business. Foreign currency risk management relies on a variety of hedging programs and combination of programs. The details of each program vary according to the pricing dynamics, the weight of FX in the business, the location of competitors, and the situation in terms of forward points. Implemented by means of Currency Management Automation solutions, foreign currency risk management 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.).

A foreing currency transaction is a sales or purchase transaction denominated in a currency other than the company’s functional currency. A foreign currency transaction involving foreign currencies commonly goes through several stages. (a) Forecast. A forecast is an anticipated transaction that is not yet legally committed. In IFRS terms, a transaction is ‘expected to occur’ if its estimated probability ranges between 20% and 75%. (b) SO/PO. Also known as a ‘firm commitment’, a SO/PO (sales order/purchase order) is a legally binding agreement that establishes the exchange of a specified quantity of resources at a specified price on a specified future date or dates. (c) AR/AP. A foreign currency denominated trade receivable or payable is a legally enforceable claim that certifies the sale/purchase to be settled at a later date. (d) Settlement. The transaction is settled when payment in cash, in a foreign currency, finally takes place.

Foreign currency translation is the restatement, 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. The process of foreign currency translation results in accounting FX gains and losses. There are three main foreign currency translation 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 foreign currency translation is used, the resulting FX gains and losses are paper only, and rarely affect cash flows.

Foreign currency valuation is a term used by vendors of Enterprise Currency Management vendors to record the impact of foreign currency changes into its FX-denominated assets, liabilities, revenues, expenses, gains and losses Once foreign currency valuation is complete, foreign currency translation is executed to prepare financial reports in the firm’s presentation currency.

Foreign exchange or ‘FX’ is a term used to describe the exchange or trading of one currency to another. The foreign exchange market has no central marketplace: spot and forward market transactions take place in an ‘Over-the-Counter’ market made up of dealers and large commercial and investment banks. Turnover in global foreign exchange (FX) markets reached $6.6 trillion per day in April 2019, according to data from the Bank for International Settlements (BIS). It is by far the largest financial market in the world. OTC markets are larger and more diversified than ever, owing in part to the rise of electronic and automated trading While trading continues to be dominated by the major currencies, in particular the US dollar and the euro, in FX markets the trading of emerging market currencies is growing faster than that of major currencies. The rise in electronic and automated trading is one of the key features of today’s foreign exchange markets.