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Glossary

Navigate the complex world of currency management with our comprehensive dictionary of financial terms and definitions.

n
natural currency hedging
natural currency hedging

Natural currency hedging refers to a hedging technique that does not require the use of financial derivatives. For example, a holding company with subsidiaries can seek to maintain equal amounts of receivables and payables denominated in a foreign currency. To undertake natural currency hedging, a firm with FX-denominated receivables could borrow short-term in that currency. When translated into the firm’s functional currency, the depreciation (appreciation) of the foreign currency would result in a loss (gain) in the value of the receivables, but in a lower (higher) value of the liabilities as well. While theoretically attractive —because of the implied lower transaction costs that it entails—, natural hedging is much less precise than hedging with forward contracts. Besides, such a technique may not be always fully ‘natural’ but forced, i.e. the company would end up subordinating business decisions to risk management decisions.

net investment hedge
net investment hedge

In Hedge Accounting, net investment hedging refers to the practice of offsetting FX-related changes in the value of net assets of a subsidiary by using a derivatives instrument. For example, a company with EUR as its functional currency has a wholly owned US subsidiary whose functional currency is USD. At the date of hedge designation, the company can include the carrying value of the subsidiary’s net assets as a hedge item. The other two types of hedges authorised under hedge accounting are fair value hedges and cash flow hedges.

netting
netting

In general terms, netting refers to the practice of consolidating two different settlements in order to create a single value.

How does netting work?

For instance, if Company A owes $50,000 to Company B and Company B owes $40,000 to Company A, they can set a netting value of $10,000 (that Company A owes to Company B).

Foreign currency netting, also known as cash pooling is a common form of netting. Multinationals with subsidiaries in other countries might need to conduct frequent foreign exchange transactions between subsidiaries and the parent company.

In some cases, these companies can use a netting centre, which holds accounts in a reserve currency, while the subsidiaries hold accounts in their local currencies.To put it simply, this structure allows the firm to reduce payments from and between subsidiaries, as each subsidiary will receive payments from the netting centre, and make single payments back to the netting centre.

There are three advantages to reducing the volume of foreign payments:

  1. Less money in transit means more money available for investment.
  2. Fewer foreign currency payments mean reduced transaction risk.
  3. A reduction in the commission paid on foreign exchange transactions.
non-convertible currency
non-convertible currency

A non-convertible currency is the monetary unit of a country where holders of the currency do not have the right to convert it freely at the going exchange rate into any other currency. A currency is considered as non-convertible if it fulfills one or more of the following three criteria about usability, exchangeability and market value: it cannot be used for all purposes without restrictions; it cannot be exchanged for another currency without limitations; It cannot be exchanged at a given exchange rate.

nonmonetary assets and liabilities
nonmonetary assets and liabilities

In the process of translating foreign-currenecy denominated assets and liabilities into a firm’s functional currency, non monetary items are foreign-exchange denominated physical assets such as inventory and fixed assets that cannot be easily converted into cash or cash equivalents. By contrast, monetary assets and liabilities are items that represent a claim to receive, or an obligation to pay, a fixed amount of foreign currency units. 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.

notional amount
notional amount

In FX futures markets, the notional amount or notional value of a contract represents the value of the futures position at any point in time. If contract size for the EUR contract is EUR 125,000 and the exchange rate for September delivery is EUR-USD 1.18705, the September contract has a notional value of $ 148,381.25 = 125,000 x 1.18705. The value is said to be ‘notional’ because delivery actually almost never takes place in currency futures. However, it is needed to calculate the P/L of the position. In interest rate swaps, the principal amount is used to calculate the cash flows of the swap, but because it is not actually exchanged, it is called ‘notional’.

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