Glossary

Reference exchange rates are a set of daily foreign exchange rates published by leading central banks. Reference exchange rates are used by companies and other participants in FX markets. They are based on a regular daily concertation procedure between the central bank and leading commercial banks. Reference exchange rates are published for information, not trading, purposes. They are often used as a valuation tool, or in annual financial statements and tax reports of corporations, as well as in statistical publications and economic analyses.

Repatriation of profit is the ability of a firm to send foreign‐earned profits or financial assets back to the firm's home country in hard currency such as USD, EUR and others, after meeting the host nation's tax obligations. Proponents of profit repatriation argue that it encourages foreign direct investments (FDIs). Opponents argue that profit repatriation boosts another country's economy. Accordingly, different countries impose different restrictions for profit repatriation.

The reporting currency is the monetary unit used by a firm to record its transactions and to present its financial statements. The reporting currency is also known as the accounting currency or presentation currency. In most cases, the reporting currency is also the firm’s ‘functional currency’, i.e. the currency in which it primarily generates and expends its cash. A company can decide to present its financial statements in a currency different from its functional currency, for example when preparing a consolidated report for its parent in a foreign country. While a company can choose its reporting currency, it cannot change its functional currency.

A reserve currency is a currency that central banks hold as part of their foreign exchange reserves. This currency is often used for their international transactions. There are several features of an international reserve currency: a large transaction area, stable monetary policy, absence of controls, a strong central state, some significant backing in terms of precious metals, a sense of permanence, and low interest rates.

A restricted currency, also known as ‘blocked’ or 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 to be restricted 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.

A revolving credit is a financial arrangement in which a bank or other lending institution allows a business or individual to borrow funds for purchases or investments as they require them.Revolving credits work like credit cards. The lending bank guarantees the maximum amount that can be loaned to the customer. Whenever the customer draws on this credit, the amount that they borrow is subtracted from the maximum amount. Periodically, and normally at the end of each month, the customer is obliged to pay off their debt, plus the interest rate, and then they are free to borrow up to the maximum amount again.The business or individual pays a commitment fee to the lending institution for this kind of credit.If the borrower fails to repay the debt by the scheduled deadline, the lending institution applies interest rates to the unpaid amount. These can range from 10-30% and can create a considerable snowball of debt and a possible credit risk.

In FX management, risk diversification refers to foreign exchange risk being managed centrally on a portfolio basis. This approach allows the firm to manage FX exposures in several currency pairs by taking advantage of natural offsets and currency correlations existing within the portfolio. When it is considered practical, the remaining exposures are hedged with forward contracts. In general terms, the lower the correlation between changes in currency values, the higher the benefits of diversification and the lower the hedging requirements.

In FX risk management, a Risk Management Framework (RMF) is the structured process used to identify the sources of currency risk and to define the goals of a hedging program aimed at eliminating or minimising the impact of this risk. The Risk Management Framework should allow management to achieve the goals of a hedging program 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. A Risk Management Framework takes into account a number of variables, starting with the firm’s pricing parameters. Budget-related 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.) Thanks to Currency Management Automation solutions, a wide array of programs is available for firms to tackle the needs formulated in their Risk Management Framework.

The risk premium is the extra compensation —in terms of rates of return— required for holding assets that are considered riskier than AAA-rated government bonds. In FX markets, the risk premium is visible in the difference in interest rates between low-risk currencies such as USD, CFH and EUR, and riskier currencies such as TRY, BRL or RUB. Because of this risk premium, high-yielding currencies trade at a forward discount rate to safe currencies. The difference between forward and spot exchange rates, measured in ‘pips’, is known as forward points. By delaying hedging as much as possible, Currency Management Automation solutions allow firms to minimise the impact of unfavourable forward points.

Rolling hedging is part of a ‘family’ of hedging programs in which the foreign-currency exposure for the current budget —divided into months or quarters— is forecasted and hedged partly (or entirely) during the previous budget period. The process is continuously updated, as the following year’s exposure is planned and hedged during the current year. The hedge rate for a given period is the average of all the forward rates used to hedge the exposure of that particular period. While keeping the exposure under management constant, rolling hedging programs require continuous forecasts, as no budget is hedged in isolation—rather, each budget is hedged in connection to the previous one. While rolling hedging programs are relatively straightforward to implement and manage, Currency Management Automation solutions allow firms to run them in a fully automated manner, minimising operational risk and freeing up time for treasury teams to concentrate on more value-adding tasks. Also, Currency Management Automation makes it possible to combine rolling hedging programs with more dynamic programs based on hedging firm commitments instead of forecasts.

Rolling positions forward refers to the extension of an FX forward contract. It is achieved by closing out a soon-to-expire contract and opening another one at the current market price for the same currency pair with a longer-dated maturity. The resulting gains or losses on the expiring forward are charged or refunded by the liquidity provider to the company. For example, a company holds an EUR-USD forward contract covering a USD 1 million payment to a supplier. The contract expires in a few weeks, but the supplier delays delivery for three months, so the company wants to roll the contract over to cover these additional three months. Suppose the initial forward rate was 1.10 and the new forward rate is 1.12. The contract issuer will close the initial contract under which the company needs EUR 909,000 to buy USD 1 million. With the new forward rate of 1.12, the company will have to pay EUR 892,000 on the new maturity date. By rolling over the forward, the liquidity provider should refund the hedger with EUR 17,000.