Glossary

Under Hedge accounting, a hedged item can be a recognised asset or liability (AR/AP, account receivable/payable), an unrecognised firm commitment (SO/PO, sales order/purchase order), a forecast transaction or a net investment in a foreign operation. The hedged item can be a single item (for example, an individual transaction) or a group of items (for example, the sum of forecast transactions). A hedged item can also be a component of such an item or group of items. The hedged item must be reliably measurable.

A hedging instrument is a financial derivative, usually a forward contract, used in FX hedging. When currency rates change, the hedging instrument creates an offsetting financial position that compensates the corresponding change in the hedged currency exposure. In Hedge Accounting, companies must provide documentation regarding the inverse relationship between the change in the value of the hedged item and the change in the value of the hedging instrument.

A hedging strategy or program is a set of procedures that allows a company to achieve its goals in terms of managing currency risk. It is based on the business specifics of the company, including its pricing parameters, the location of its competitors, the weight of FX in the business. A hedging strategy or program also takes 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.) The most widely used hedging strategies or programs include: static budget hedging, rolling hedging, layered hedging, hedging based on conditional orders, SO/PO (sales orders/purchase orders) and combinations of programs. Some of these programs and combinations of programs can be quite demanding in terms of calculations and/or currency trading, a real challenge for treasury teams relying on manual systemes. Their proper implementation and management requires, therefore, automated solutions provided by Currency Management Automation.

Hidden FX exposure is the amount of accounting, transaction or operating exposure that is not properly identified by the treasury team. Most FX surveys show that lack of visibility and reliability of FX forecasts is the biggest challenge in managing FX risk. Sources of hidden FX exposure include: manually executed data gathering and consolidation, use of spreadsheets gathered from many different sources, lack of transparency of internal processes, errors in the definition of the appropriate currency for translation purposes, difficulty in processing numerous intercompany transactions, and inaccurate or untimely monitoring of FX markets. To the extent that they automate the process of exposure collection and monitoring, Currency Management Automation solutions allow managers to mitigate the risks stemming from hidden exposures.

Hidden FX risk is the amount of accounting, transaction or operating exposure that is not properly identified by the treasury team. Most FX surveys show that lack of visibility and reliability of FX forecasts is the biggest challenge in managing FX risk. Sources of hidden FX risk include: manually executed data gathering and consolidation, use of spreadsheets gathered from many different sources, lack of transparency of internal processes, errors in the definition of the appropriate currency for translation purposes, difficulty in processing numerous intercompany transactions, and inaccurate or untimely monitoring of FX markets. To the extent that they automate the process of exposure collection and monitoring, Currency Management Automation solutions allow managers to mitigate the pitfalls created by hidden FX risk.

IAS 39 is the international accounting standard, established by the International Accounting Standards Board (IASB), which sets out the requirements for recognising and measuring financial assets and liabilities, as well as some of the contracts to buy and sell non-financial items.In this respect, IAS 39 also establishes the conditions to apply hedge accounting as well as the procedures for its application.According to IAS 39, financial instruments are recognised in the financial statement when the organisation is a party to the financial instrument contract. Financial liabilities are removed from the statement when the obligation established in the contract extinguishes. In the case of financial assets, these are removed from the financial statement when the entity's contractual rights to the asset's cash flows expire.Financial assets and liabilities are initially measured at fair value. During the life of the instruments, they can be measured at amortised cost or at fair value, depending on the category of the financial instrument.In 2014, IAS 39 was replaced by IFRS 9.

The IFRS 9 Financial Instruments are the new accounting standards introduced by the International Accounting Standards Board (IASB) in 2014, to replace the IAS 39 Financial Instruments: Recognition and Measurement, and their application has been mandatory from the 1 January 2018.These new standards determine the requirements for the recognition, measurement, impairment and derecognition of financial instruments as well as the conditions to apply hedge accounting.According to IFRS 9, financial assets and/or liabilities are recognised in a financial statement when the organisation becomes party to the financial instrument contract.At initial recognition, all financial instruments are measured at fair value. For financial assets or liabilities that are not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the asset or liability should also be factored in.Subsequent measurements are done at amortised cost, at fair value through other comprehensive income (FVTOCI) or at fair value through profit or loss (FVTPL), depending on the classification of the financial asset, which is determined at initial recognition. During the life of the contract, however, assets – but not liabilities – may be reclassified.

ISO 4217 is the standard established in 1978 by the International Organization for Standardization which defines the rules to create the three-character codes representing each one of the world currencies in circulation (except for several minor currencies, that are pegged to a bigger one).ISO 4217 is the code used by banks and businesses internationally to designate different currencies as well as airline tickets or other international travel tickets to avoid confusion with the price.The code is formed by three characters, the first two representing the country, while the third one represents the name of the currency. For instance, the code for the Australian Dollar combines the first two letters of the country (AU) and the third letter, (D) for the dollar.In the foreign exchange market, these codes eliminate potential confusion caused by common currency names shared like the dollar, peso, pound, or krona.

Inflation is an economic concept referring to the pace at which the prices of goods and services increase over time.A low, sustainable level of inflation is crucial for healthy economic growth, and therefore one of the main objectives of central banks' monetary policy is to maintain inflation close to a 2% annual rate.Inflation, however, reduces the purchasing power of the currency and so it may have very negative economic consequences if it rises too quickly.In some cases, sharp declines in foreign exchange rates have led to soaring import prices and ultimately to ballooning inflation. Venezuela and Zimbabwe are two examples of how these dynamics can hurt national economies. In these cases, when inflation reaches uncontrolled, very high levels, it is termed hyperinflation.On the other hand, low inflation can be equally detrimental to economic health. One danger is that inflation may lurch into deflation – a generalised decrease in prices of goods and services – which can bring untold problems to an economy. For example, Japan has been stuck in a deflationary cycle in recent years, keeping economic growth very low.

Interest rate risk is risk that moves in interest rates affect the value of fixed-income instruments such as bonds. Because the value of a bond is the present value of its discounted cash flows, an increase in interest rates (used as discount rates) automatically translates into a lower present value. In banking, interest rate risk is assessed both in terms of assets and liabilities. If, for example, short-term interest rates rise while long-term interest rates stay stable or fall, the net interest margin —and the bank’s profitability— would decline as a consequence.

An interest rate swap is an agreement between two parties to exchange interest payments (in the same currency) for a specific maturity on an agreed-upon notional amount. No principal is exchanged in an interest rate swap. The notional amount or notional principal is a reference amount needed to calculate the interest rate. The most common type of interest rate swaps are fixed-to-floating swaps, in which party A receives floating-rate payments from party B in exchange for fixed-rate payments from A to B. This is done in order to achieve savings on the total interest cost, as one party usually has a comparative advantage in borrowing at a fixed or floating rate. Using this relatively straightforward mechanism, interest rate swaps transform debt issues, assets and liabilities from fixed-to-floating or vice-versa.