Glossary

A layered hedging strategy is an FX hedging program designed for firms that require continuity on pricing period after period, i.e. firms that need to keep prices constant—even on the back of an adverse intra-period currency movement known as a ‘cliff’.  Firms in this scenario need to achieve a smooth hedge rate over time. In order to achieve a smooth hedge rate, successive layers of hedges are applied as time passes (for example, 1/12 of the exposure is hedged every month). The resulting commonality in hedge rates creates a ‘smooth hedge’.  Depending on the goals of the firm, on the reliability of its forecasts, and on the forward points situation, layered hedging programs can be adjusted and combined with programs that hedge firm commitments (sales/purchase orders) and balance sheet items (accounts receivable/payable).  These programs and combinations of programs can be very demanding in terms of calculations and/or currency trading, a real challenge for treasury teams relying on manual procedures. Their proper implementation and management requires, therefore, the application of Currency Management Automation solutions.

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Learn more about layered hedging strategies in our blog: Hedging Strategies 101: Layered Hedging

A Leveraged Forward contract is an over-the-counter derivative product that allows holders to lock-in more favourable exchange rates than an outright forward for part of their exposure as well as to benefit from favourable market movements using leverage. The leverage defines the amount of risk the hedger is willing to assume. Due to their complex character, leveraged forwards are not the most suitable products for corporate treasurers wishing to protect their profits from FX risks. Leveraged forwards can have a negative market value and may involve costs if holders want to close out the position prior to contract expiration.

In FX trading, leverage trading refers to the use of credit —extended by the dealer or trading platform— aimed at magnifying the notional value of a position. If a trader has a given amount of margin in deposit, he or she is allowed to speculate on a notional amount that can be many times as large. Some retail forex brokers allow traders to open accounts and, upon depositing a margin amount, they can trade in a large multiple of the margin amount. For instance, 5:1, 10:1 or 50:1. This is why leveraged trading is like a double sword: both gains and losses are amplified by the effect of leverage. Leveraged trading is a popular, but highly speculative activity that has nothing to do with FX hedging.

A limit order, in the context of foregin exchange risk management, is an order to buy or sell a currency forward at a specific exchange rate or better. This exchange rate is determined by the treasury team. A buy limit order can only be executed at the limit exchange rate or lower; a sell limit order can only be executed at the limit exchange rate or higher. Limit orders are the most common type of conditional orders. Other conditional orders, used in Currency Management Automation solutions like Dynamic Hedging, are stop-loss orders and take-profit orders. For example, a British company that pays a China-based supplier USD 1 million every 3 months must exchange GBP to USD in order to complete the transactions. If the current exchange rate is GBP-USD 1.30, the company may impose a limit order to buy USD at an exchange rate no lower than GBP-USD 1.28. If USD appreciates to GBP/USD1.25, the company will have stemmed the FX losses through its limit order at 1.28.

A line of credit is a loan facility agreement between a lender and a borrower. A total amount is agreed for the credit line.It is extended to creditworthy customers by banks and money lenders.Lines of credit form an integral function in assisting businesses in completing purchasing operations.Advantages to using a line of credit over a loan1. A line of credit allows the borrower to draw down as many times as they need to, up to the maximum amount permitted.2. Unlike a loan, interest on a line of credit is only charged on the actual credit that is used. Any available credit not used up does not incur any interest payment.A line of credit is often used in conjunction with a letter of credit obtained from the same money lender when making international transactions.

Liquidity is a financial concept that refers to the ability to convert assets into cash.It is crucial for a company to have good liquidity in order to pay its bills in a timely manner. In order to fulfil payment obligations on an ongoing basis, a company must ensure that total cash flow exceeds total liabilities, ensuring a minimum level of liquidity.Managing liquidity is seen as one of the core functions of a company's treasury department. Since the 2007-09 global financial crisis, maintaining good levels of liquidity has been an increasing challenge for many companies due to a variety of factors, including the marked decrease in bank credit globally.A company that maintains a minimum level of liquidity is said to be solvent.Foreign exchange risk is a major threat to a company's liquidity. Companies with business lines in foreign markets may experience an adverse impact on their cash flow if they are not able to protect their margins, which might end up eroding their liquidity ratio.

In corporate finance, liquidity ratios measure the level of assets that can be quickly and cheaply converted into cash and their proportion to the firm’s short-term obligations. Because the book value of liquid assets is usually reliable, liquidity ratios allow investors to get a picture of a firms’ liquidity position. The most widely used liquidity ratios are the current ratio, the quick ratio and the cash ratio. In these three ratios, the denominator is the level of current liabilities. The current ratio is simply the ratio of current assets to current liabilities. Because some current assets are closer to cash than others, inventory is subtracted from the numerator (of the current ratio) when calculating the quick ratio, which is also known as the ‘acid test’. Finally, the cash ratio is even more stringent, as it only includes cash and marketable securities in the numerator. While investors generally applaud firms with strong liquidity ratios, an excess of liquidity can indicate sloppy use of capital.

In corporate finance, liquidity risk is the risk that a firm may not be in a position to lay its hands on the cash needed to meet its short-term obligations. To assess liquidity risk, investors look at several financial ratios, including the current ratio, the quick ratio and the cash ratio.

Live exchange rates are real time spot and forward currency quotes provided by liquidity providers such as banks, FX brokers and dealers, and multi-dealer trading platforms. Live exchange rates allow managers to monitor their FX exposure and to execute hedges when required. By connecting to providers of live exchange rates, Currency Management Automation solutions allow managers to monitor their exposure in real time, 24/5, in any currency pair, and for any number of transactions.

For a company that operates internationally, local currency payments are transactions that are priced, invoiced and settled in the local currency of a client (sales transactions, or exports) or supplier (purchase transactions, or imports), rather than in the firm’s own functional currency. On the contracting side, buying capacity in the local currency immediately results in a wider range of inventory choices. Crucially, it allows firms to avoid costly markups charged by suppliers who seek to protect themselves from FX risk when forced to sell in a foreign currency. On the selling side, firms that sell in the local currency avoid passing on FX markups to their clients, gaining competitiveness and expanding sales. Finally, in terms of pricing, there are several ways in which the FX-savvy travel firm can take advantage of forward points, the difference between forward and spot currency rates. Operating in the currency of clients/suppliers presupposes effective FX hedging. Depending on a company’s specific parameters, Currency Automation Management solutions allow managers to design the hedging programs that best protect them for currency risk, in an automated manner.

A long currency hedge refers to a strategy aiming to minimise the risk related to cash flows due for settlement at a future date, for instance in one year’s time. The hedger secures the current exchange rate for that payment to protect themselves from potential losses due to exchange rate fluctuations.For example, a French company (which uses the euro as its functional currency) places a large order with its US supplier (who accept payments in US dollars) worth $10 million, to be paid for in a year’s time. By using a long currency hedge to set the exchange rate at the current rate, the company reduces its exposure to the fluctuation of the EUR/USD exchange rate.For instance, if the one-year forward rate is EUR/USD 1.20 and the spot rate in one year’s time is EUR/USD 1.15, the company will have benefited by locking in the exchange rate in advance, saving the equivalent of $500,000 that would otherwise be lost to the FX market. However, if the dollar appreciates against the euro, the company will have made a loss against the exchange rate available when they have to pay for their order.If this loss is sizeable, it could be highly detrimental to the company. To diversify risk, the company could choose to only take a long currency position for a specific percentage of its exposure and mix its hedging methods.