Currency Exposure and Risk Management



The Council of the Malaysian Institute of Accountants has approved this Foreword for publication.

The status of Statements on International Management Accounting Practice is set out in the Councilís statement on Approved Management Accounting Statements




Currency Markets 1-3


International Trade 4-6


Exchange Rates 7-16


Business Implications 17-23


Definition 24


- Types of Exposure 25-30


- Translation Exposure 25-26


- Transaction Exposure 27-28


- Economic Exposure 29-30


Identification of Exposure 31-42
RISK 43-60


Definition 43-45


Assessment of Risk 46-60


- Forecasting 47


- Assumptions 48-53


- Measurement 54-60


Introduction 61-62


Corporate Philosophy and Policy 63


Management Objectives 64-65


Organization and Responsibility 66-75


Tactics and Techniques 76-103


- Forecasting 76-80


- Management Techniques 81-103


Accounting Standards and Practices 104-107


Taxation Considerations 108-110


Foreign Exchange Controls 111-113
APPENDIX 1 - Translation Accounting Conventions  
APPENDIX 2 - Example of an Organizational Flow Chart Which Would Support an Active Exposure Management Program  
APPENDIX 3 - Example of a Translation Exposure Report  
APPENDIX 4 - Example of a Transactional Cash Flow Report  
APPENDIX 5 - Example of an Economic Exposure Cash Flow Forecast  

This International Management Accounting Practice Statement has been prepared in order to summarize for the benefit of senior management and, in particular, financial and accounting managers, those matters concerning the management of foreign currency exposures and the risks associated with changes in the rates of exchange between currencies. It is intended to serve as a framework for those who are required to determine overall policy in this regard as well as for those who are expected to manage such exposures and risks.

While some background and causative influences are discussed, no attempt is made to analyze the economic theory behind exchange rate fluctuations. Rather, it is accepted that such fluctuations are an integral part of the present international financial environment and the objective of the paper is to provide managers with a more systematic approach to the issues involved.

It would not be possible in a statement of this length to deal exhaustively with the subject. However, the main concepts are highlighted and the general principles discussed. 


Currency Markets

  1. Since the beginning of the seventies there has been extreme movement and instability in international currency markets, bringing about violent fluctuations in currency relationships. Differences in the economic performances of countries, as well as in their political, monetary and fiscal policies, have aggravated this situation. Attempts to impose a fixed exchange rate system, first in relation to gold and later in terms of the U.S. dollar, were dropped in favour of a free float by all the major currencies in the early seventies.

  2. A number of secondary monetary systems have evolved out of the attempts to introduce some stability. Many smaller countries have sought to tie the value of their currencies to that of a major currency or basket of currencies. A series of currency blocks has emerged. Within each block, the currencies involved float in a narrow band, while the main blocks themselves float relative to each other, significantly influenced by the dominant currency in each block (i.e., the exchange rate mechanism of the European Monetary System).

  3. Despite these developments, volatility of exchange rates has been the rule rather than the exception. They remain highly sensitive to national and international economic and political conditions and expected changes. Uncertainty has also spawned increased speculative activity in the currency markets themselves.

International Trade

  1. World output continues to expand and the increasing liberalization of international trade and financing has dramatically increased cross-border flows of goods, services and investments. While this has greatly assisted economic integration and growth, it has brought about widely fluctuating fortunes in the countries involved.

  2. Large multinational enterprises have become more and more prevalent as the needs to grow, diversify, spread risk and extend markets have led to the expansion of activities into foreign countries. Business enterprises in the present day have ready access to most foreign markets and can exercise a wide geographical choice in the procurement and distribution of products and services. Foreign financing (especially with increased focus on cross-border risks), investing and, sometimes, disinvesting occur on an ever increasing scale. These activities inevitably exert a high degree of influence on the economic performance of countries and the strength of their currencies.

  3. Changes in the availability and price of key commodities, e.g., food and mineral resources have precipitated financial crises in many countries and subjected their exchange rates to a high degree of vulnerability.

Exchange Rates

  1. Variations in the relative purchasing powers of currencies may result in sharp and often severe exchange rate corrections. The purchasing power parity theory suggests that, over time, the cost of a common set of goods in one country should equal the cost of those same goods in another, when translated at the ruling rate of exchange. Disparities in relative purchasing powers are created where:

    • the domestic price of goods remains stable over a period of time but the exchange rate alters significantly. The result is that a country with a declining exchange rate is able to offer its goods on the international market at a lower price than that of another country whose currency is appreciating; or

    • there is no change in the exchange rate between the two countries but a high level of inflation in one country has the effect of increasing its domestic price of goods as against another country's domestic price.

  2. Disparities can also occur because of:

    • capital flows;

    • transport and associated costs;

    • only certain goods being traded; and

    • quotas, import surcharges, tariffs or other government constraints

  3. Real interest rate differentials play an important part in determining the rate of a currency. As domestic interest rates are raised or lowered, the investment of funds in one currency is made more or less attractive than in another, and this may result in the movement of short- and long-term funds between countries. Any significant net movement of funds into a country will usually improve its exchange rate while weakening the currency of the country from which the funds have come.

  4. However, the establishment of the Group of Seven (G-7) by the seven major industrialized nations, in part to facilitate coordinated movements of interest rates, is an important initiative in seeking to keep real interest rate differentials reasonably static in the long term.

  5. The extent to which countries enforce or relax foreign exchange controls will affect the international flow of funds in and out of the countries concerned and influence their relative exchange values.

  6. The net result of all current transactions a country has with all other countries is reflected in its balance of payments, as either a surplus or a deficit. Where a country has to consistently draw on its reserves to rectify any deficit in its balance of payments, its currency will weaken. The converse applies when surpluses are generated.

  7. Different economic and political conditions among countries as well as their contrasting economic policies cause realignments in relative exchange values. It becomes important, therefore, to identify the dominant influences as well as the other exacerbating or alleviating factors. Perceptions, more than actualities, are often key determinants in the pricing of a country's currency.

  8. Because of the scale of financial, interbank (or secondary), speculative and interventionist transactions, the proportion of foreign exchange dealings that relate directly to payment of goods and services is normally relatively small and the volatility in the foreign exchange markets is increased. The role played by currency speculators, particularly, should not be underestimated, as it exerts significant influence on the market. In addition, foreign investment in equities/stock, property and bond markets can play an important role in influencing a currency market.

  9. Central bank intervention can create pre-determined trading ranges for specific currencies. Although isolated intervention may not have a material effect, concerted intervention by a group of central banks can force market participants to honor these price levels for a limited length of time. The market will attack these ranges only when there is a perception that fundamentals have changed sufficiently to warrant policy changes by the countries concerned.

  10. The short-dated forward foreign exchange market, which is driven primarily by trade flows and short-term capital movements, either genuine or speculative, is used extensively by central banks as a mechanism for intervention to influence market conditions or exchange rate movements. The forward market is closely allied to short-term money markets in the relevant currencies and the process of arbitrage forces the forward rates on currencies to reflect the interest rate differentials between the respective currencies.

Business Implications

  1. An enterprise faces the risk that fluctuations in the exchange rate between the domestic and the foreign currencies involved will affect the cash flows of the enterprise, its profitability and even its solvency. The more currencies involved and the longer the time period before settlement, the more complex is the management of the risk and the greater the implications of its mismanagement. Normally the more the proportion of foreign currency exposure relative to the domestic currency, the larger is the actual risk.

  2. Exchange rate movements focus attention on cash flows and on those assets and liabilities, revenues and expenses of an enterprise which are denominated in foreign currencies, and create the possibility of foreign exchange gains and losses. What could otherwise be a profitable economic transaction or investment may be rendered unprofitable on realization because of exchange rate fluctuations. Conversely, movements in the opposite way may render potentially unprofitable transactions profitable. The performance measurement of certain divisions and products can be significantly affected by exchange rate movements as can also their competitiveness against locally available foreign products.

  3. There is a close relationship, even at times a mutual interdependence, between currency rates and interest rates. Both need to be considered when loan arrangements in foreign currencies are contemplated.

  4. The trend towards expanded accounting disclosure requirements has accompanied increased visibility of foreign exchange matters and the related accounting practice rules have more properly circumscribed the methods of accounting for them. This is especially applicable to disclosure of speculative positions and to unrealized profits and losses.

  5. Greater central bank restrictions and controls may severely limit an enterprise's freedom of action and, therefore, these warrant close monitoring.

  6. An increasing number of fiscal authorities are devoting more attention to their rules and practices regarding the tax treatment of exchange gains or losses incurred by an enterprise. The implications of this cannot be ignored in assessing the desirability or otherwise of any contemplated foreign currency action.

  7. The management of foreign currency exposure and risk by senior management, especially the financial executives, but also the marketing, sales and purchasing executives, is an important area of responsibility in many enterprises. It is an aspect of management that enterprises can no longer afford to ignore as there are risks which must be addressed and opportunities which could be exploited.



  1. Foreign currency exposure is the extent to which the future cash flows of an enterprise, arising from domestic and foreign currency denominated transactions involving assets and liabilities, and generating revenues and expenses are susceptible to variations in foreign currency exchange rates. It involves the identification of existing and/or potential currency relationships which arise from the activities of an enterprise, including hedging and other risk management activities.

Types of Exposure

Translation Exposure

  1. Translation exposure is also referred to as accounting exposure or balance sheet exposure. The restatement of foreign currency financial statements in terms of a reporting currency is termed translation. The exposure arises from the periodic need to report consolidated worldwide operations of a group in one reporting currency and to give some indication of the financial position of that group at those times in that currency.

  2. Translation exposure is measured at the time of translating foreign financial statements for reporting purposes and indicates or exposes the possibility that the foreign currency denominated financial statement elements can change and give rise to further translation gains or losses, depending on the movement that takes place in the currencies concerned after the reporting date. Such translation gains and losses may well reverse in future accounting periods but do not, in themselves, represent realized cash flows unless, and until, the assets and liabilities are settled or liquidated in whole or in part. This type of exposure does not, therefore, require management action unless there are particular covenants, e.g., regarding gearing profiles in a loan agreement, that may be breached by the translated domestic currency position, or if management believes that translation gains or losses will materially affect the value of the business. International Accounting Standards set out best practice.

Transaction Exposure

  1. This is also referred to as conversion exposure or cash flow exposure. It concerns the actual cash flows involved in setting transactions denominated in a foreign currency. These could include, for example:

    • sales receipts

    • payments for goods and services

    • receipt and/or payment of dividends

    • servicing loan arrangements as regards interest and capital

  2. The existence of an exposure alerts one to the fact that any change in currency rates, between the time the transaction is initiated and the time it is settled, will most likely alter the originally perceived financial result of the transaction. It is, for example, important to commence monitoring the exposure from the time a foreign currency commitment becomes a possibility, not merely when an order is initiated or when delivery takes place. The financial or conversion gain or loss is the difference between the actual cash flow in the domestic currency and the cash flow as calculated at the time the transaction was initiated, i.e., the date when the transaction clearly transferred the risks and rewards of ownership. Where financing of a transaction takes place, such as a loan obligation, there are also gains/losses which may result.

Economic Exposure

  1. Economic exposure or operational exposure moves outside of the accounting context and has to do with the strategic evaluation of foreign transactions and relationships. It concerns the implications of any changes in future cash flows which may arise on particular transactions of an enterprise because of changes in exchange rates, or on its operating position within its chosen markets. Its determination requires an understanding of the structure of the markets in which an enterprise and its competitors obtain capital, labour, materials, services and customers. Identification of this exposure focuses attention on that component of an enterprise's value that is dependent on or vulnerable to future exchange rate movements. This has bearing on a corporation's commitment, competitiveness and viability in its involvement in both foreign and domestic markets. Thus, economic exposure refers to the possibility that the value of the enterprise, defined as the net present value of future after tax cash flows, will change when exchange rates change.

  2. Economic exposure will almost certainly be many times more significant than either transaction or translation exposure for the long term well-being of the enterprise. By its very nature, it is subjective and variable, due in part to the need to estimate future cash flows in foreign currencies. The enterprise needs to plan its strategy, and to make operational decisions in the best way possible, to optimize its position in anticipation of changes in economic conditions.

Identification of Exposure

  1. The three types of exposure mentioned earlier require to be identified, classified and collated in terms of the foreign currencies involved and their related time frame. This is crucial for management reporting within an enterprise. At no time should the enterprise lose sight of the overall position in the process of managing any one particular type of exposure.

  2. The detail to be assembled, and the frequency at which it is done, should be directly related to the size and significance of the exposures in relation to the enterprise as a whole, or to any particular sub-activity or area of operation.

  3. In essence, the overall position must first be determined by way of a set of exposure reports, containing information on each form of currency exposure to which the corporation is subject. In the case of translation and transaction exposure, the normal format for such statements (see Appendices 3 and 4 to this Statement respectively for examples) is to distinguish the local currency items which together constitute the final translated numbers. The format can be adapted to show changes from the date a transaction is first initiated to the date on which it will be concluded - the selection of the time period of measurement is totally flexible.

  4. The balance sheet should address the closing (future) position on two bases:

    • assuming no change in the actual opening (present) exchange translation rates

    • applying forecasted closing rates available from the currency markets

  5. From this it is possible to make an assessment of the size of the net translation exposure as well as of the possible impact which any expected exchange fluctuations would have on that position.

  6. As regards the income statement, where the currencies concerned are relatively stable, it is usually adequate to utilize the average exchange rates expected over the period unless there are significant seasonal or volume imbalances. International Accounting Standards should be followed. Again, the nature and quantum of the exchange sensitive items can be determined.

  7. IAS 21 and national equivalents specify the accounting and external reporting methods for exchange rate effects (see Appendix 1 to this Statement for details). Within those standards, consistent and informative treatment is the key to any determination being made.

  8. From the foregoing information, a transactional cash flow report can be extracted (see Appendix 4 to this Statement for an example). This deals only with foreign currency receipts and payments, separates the currencies involved and identifies the applicable settlement or maturity dates.

  9. A weekly/monthly/quarterly position can thus be established detailing the expected exposures to be managed, as well as any unmatched surplus or deficit positions which may require to be hedged. Where applicable, cash outflows can be matched and offset against cash inflows. An important input to this exercise will be the extent to which the maturity dates of the cash flows can be varied.

  10. The net of the aforementioned outflows and inflows gives the net transaction exposure for each time period.

  11. However, first consideration must be given to identifying economic exposure whose management will normally fundamentally influence the shape of future transaction and translation exposure. This is a far more sophisticated exercise which calls for detailed short and longer term analyses of optional foreign investment, borrowing and transaction decisions using simulation or modelling techniques, and/or conducting regular sensitivity analyses. Factors that would be considered include the extent to which commitments have already been made, the actions and market positions of major competitors, the flexibility to vary pricing in the market places concerned, and whether acquisitions and operations in foreign countries can be effectively financed in the currency of the country concerned. The examination of the implications of this exposure should be undertaken prior to the commitment and be subjected to regular review thereafter.

  12. To the extent that it is quantifiable, economic exposure can be identified in a similar manner to transaction exposure, by focusing on the cash flows involved. The time horizon will, however, be much less specific for economic exposure and will depend on the particular circumstances of the enterprise and the degree of detail and expertise available. It may help to look at how economic exposure has affected the business in the past as a starting point for assessing how it may do so in the future.

:: RISK ::


  1. Foreign currency risk is the net potential gains or losses which can arise from exchange rate changes to the foreign currency exposures of an enterprise. It is a subjective concept and concerns anticipated or forecasted rate fluctuations together with the assessment of the vulnerability of an enterprise to such fluctuations. The element of uncertainty gives rise to the risk and creates an opportunity for profitable action.

  2. Currency risk may be usefully classified as recurring or nonrecurring. Recurring risks may arise from the financial structure of the enterprise and are directly attributable to the exchange rate movements arising from an enterprise's currency composition. Or they may result from the enterprise's specific line of business and hence are related to an enterprise's operating activities. Nonrecurring risks result from one-off transactions and relate to transaction exposure.

  3. The solutions to currency risk differ depending on whether the risk is nonrecurring or ongoing. Short-term strategies are more appropriate for nonrecurring risks, whereas ongoing risks should be dealt with using long-term strategies. An analysis of the frequency of the risk determines the appropriate method of managing that risk.

Assessment of Risk

  1. The process of assessing risk is an ongoing, dynamic activity extending from the time an initial forecast is made (when the risk concerns the potential for fluctuations between the contract rate and the market rate) right up to the eventual conclusion (when the risk relates to the settlement of the transaction and the resultant variation from that originally contemplated). The existence of a net transaction or translation exposure or the contemplation of a possible net economic exposure requires the use of suitable and practical techniques to measure and evaluate the risks involved.


  1. The environment for the assessment of exchange rates is a constantly changing one and the available sources of information vary considerably in their reliability and sophistication. Nevertheless, from such governmental and monetary authority statistics as are available, as well as from the worldwide exchange markets themselves, it is necessary to obtain the appropriate external inputs to facilitate the requirement for any internal prediction (see also paragraphs 76-80). Within each enterprise the availability of expertise will vary and this must also be recognized in any risk assessment. In some enterprises, the view adopted may be that future exchange rates cannot be forecasted. If this is the case, forward rates reflect the market's best expectations, and these rates should be used.


  1. It is essential to determine and record each and every assumption used in the measurement and forecasting processes and its source, in order to be quite clear as to the starting point and to be in a position to monitor, investigate, explain and quantify each and every subsequent deviation or variance that occurs.

  2. The regulations, restrictions and constraints imposed by legislation or other regulatory bodies must be identified and their likely impact and evolution has to be anticipated, both as regards the situation:

    • nationally

    • internationally, by currency or country involved

  3. The course and pattern of economic events has a crucial bearing on exchange rate trends and movements. Predictions may be required in the areas of:

    • economic growth

    • interest rates

    • movement in money aggregates and reserves

    • central bank actions

    • governmental actions

    • political perceptions

    • inflations rates

    • taxation rates

    This applies again:

    • nationally

    • internationally, by country involved, as well as globally in certain instances

  4. Risk is dependent on the possible degree of exchange rate fluctuations in the currencies involved. The expectations of such fluctuations in the currency markets themselves are reflected in changes in the premium or discount between the spot and forward exchange rates for any currency. Where the enterprise has a choice as regards the currency in which a transaction may be settled or initiated, these options should also be considered. Then, for each currency, dependent on the materiality of the currency exposure, the enterprise should forecast its expected or likely exchange rate movements:

    • on a month by month basis or as otherwise required for the cash-management cycle for transaction exposures

    • on a semi-annual or annual basis for translation exposures

    • over time periods which are consistent with the particular circumstances of the enterprise for economic exposures

  5. Risk analysis is concerned with the future and with predictions of exchange rates. This, by definition, involves uncertainty and it is crucial to examine many alternative scenarios and possible trade-offs for any assumptions made. It is normally advisable to assess the future on the basis of:

  • optimistic assumptions;

  • pessimistic assumptions; or

  • most likely assumptions;

with probability ratings applied to each basis.

  1. The degree of sophistication used in dealing with the variable factors will depend on the scale of the operations concerned, the significance of the risks involved, the resources available to the enterprise and the cost/benefit thereof.


  1. When attempting to measure risk, the enterprise should first look at the most likely time frame and resulting exposure position. This time frame may be specific or variable:

    • specific, where the period of exposure is capable of precise identification and is not at the discretion of the enterprise

    • variable, where the period of exposure extends over a long period of time or the dates of settlement are, to some extent at least, at the discretion of the enterprise

  2. The timing of cash flows, and, therefore, the different time value of transactions, must always be clearly identified. Moving certain settlement dates could reduce the net exposure.

  3. In its simplest form, the formula for calculating possible foreign exchange gains and losses is stated as: the amount of net foreign currency exposure multiplied by the expected percentage change in the exchange rate.

  4. In measuring risk, the various currencies must be examined separately, and not merely aggregated. However, interrelationships between currencies must be considered in evaluating the overall risk of the enterprise. Where currency blocks have been established in which currencies move in tandem, it may be possible to offset a potential loss in one currency against a potential gain in another.

  5. The measurement of risk should include a determination of the cost (actual or estimated) to close any mismatched positions in the forward market.

  6. Since risks arise from many different sources and most enterprises operate within the constraints of scarce resources, it is necessary to determine the importance of the various risks being faced, to rank them as regards their impact on the enterprise and to identify the tolerance of the enterprise to any range of exchange rate movements.

  7. Total exchange risk can, finally, be expressed in aggregation together with supporting sensitivity analyses and probability ratings.



  1. The approach of an enterprise to the management of foreign currency exposure and risk is ultimately based on the costs and benefits of alternative strategies. Some enterprises may adopt a comprehensive system of risk management, particularly where the extent of exposure is large, or where management has a defensive attitude to risk. On the other hand, the costs of a comprehensive risk management strategy may outweigh the benefits where the extent of exposure is small, or where management chooses to adopt a speculative approach to exchange rate movements.

  2. Whatever approach is adopted, it is absolutely necessary that the basic philosophy, policies, objectives and organization structure of the enterprise concerning the management of foreign currency exposure and risk are set at the highest level, formally recorded and communicated, as well as regularly reviewed and modified.

Corporate Philosophy and Policy

  1. The fundamental questions to be considered include:

    • What is the relationship between the policies and the philosophy of the enterprise generally and those specific to currency exposure?

    • Is the enterprise able and willing to forecast exchange rates?

    • How extensive is the enterprise's exchange risk?

    • What is an acceptable level of foreign exchange risk?

    • What is the enterprise's capacity to absorb foreign exchange losses?

    • Is exposure to an exchange risk to be accepted without further management?

    • Are exchange losses to be minimized, or are exchange gains to be maximized or a combination of both?

    • Is the extent of any foreign exchange risk to be set or fixed at the outset of a transaction or left partly or wholly open for subsequent management?

    • What are major competitors doing regarding the impact of currency fluctuations on their prices and costs and what opportunities or threats do these actions pose?

    • Are the short-term effects crucial, or is it the longer-term position that is important, or are both to be given due consideration?

    • Is a flexible stance to be adopted, changing as circumstances demand or are there certain "non negotiables"?

    • Is currency dealing to be actively engaged in, or is management merely to be reactive to existing exposures?

    • Is there any latitude to move off full cover to partial cover and how much open risk can be accepted?

    • Are speculative currency transactions permitted and within what limits?

    • What degree of responsibility and authority is to be delegated through the organization structure?

    • Does this require an ongoing structured (proactive) or an ad hoc (reactive) but formalized approach?

    • How comprehensive is the market information system?

    • Are there any particular taxation implications?

Management Objectives

  1. Management of foreign currency exposure and risk must always distinguish between realized and unrealized currency gains and losses and be concerned with the response required to achieve the enterprise's overall policy objectives as it concerns the following aspects:

    • the maintenance of the reporting enterprise's book value of global investments in terms of accounting communication in the reporting currency. This is synonymous with managing translation exposure.

    • the maintenance of exchange values on contractual receipts and payments which are denominated in foreign currencies. This is synonymous with managing transaction exposure.

    • the maintenance of future foreign currency cash flows in terms of the reporting currency. This is synonymous with managing economic exposure.

  2. In determining management's response, the following need to be addressed:

    • The exposure management process should be proactive and should, as far as practicable, commence before the exposure is generated.

    • The resources to be committed and the money which can be spent to protect a new exposure position should be explicitly agreed.

    • A defensive approach should be adopted if the risk is to be minimized or eliminated.

    • An active or aggressive approach should be adopted if the exposure is seen as an opportunity for gain.

    • Appropriate risk/buffer ratios should be set and regularly reviewed.

    • Performance measurements should be agreed at the outset.

    • Disciplines, limits and constraints should be clearly defined (these require to be addressed in total terms as well as in detail by transaction, currency, dealer, etc.).

    • Internal control procedures should be established to ensure adherence to the agreed policies and to minimize the dangers of fraud and unauthorized dealing or position taking.

    • Regular feedback should take place between the exposure managers and, where different, the line operating managers in order to facilitate better decision making at the outset of a transaction or investment.

Organization and Responsibility

  1. No single organization structure and exposure management system is appropriate to all enterprises because of their differing operating styles, management philosophies, skills, business environments, sizes and available expertise and resource. There are, however, four criteria which must be present in an effective exchange management organization structure:

    • an accurate and timely flow of information;

    • a centrally coordinated information system for all inputs, directives, actions and evaluations;

    • full interaction between all departments and individuals participating in the management of currency exposure in the enterprise; and

    • clearly defined functions, duties and levels of delegated authority and responsibility.

  2. Consideration must also be given to the alternatives of:

    • a centralized management approach; and

    • a decentralized management approach.

  3. Since exchange exposure can result from one or a combination of financing, marketing or production decisions, there is a great potential for conflict and information flow constraints. As a result, the questions of responsibility, consultation and control assume added importance.

  4. In order to minimize conflict, it is necessary to take an overall or global viewpoint and to ensure that there is close coordination between central or corporate finance management and line management or the operating side of the business. There is always potential for conflict between the management of the reporting enterprise and the management of its foreign operations, which should be avoided through speedy and comprehensive communications.

  5. Appendix 2 to this Statement gives an example of a possible organizational flow chart to support an active exposure management program. It should be emphasized that this is an illustration and should be varied in order to meet the needs of a particular enterprise. Depending on the size of the enterprise and its cost constraints, certain functions may require to be allocated to external professionals.

  6. The size of the activity will likely influence the extent to which decision making can be delegated. The key components of the illustration are as follows:

  7. Board of directors:

    • determines its fundamental philosophy towards foreign exchange risks;

    • details the objectives for and constraints applicable to the risk management program;

    • defines where the organizational responsibility for the program will be;

    • ensures that the program is reviewed or confirmed at least annually;

    • makes provisions on permissible or non-permissible tactics and techniques;

    • approves the overall reporting framework; and

    • reviews appropriate reports as to risk and its management.

  8. Corporate currency committee:

    • consists of selected members of the corporate finance department (and the treasury if there is one), such as the chief financial officer (chairman), the treasurer and exposure manager, the senior management accountant, a senior manager responsible for strategy/corporate planning, together with line operating executives in the fields of purchasing (importing) and selling/marketing (exporting) as appropriate.

    Many corporations do not have a dedicated treasury, so the existence of one should not be assumed. The senior management accountant should be on the committee as currency issues are vital to costing, pricing, budgeting, investment appraisal, etc. The subject is also of major strategic concern, so a senior manager or strategist should be on the committee.

    • considers all the available input in order to indicate the broad strategy to be adopted in managing exposure; and

    • may, in some organizations, have a remit which includes operational matters such as agreeing procedures, issuing guidance and periodically reviewing the currency management activity.

  9. Corporate finance (treasury) and/or accounting departments (as appropriate):

    • establish proper channels of communication between all involved persons, and/or departments, in order to ensure that the corporate currency committee receives the correct information on which to base its decisions and that such decisions are communicated to the correct individuals for implementation;

    • develop such external relationships as will improve access to pertinent information and facilitate the implementation of any action required;

    • define the accounting policies to be used in recording and reporting the results of foreign currency transactions, within the constraints of applicable legislation and accounting standards;

    • formulate and maintain the necessary information systems and the supporting analytical and operating control procedures;

    • ensure it is equipped with appropriate processing hardware and software to support the information needs;

    • collect and analyze data for submission to the corporate currency committee and provide appropriate reports to the exposure manager;

    • act on the advice and directives of the corporate currency committee;

    • issue the detailed day to day tactics and techniques to the exposure manager;

    • provide guidelines which ensure vigorous separation of speculative from nonspeculative action and which cater for divergent risk profiles;

    • set levels of authority and responsibility for dealing in currencies; and

    • define and set stoploss limits and risk/buffer ratios.

  10. Exposure manager:

    • carries out the day to day transactions in accordance with the instructions and authorizations received from the corporate finance, treasury and/or accounting department (as appropriate);

    • obtains frequent and regular market information from external banking sources; and

    • provides corporate transactional information to the information system.

Tactics and Techniques


  1. A program of active exposure management needs to have access to a considerable amount of data which requires analysis and assessment leading to recommendations for direction and action. Formal forecasts should, therefore, be prepared at least semi-annually and reviewed at least monthly, having due regard to the volatility of currency markets. Predictions are to be made not only of future rates, but also their likely movement, volatility and trends.

  2. There are five main sources of input which assist in the forecasting process:

    • the highly efficient currency markets themselves and the forward rates prevailing in these markets;

    • ongoing daily contact with foreign currency dealers;

    • economic and financial information from public or proprietary sources;

    • external currency forecasting specialists, notably the international divisions of major banking groups; and

    • journals and newsletters which concentrate on analyzing currency movements and predicting trends.

  3. Depending on the resources available, some or all of these sources should be used. They, in turn, would rely on one or all of the following forecasting techniques, each having a role to play in arriving at a recommendation:

    • time-series and other statistical or econometric analyses;

    • opinion gathering and judgment; and

    • alternative scenario and sensitivity analysis.

  4. Without any forecasting activity, the scope of the exposure management function becomes unduly curtailed to little more than the use of simple hedging techniques or the implementation of a straightforward formal cover or uncover policy.

  5. The purpose of any forecasting activity is to identify the possible/probable exchange rate fluctuation and at the same time to determine:

    • What is acceptable as a range of variation in exposure?

    • What risk exceeds the tolerance capacity or buffer limits of the enterprise?

but, at all times, there must be the realistic acceptance that forecasts do not provide certainty, but, at best, a reasoned prospect.

Management Techniques

  1. Where relevant, the various techniques for managing currency exposure (which are only briefly identified in the following paragraphs) are used, subject to the approval of any exchange control authority, and subject to the availability of the particular technique in the market place. The extent to which the techniques can be employed is also dependent on their commercial practicality in particular situations, as well as on the enterprise's size and negotiating strength. Only brief definitions are given of the general and specific techniques more commonly in use, without attempting, in the space limitation of this Statement, to discuss them in any detail or their respective merits. They are included merely as useful examples.

  2. Where many companies operate within an overall group of companies, whether they be subsidiaries or associates, the opportunities to apply balancing techniques between companies should always be explored at group level.

  3. Netting - This process offsets intra-group transactions (between parent and subsidiary, or subsidiary and fellow subsidiary) in order to reduce transfer values and only reflect and account for the net balance.

  4. Typically, a group of companies would modify settlement dates to select a single date for settling the net amount. Each subsidiary still retains the same currency risk, but a netting system, which offsets and manages exposures centrally, enables cover to be limited to net currency positions.

  5. Substitution - Changing the source of raw materials, finished products, and/or markets operated in, as a reaction to, or in anticipation of, changes in currency relationships.

  6. Matching - The action within an enterprise whereby receipts and payments or loans and investments in the same or correlated currencies are specifically matched so that only the net exposure difference on each transaction date or reporting date needs to be addressed.

  7. Leading and lagging - A mechanism whereby a company accelerates (leads) or delays (lags) payments or receipts in anticipation of exchange rate movements. This requires an appraisal of both the exchange rates and the interest rates of both countries, since the interest earned on a local currency investment may compensate for any depreciation in that currency.

  8. Pricing policy - This technique requires a choice to be made in advance of the currency in which the transaction is to be designated and subsequently settled, or regularly adapting and amending prices to take account of altered exchange rates or even incorporating price adjustment/escalation clauses into the terms of the contract, whereby the currency risk is transferred away. It assumes the cooperation of the outside party (supplier or customer). For example, if customers agree, an enterprise can effect all its foreign invoicing in its local currency and thereby reduce its exposed receivables.

  9. Asset/liability management - The process whereby equal and opposite deposits or borrowings are created in a particular currency to match payments or receipts, or liabilities and assets or, alternatively, where foreign and domestic banks accounts are denominated in appropriate currencies through which settlements can be effected. This technique may be used in the Euro currency markets or in the local market where the exposure exists. An appraisal of the exchange rates and interest rates of both countries is necessary.

  10. Hedging - This is the general term used for the process of protecting the accountable value of foreign currency monetary assets and liabilities by anticipating future exchange rate movements. Exposure to unrealized foreign exchange (translation) losses can be reduced to nil, or to a defined or budgeted amount, by entering into forward exchange contracts or using other hedging instruments, taking due consideration of the cost/benefit relationships. It can be also achieved by "natural" hedging, for instance, whereby foreign assets are financed by foreign borrowings, both in the same currency.

  11. Forward exchange contracts - The "classic" exposure management technique is the purchase or sale (i.e. covering) of a company's future currency commitments in the forward markets which exist in all major industrial countries. This technique is normally used for the protection of transaction exposure with a time frame of up to twelve months. It is, however, possible in some currencies to obtain longer periods of cover or to roll over cover arrangements. By using a forward exchange contract, the counterparties agree to exchange two currencies at a rate which is fixed at the time the contract is made (the forward rate), on a specified value date which is more than two business days in the future.

  12. The forward rate is either higher (premium) or lower (discount) than the spot rate and the price (premium or discount) may be influenced by a number of factors, including:

    • forecast inflation differentials;

    • interest rates in the relevant countries;

    • expectations of spot rate movements; and

    • supply and demand.

  13. In practice, however, the forward rate is determined principally by computing the interest rate differentials between the relevant currencies.

  14. Forward/forward or forward swap - Often the precise date for the settlement of a transaction is not known. The original forward contract, in such cases where it does not coincide with the final transaction date, needs therefore to be extended (or in some cases brought back) to the now known settlement date. This is done by the simultaneous purchase and sale of a currency for different maturity dates, effectively cancelling the original contract and reinstating it to the new forward date.

  15. A forward/forward is a swap whereby the foreign currency is bought (or sold) for one future date (say one month later) and sold (or bought) back for another future date (say three months later).

  16. A forward swap (or spot against forward spot) is where a currency is bought (or sold) for the spot value date and simultaneously sold (or bought) back for a future value date. It is sometimes referred to as a currency swap.

  17. Rolling cover - Where there exists a continuous stream of a large number of relatively low value transactions, it is more cost effective to take out one single large forward contract. This contract is renewed or "rolled forward" on maturity and the individual transactions can be accumulated on a currency advance account rather than settled on a spot basis.

  18. Currency option - This allows the buyer the right, but not the obligation to purchase (or sell) currency at an agreed price on the expiry date (European) or within a specified option period (American). For this right, the buyer pays the seller a non-refundable premium. Normally options and futures, singly or in combination, are used as a stoploss mechanism or can be traded in and out, up to the date they expire.

  19. Currency futures contract - Such a contract gives rise to an obligation to purchase (or sell) a standard amount of a currency at a specified price on a future standard date through an organized exchange. The buyer or seller of a futures contract is required to lodge an initial deposit (margin) with the clearing house of the exchange and this must be left in place for as long as the position is held. In addition, variation margin is received from, or paid to, the clearing house as the position held generates profits or losses through movements in market prices. Futures contracts are tradeable up to expiry date and may be used in place of forward exchange contracts.

100.  Cross-currency swaps - The technique whereby two parties with either existing or anticipated liabilities (or assets) in different currencies agree, usually via an intermediary, to exchange (swap) their liabilities (assets) so that the first party would be servicing (receiving the cash flows from) the liability (asset) of the other party and vice versa. Cross-currency swaps may take various forms, but the conventional structures include fixed-to-fixed, floating-to-fixed and floating-to-floating interest rate swaps. By executing a cross-currency swap, a borrower may thereby alter or eliminate the exchange risk for the remaining life of the liability (asset).

101.  Risk transfer (Risk guarantee) arrangement - To encourage exports, government agencies offer insurance in the form of accepting the currency risk inherent in receivables denominated in foreign currencies. Typically, the exporter will, for a small premium, transfer the risk of all subsequent movements in the exchange rate relative to the specific transaction.

102.  Barter trade - Cross-border barter transactions can be a direct response to exchange rate uncertainties in that they eliminate any form of exposure by virtue of matching, in advance, corresponding financial assets/liabilities created by the underlying movement of goods or services between two countries and arranging for them to be settled by the originators of the transactions in their country of origin.

103.  General - The foregoing techniques are among the most widely used but consideration should also be given to other techniques including any of the new sophisticated variations constantly being developed. It is important to consider the impact of using these techniques singly or in combination. The techniques used must relate to the nature of the combined exposures the enterprise faces. The overall question to ask is, "Do the techniques employed adequately and appropriately address the exposures faced by the enterprise?"


Accounting Standards and Practices

104.  The accounting treatment of foreign currency transactions and operations and the resulting exchange differences have been dealt with in International Accounting Standard 21 issued by the International Accounting Standards Committee.

105.  This standard sets forth proper methods of accounting for transactions in foreign currencies in the financial statements of an enterprise and for the translation of the financial statements of foreign operations into a single reporting currency for the purpose of including them in the consolidated financial statements of the reporting enterprise. Accordingly, it warrants close study and consideration.

106.   Considerable progress has been made in harmonizing the different provisions in the various national accounting standards in International Accounting Standards (see IAS 21 and the forthcoming IAS 32 on financial instruments). However, as regards the accounting treatment of foreign currency transactions and operations and the resulting exchange differences, some significant points of difference still remain:

    • whether the income statement should be converted at the closing rate or the average rate;

    • what treatment is appropriate for translating currencies in highly inflationary economies;

    • the treatment of equity investments especially when financed by borrowings;

    • in what circumstances the temporal method or the current rate method of translation is appropriate;

    • the treatment of foreign exchange reserves on the disposal of an investment which has already given rise to such reserves;

    • the treatment of forward exchange contracts;

    • the treatment of exchange differences arising from the effect of currency fluctuations on long-term loans;

    • the treatment of deferred taxation balances;

    • the merits of dealing with highly uncertain and unstable country situations on a cash received basis only and without recognizing any ongoing value;

    • the treatment of speculative transactions;

    • the treatment of hedge instruments; and

    • the treatment of gains and losses on hedge transactions, general or specific.

107.  Consequently, a diversity of practices still exists around the world. It is, in fact, not possible to generalize about the prevailing practices in the various countries. It is, therefore, imperative for the purposes of reporting on foreign currency transactions, translations and gains and losses, that the applicable standards or practices are clearly and explicitly identified and the relevant accounting policies noted in the annual financial statements. It would be appropriate to comply with the International Accounting Standards as well as with the applicable national standards, except where national and international standards require materially different measures.

Taxation Considerations

108.  Gains or losses on foreign currency transactions receive widely different tax treatment from one country to another. This diversity in itself presents opportunities for an enterprise to optimize the after-tax cost of its multinational dealings. It is possible, therefore, to institute parallel tax strategies which would operate alongside the foreign currency management activity. Benefit can then be obtained in a planned and proper manner from the lack of symmetry in the tax laws of various countries.

109.    The essential questions to be addressed when dealing with taxation authorities are generally:

  • the need to disclose material effects;

  • the source of the gain or loss, either actual or deemed;

  • whether the translation giving rise to the gain or loss is of a capital or revenue nature;

  • the inclusion of the gain or loss as forming part of the underlying transaction or the separation of the gain or loss for special treatment; and

  • the extent to which the gain or loss is considered realized.

110.   It must be remembered, however, that the rates of taxation vary between countries and, sometimes, between categories of taxation within a particular country. Also, the pace of change in the various tax regulations adds further complication and risk.

Foreign Exchange Controls

111.  Ultimately, the value of a currency depends on its supply and demand equation. A free market will always find an equilibrium value which balances out the forces of supply and demand. However, dramatic fluctuations in this value can be regarded as particularly harmful to national interests. Governments, often unwillingly, are forced to intervene, in one form or another, in attempts to alter the free market value and to influence the exchange rate of their currency.

112.  It is comparatively rare to find simple and concise exchange control regulations outside of the major developed Western nations and, accordingly, an enterprise has to be equipped with expert knowledge of the complexities of the rules applied in the countries with which it is involved, as well as to be sure that it receives speedy communication regarding any changes.

113.  Again, within these complexities, foreign currency management can seek to obtain advantage by directing transactions into currencies or countries where the exchange control regulations are more favourable.


114.  As referred to in the Preface, this Statement of recommended practice is intended to provide a basic framework to senior management. The specific practices are, however, continuously evolving and, accordingly, further reading and interface with experts in the field of foreign exchange dealings are absolutely essential.

115.  In the final analysis, foreign currency risk management seeks to identify and manage risk, not create risk. This can only be tackled with commitment from the chief executive of an enterprise downwards and with appropriate professionalism.

Appendix 1

Translation Accounting Conventions

The principal alternative methods of translating foreign currency financial statements to domestic financial statements are briefly explained below. Each of these methods will produce a different reported amount of gain or loss.

The Current, Closing Rate or Net Investment Method

The Current Rate Method translates all assets, liabilities, revenues and expenses at the current rate of exchange. Under this method, a devaluation of the foreign currency results in a translation loss; a revaluation results in a translation gain. The occurrence of the translation gain (or loss) is recognized in the period in which the exchange rate changes, usually through reserves.

The rationale for this method is the maintenance of the operating relationships and income statement ratios intact throughout the translation process. However, this method often leads to substantial variations in valuations that may reverse over time. The methods which follow are, therefore, derivatives which seek to address the substantial variations regarded by many people as inconsistent with the going concern concept.

The Temporal Method

Using this method, fixed assets, long-term investments, inventories and short-term investments valued at cost, are translated at the historical rates prevailing when the assets were acquired. All monetary assets and liabilities are translated at foreign exchange rates ruling at the current reporting date. Revenues and expenses are translated at rates ruling at the time of their occurrence.

The rationale for this method is that the translation is treated simply as a measurement conversion process and that, as opposed to transactional items, this process should not change the characteristics of the items being measured. The amount of an item is determined at a given point in time by the foreign exchange rate for the currencies at that time. If the historical rate is used, the temporal characteristics of the item being measured can be retained.

This method is regarded as flawed by some in that it fails to address fluctuations arising from long-term liabilities which may be linked to long-term assets. The translation at current rates of inventories and short-term investments valued at net realizable value is inconsistent with the monetary characteristics of the assets. However, this method is considered suitable for self-sustaining foreign operations.

The Current/Non-current Method

This method translates the current assets and current liabilities of the foreign operation at the current exchange rate. The non-current assets and non-current liabilities of the foreign operation are translated at the foreign exchange rates that were in effect when the assets and liabilities were acquired or incurred in the foreign operation's records. Revenue and expense items relating to current assets and liabilities are translated using the average exchange rate computed for the time period being reported. Other items (for example, depreciation) are translated at the rate that corresponds to the particular non-current asset or liability on the balance sheet. If the foreign operation is in a positive net working capital position, the parent will incur a translation gain from a foreign currency revaluation and a loss from a devaluation. Contrary effects occur if the foreign operation is in a negative working capital position.

The rationale for this method is to recognize the time frame of assets and liabilities rather than their monetary characteristics. However, this method can lead to problems when long-term assets and/or liabilities are liquidated or settled.

The Monetary/Non-Monetary Method

Monetary assets and liabilities are translated at the current rate, while non-monetary assets and liabilities are translated at the rate ruling at the time they were acquired or incurred. There are two variants of these procedures.

In the first method, for inventories that are valued at cost, the historical rate is used, and for other current items carried at net realizable value, the current rate is used. The rationale for this approach is to focus on the monetary/non-monetary characteristics of the assets and differs from the temporal method only in that inventory is always converted at the historical rate, while investments are always converted at the current rate.

The second variant translates all assets and liabilities using the monetary/non-monetary approach, except long-term debt, which is translated at the historical exchange rate. Revenue and expense items relating to non-monetary assets or liabilities are translated at the same rates as the corresponding balance sheet items. A positive net monetary position results in a gain in a revaluation and a loss in a devaluation. The opposite occurs with a negative net monetary position. The rationale for this approach is to recognize the linkage that can exist between long-term assets and long-term liabilities. It seeks to eliminate distortions arising in such circumstances by using varying exchange rates for such items.

The Combination Method

This method simply translates all revenue and expense items at the average exchange rate computed for the time period being reported and all balance sheet items at the closing rate ruling at the end of that time period.

Neither the time frame differences of assets or liabilities nor their different monetary characteristics are recognized under this method. Nevertheless, wide support exists for the "broad bush" effect of this method and for its very simplicity.

Appendix 2

Example of an Organizational Flowchart Which Would support an Active Expose Management Program

Appendix 3

Example of a Translation Exposure Report

Appendices 3A and 3B are formats for estimating income statement and balance sheet translation exposure respectively. A separate statement would need to be produced for each foreign subsidiary and a consolidated statement for foreign subsidiaries as a whole. Totals for Income Statement and Balance Sheet items are entered in the first column in local currency. The figures in the first column are multiplied by the budgeted conversion rate entered in column two and the resulting sum, the budgeted parent currency amount, is entered in column three. The forecast end of period or average rates are entered in column four. These are then multiplied by the local currency amount in column one to produce a forecast parent currency amount. The difference between the budgeted parent currency amounts and the forecast parent currency amount is the variance in total exposure from budget. The net income in the total exposure column is the net exposed position. The net uncovered position is the net exposed position less the amount covered.

Appendix 4

Example of a Transactional
Cash Flow Report

Appendix 4 is for calculating transaction exposure. A separate statement would need to be produced for each foreign subsidiary and also for the parent company and a consolidated statement would have to be produced for the group as a whole. Using the agreed dates for payment of already contracted transactions, foreign currency denominated receipts and payments for transactions already entered into are listed currency by currency in the rows marked receipts and payments. Contracted for payments are then deducted from contracted for receipts for each currency to give contracted for net receipts for each currency. The amount of forward cover for each currency, either foreign currency purchased or sold at current rates is then entered in the forward cover rows. The amount of net forward cover for each currency is calculated by deducting from the forward cover receipts the forward cover payments. The unmatched surplus/deficit for each currency is the net receipts or payments for a currency less the net forward cover for that currency. The total column sums the position for the total number of weeks, months, quarters, etc., analyzed.

Appendix 5

Example of an Economic Exposure
Cash Flow Forecast

Although transaction and translation exposure can be formatted relatively straightforwardly on a single document, economic exposure is best analyzed using a spreadsheet. This can be done by setting out the impact which a range of possible exchange rates are calculated to have on the expected pattern of future cash flows of a business when these are estimated using expected future exchange rates. (Exchange rates relevant to the business are the exchange rates of markets in which the business, its suppliers, its customers and its competitors operate).

The exercise carried out is one which summarizes the cash flow impact on different aspects of the operations of a business which result when different exchange rates scenarios are used. The exercise will need to be repeated for different possible exchange rate scenarios as a series of "what ifs". Since a number of currencies may be relevant and the rate of exchange between different currencies can vary continuously into the future, only a manageable number of likely scenarios can sensibly be analyzed.

The analysis is conducted by listing the changes in cash flow expected as a result of the impact on the different aspects of the business listed, of the exchange rate scenario predicated on the current exchange rate or exchange rate scenario budgeted, if different from the current exchange rate.

Glossary Of Terms

American Option

An option, wherever written, which may be exercised on any business day within the option period.


Arbitrage is that activity which attempts to take advantage of temporary rate discrepancies between different foreign exchange markets. Arbitrageurs buy in the low cost market and sell in the high cost, thereby forcing spot and forward rates in the different markets towards a common price.


An option with an exercise price equal to or near the current spot price.


Maximum permitted range of fluctuation of a given currency against a reference currency according to the existing international agreement.

Bid or Bid Rate

The rate of exchange at which a foreign exchange dealer will buy a currency.

Bilateral Netting

The process whereby two affiliated companies regularly offset their receipts and payments with each other, so that a single net intercompany receipt or payment is made between the two in each period. (This can also be extended to a multilateral process).

Blocked Account

The bank account of a non-resident of a country, where the amount of currency in the account cannot be transferred to another country or currency without special permission.

Broken Date, Odd Date

Interbank dealing is usually for fixed periods of 1, 2, 3, 6 or 12 months as standard periods. Any other value date (such as 4 months 6 days) is a broken or odd date. Broken date quotes interpolate between available fixed date prices.


An intermediary who arranges the buying or selling of currencies between third parties, usually banks. He does not buy or sell currency on his own account.


Commission charged by a broker for his services.

Business Day

Any day on which a foreign exchange contract can be settled, i.e., the banks at both ends of the deal must be open for business that day.

Buyer's Option

The owner of a buyer's option can take delivery on the currency contract at any time between the dates specified in the option.

Buyer's Rate

The rate at which the bank buys the quoted currency.


The spot exchange rate between the U.S. dollar and sterling.

Call Option

Confers on the holder the right to buy a specified currency.

Closing Exchange Rate

The exchange rate prevailing at a financial reporting date.


This is the written document confirming the verbal foreign exchange contract agreed by telephone between dealer and dealer or dealer and client.

Convertible Currency

A currency having a reasonably adequate international market through which it may be readily converted into any other currency.


A principal in a foreign exchange deal.


The equivalent currency obtained. For example, in a foreign exchange deal, if a principal buys DM500,000 against dollars at a rate of say 1.80, the countervalue would be $277,777.78

Covered Interest

This refers to borrowing in one currency, converting the proceeds into another currency in which it is invested and simultaneously selling this other currency forward against the initial currency. Covered interest arbitrage takes advantage of - and in practice quickly eliminates - any temporary discrepancies between the forward rate and the interest rate differential of the two currencies.


Protecting the value of the future proceeds of any international transaction, usually by buying or selling the proceeds in the forward market.

Cross Rate

The rate of exchange between two foreign currencies. For example, when a dealer in New York buys (or sells) Italian lira for French francs, he uses a cross rate.


A single transaction in foreign exchange. A customer calling his bank and effecting forward cover for a series of four payments due under a commercial contract, will do four "deals", one for each date.


Specialist in a bank, financial institution or enterprise who is authorized to effect exchange transactions. The dealer usually attempts to keep his book in balance but may be allowed to take up a position in his own right.

Deposit Margin

A deposit made to the clearing house on establishing a futures or options position. This can either be an initial margin (a fixed amount per contract, deposited when a position is opened) or a variation margin (being the daily calculation of the unrealized profit or loss on the contract).

Depth of Market

Extent to which transactions may easily be placed in the market without causing disturbances to the rate.


European Currency Unit.


Currency held by non-residents and placed on deposit with banks outside the country of the currency; e.g., U.S. dollars owned by a Middle East country and deposited in London.


U.S. dollars deposited outside the United States being held by one who is not a resident of the United States. These are mostly deposited in Western Europe.

European Option

An option, wherever written, which can only be exercised on the expiry date.

Exchange Control

Country regulations restricting or forbidding certain types of foreign currency transactions by nationals.

Exchange Contract

A contract to exchange one foreign currency for a given amount of another on a given date.

Exercise (or Strike)

The agreed price at which a currency can be bought or sold under an option contract.

Exotic Currencies,

Currencies not having a developed and international market, and which are, therefore, infrequently traded.

Fixed Dates

Forward dates for which market prices are readily available (usually in whole months).

Fixed Exchange Rate

The monetary authority of a country agrees to keep the value of its currency within a given percentage of the fixed value of certain other currencies.

Fixed Rate Currency

Currency having a fixed rate of exchange within narrow limits versus another reference currency, usually the dollar, sterling or the French franc.

Floating Exchange Rate

The exchange rate of a currency is allowed to find its own level depending on the supply of and demand for the currency.

Floating Rate Currency

Currency having its exchange rate determined by market forces including central bank intervention, but having no limits to its fluctuation relative to any reference currency.

Foreign Exchange Deal

A contract to exchange one currency for another at an agreed price for settlement on an agreed date.


Foreign exchange.

Forward Book

The net position arising from all forward transactions in a given currency.

Forward Contract

A contract to exchange a given amount of one currency for another at some future date (usually at one, three or six months ahead).

Forward/Forward Deal

Simultaneous purchase and sale of one currency for different forward value dates or simultaneous deposit and loan of one currency for different maturity dates, which effectively provides a deposit to commence on a future date.

Forward/Forward Swap

A pair of forward exchange deals involving forward (or Forward Swap) purchase and a forward sale of a currency, simultaneously entered into, but of different maturities.

Forward Margin

The difference between the forward rate and the spot rate of a currency. The forward margin is either at a discount or a premium to the spot rate.

Forward Market

The future market in foreign exchange.

Forward Premium

The excess of the forward rate over the spot rate.

Full Cover

An exposure is fully covered if the value of the future proceeds of any international transaction is fully protected against exchange rate fluctuations.

Group of Seven (G-7)

An informal group established in 1985, consisting of finance ministers from the United States of America, Japan, Germany, the United Kingdom, France, Italy and Canada. The main intentions of the group are to stabilize exchange rates and interest differentials and to reduce distortions in trade balances by ensuring that policy decisions and actions are coordinated.


Action taken by a company to reduce or eliminate a currency exposure.


The protection of the accounting value of foreign currency assets and liabilities against unrealized foreign exchange (translation) losses.


International Money Market.


An option which has a more favourable rate for the holder of the option than the current spot price.

Indirect Quote

A quotation in which the local currency is the base currency.


Action taken by a central bank to influence the rate of exchange of its currency in the market.


London International Financial Futures Exchange.

Leading and Lagging

The adjustment of credit terms, "leading" meaning a prepayment of an obligation and "lagging" a delayed payment. The converse applies to receipts.


London Interbank Offered Rate. The rate at which principal London banks offer to lend currency (especially dollars) to one another at a given instant. Often used as a base rate for fixing interest rate on bank loans: i.e., "Interest to be fixed at 1 1/4% per annum over LIBOR".

"Long" Exposure

A net asset, net revenue and/or net cash inflow position in a currency. If the currency appreciates, a foreign exchange gain is generated. If it depreciates, a loss is incurred. The opposite is true of a "short" position.


Formal authority from a customer to its banker specifying what shall constitute proper instruction for the bank to act on the customer's behalf.

Matching (or "Natural"

A process whereby an enterprise matches its long positions in a given currency (assets, revenues or cash inflow) with its offsetting short positions in that currency (liabilities, expenses or cash outflows). The remaining unmatched position is the net exposure in the currency.

Maturity (or
Settlement) Date

The date on which a foreign exchange contract is due to be settled.

Middle Price

An average of the buying and the selling price for a given currency.


Practice of dealing only for net amounts in a currency where an enterprise has a two way cash flow. For example, if an enterprise has an inflow of $5 million and an outflow of $2 million in a given period, the enterprise could "net" and deal only for $3 million.

Odd Date

Most contracts on the forward market are settled one, three or six months ahead. Dates outside these standard periods are called "odd" dates.

Offer Rate

The rate of exchange at which a foreign exchange dealer will sell a currency.

Open (or Net Position)

The difference between the long and short positions in a given currency.

Optional Date Forward
Contract (or Forward
Option Contract)

A forward exchange contract where the rate is fixed but the maturity is left for the enterprise to decide subsequently, within a specified range of dates.


An option which has a less favourable rate for the holder of the option than the current spot price.

"Parallel" Matching

A long (or short) position in one currency is matched against a short (or long) position in a different currency, since movements in the two currencies are expected to run closely parallel.

Parent Country

The country in which the parent enterprise is located.

Parent (or Home)

The currency of the parent enterprise.


The official rate of exchange between two currencies.

Partial Cover

An exposure is partially covered if the value of future proceeds of any international transaction is only partially protected against exchange rate fluctuations, leaving some degree of the exposure still uncovered.


Usually the most junior digit in a currency quotation: e.g., (£)1 = $2.10364. The fifth place after the decimal point is "4 pips".


The second most junior digit in currency quotations (e.g., (£)1 = $2.10364, when the fourth place after the decimal point is "6 points").


Difference between spot price and the price for forward settlement. Forward price equals the spot price less the premium.

Put Option

Confers on the holder the right to sell a specified currency.


The extension of a maturing forward contract or the extension of a maturing loan: i.e., a new interest determination date. Medium term Euro-currency loans are often arranged "for a period of five years with a rollover every six months".

Selling Rate

The rate at which the bank sells the quoted currency.


Payment of funds on the maturity of a foreign exchange contract.

"Short" Position

An oversold position where the liabilities in the currency exceed the assets in that same currency.

"Spot Forward" Swaps

The simultaneous spot purchase or sale of a currency and an offsetting sale or purchase of the same currency in the forward market.

Spot Deal

A deal for currency for delivery two business days from today.

Spot Market

The currency market for "immediate" delivery. Delivery is usually two working days after transaction date, though in some markets spot transactions may be executed for next day value.

Spot Next

A deal from the spot date until the next day, either as a deposit or a swap.

Spot Rate

The current rate of exchange quoted between two currencies. The spot rate is usually quoted as a bid rate and an offer rate.

Spot Transaction

A purchase or sale of foreign currency for "immediate" delivery.


The difference between the buying and selling rate for a currency.

Stoploss Mechanism

A mechanism whereby orders are placed in the market to purchase or sell a particular amount of a currency if a specified price level is reached, which may be either above or below the price that prevailed when the order was given. This provides protection against the degree of adverse fluctuation that may occur in a currency.

Swap Deal

A simultaneous spot sale and a forward purchase, or a simultaneous spot purchase and a forward sale.

Thin Market

A low turnover market, where an attempt to do a substantial transaction will result in a definite movement in the market rate. Spreads are wide in a thin market as dealers are apprehensive as to the rate at which they will be able to lay off any deal done.

Tom Next

Short for "from tomorrow to the next day". A deal from the next business day until the one after, either as a deposit or a swap. Note that on Friday "tom next" is from Monday to Tuesday.

Transaction Date

In the foreign exchange market, the date on which a foreign exchange contract is agreed.

Value Date (or For Value)

The date agreed for settlement of an exchange transaction.


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Last edited : Wednesday, 06 May 2009 02:59 AM
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