Printer FriendlyAmerican Option - An option which can be exercised on any business day within the option period.
Arbitrage - Traffic in bills of exchange or stocks to take
advantage of different prices in other markets. Transfer of deposits across
foreign exchanges to take advantage of temporary favourable interest rates.
At the Money - An option in which the exercise (or 'strike') price is
equal to the market price of the underlying asset (e.g. the current spot rate).
A currency option is
described as 'at the money forward' when the exercise price is equal to the
forward rate for its maturity date and 'at the money Spot' when the current
Spot Rate is equal to the exercise price.
European options can
only be exercised on their expiry date and so are often sold 'at the money
forward' whilst American options can be exercised any time and so are sold 'at
the money Spot'.
Basis - Cash price minus futures price.
Basis Point - The smallest increment of price measurement.
Breakeven - The exchange rate at which the buyer/seller of the
option is exactly as well off as if he had not bought or sold the option.
Call Option - The holder has the right to
buy (call) a particular currency and sell another.
'Cash' Market - The market in the 'actual' financial instrument on which
a futures or options contract is based.
Close-out - This relates to forward FX contracts in circumstances
when payment in currency will not be received or, in the case of imports, not
needed. The binding forward FX contract
must be honoured by delivering the contracted currency in order to complete
(close-out) the FX contract.
Convertible Currency - A currency that is openly traded at the Spot Rate in the
international foreign exchange markets, and is quoted on the Forward Market
such as US Dollar, Euro, Japanese Yen.
Cross Rate - The rate of exchange rate between two currencies calculated via a third currency. For example, to find the cross rate for Mexican Pesos for first calculate the rate for Mexican Peso/US$ and then US$/
Deliverable - The physical settlement of notional amounts in an FX contract
Non-deliverable - Contracts which are valued and net settled in
hard currency
Devaluation - This occurs when the Central Bank
decides to reduce the external value of the currency. This could happen when
there is persistent selling of its currency that is in excessive supply. The
value of the currency is decreased in relation to others. The immediate impact
is that exports become cheaper and imports more expensive. In the medium term
the effects are inflationary.
Derivatives - Derivative securities are
those whose value and performance are derived from other securities such as
forwards, futures and options.
Discount - The difference in the
borrowing and deposit interest rates of the two currencies over the term of the
forward contract. It is the amount added to the Spot rate.
Economic Exposure - The risk that cashflow forecasts would vary
due to the economic condition of the overseas country in which the cashflow
originates. Profits, dividends and interest payments generated overseas would
reduce in value in
European Option - An option which can only be exercised on the expiry
date.
Exchange Rate - Price of one currency in terms of another. It is the number of units of one currency that will be exchanged for a given number of units of another currency.
Exchange Traded Option - An option quoted on a recognised
exchange, which may be traded prior to exercise date.
Exercise Price or Rate - Fixed price or rate at which the
currency can be bought or sold under an option contract. In currency options the Exercise Price (or rate) is the same as ‘Strike
Price’. It is the rate at which an option buyer has the right to call or put a
currency. It is the pre-determined exchange rate at which a purchaser can
exchange two currencies at a certain future date (Expiry Date).
Expiry Date - Last business day on which
the option can be exercised. In currency Options this is the future date at
which a purchaser can exchange two currencies at a pre-determined Strike Price.
An 'American style' option can be exercised at any time up to the Expiry Date.
A 'European style' option must be exercised on the specified maturity (Expiry)
date.
Fixed Rate - Spot Currency Rate that is fixed
by Central Bank regulation. It can only be traded at one buying and one selling
rate of exchange. It cannot vary despite supply and demand pressures for that
currency. If the underlying economy does not support the fixed rate, eventually
speculative pressure will force either devaluation or a revaluation.
Floating Exchange Rates - Spot Currency Rate that
varies according to world trade distortions (reflected by supply and demand for
that currency) and not subject to exchange control.
Forward Contract - A contract to exchange a specified amount of one
currency for an amount of another currency determined by the Forward rate on an
agreed future Value Date.
Forward Discount - Negative difference between Forward and Spot
Rate.
Forward Market - Where you buy or sell
currencies for delivery at a future date.
Forward Premium - Positive difference between
Forward and Spot Rate.
Forward Rate - The rate at which a contract
may be made to exchange one currency for another at a specified future date. It
is calculated by adjusting up or down the prevailing Spot Rate by the interest
rate differential of the two currencies over the period of the forward
contract. It is not a view of the likely exchange rate movement over that
period. Interest rate differentials tend always to equal forward discounts or
premiums for the same period.
Forwards - Binding financial deals
agreed now but not carried out until some agreed future date.
Futures - Standardised forward
agreements which can be traded in their own right.
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Hard Currency - A currency from a country
whose political stability engenders worldwide confidence. It is associated with
countries with stable or strong economies and relatively low inflation. It is
regularly traded and in constant demand for trade and investment. It is a
currency that an investor would hold or move between during times of world
economic weakness as it is inclined to maintain its value or strengthen.
Holder - Party which has the option to
buy (or sell) the currency.
In-the-money - An option is regarded as 'in the money' if it has
Intrinsic Value (i.e. the Strike Price is better than the market rate - Spot or
Forward - according to the type of option). A Call option is 'in-the-money' if
the asset price is above the Exercise Price and a Put is 'in-the-money' if the
asset price is below is below the Exercise Price.
Intrinsic Value - That part of the premium representing the value of
the option were it to be exercised immediately (i.e. the amount by which it is
in-the-money).
Leading & Lagging - Accelerating or delaying cross-border payments depending on whether the currency is expected to strengthen or weaken.
Long Position - An excess of purchases over sales in a currency or
commodity.
Margin - Same as Spread. Difference
between Spot buying and selling price.
Margin - The interest rate
differential between two currencies for borrowing and depositing currency for
the required forward period.
Margin - A deposit made to a clearing
house on establishing a futures or short option position.
Mark to Market - The revaluation of foreign exchange contracts and options at their current market value in order to reflect gains and losses resulting from market price movements.
Netting & Pooling - Cash pooling and netting is
the practice of consolidating positive and negative cash balances in order to
offset (net out) balances for interest, risk and currency exposure.
Non-Convertible Currency - A currency that is not openly
traded at the Spot Rate in the international foreign
exchange markets, and where the Forward Market is non-existent , such as the
Congolese Franc or Kazakhstan Tenge.
Off-Shore/On-Shore - Used to differentiate between
financial counterparties/markets in an emerging country 'on-shore' (and subject
to local laws) and those in the international financial markets of London, New York, Tokyo etc-'off Shore'.
Open Interest - The number of outstanding 'longs' and 'shorts' for a
given Option or Futures contract.
Option - A currency option gives the purchaser the right, but
not the obligation, to exchange two currencies at a pre-determined exchange
rate (Strike Rate) at a certain future date (expiry date) for payment of a
premium.
Out-of-money - An Option that has no intrinsic value (i.e. a rate
worse, for the holder, than the current Spot Rate). A Call Option is
'out-of-the-money' if the Exercise Price is higher than the asset price; a Put
is 'out-of-the-money' if the Exercise Price is lower than the asset price.
Over-the-Counter (OTC) Option - An option, granted usually by a bank, (which, while not
tradeable in the same way as exchange-traded options, can usually be traded
back to the selling institution) but where the Exercise Date, Expiry Date,
Strike Price and amount may be tailored to suit the purchaser.
Overvalued Currency - Currency whose rate of
exchange is persistently below the parity rate. Where the high value of the
currency cannot be supported by the underlying economic conditions. Rate may be
inflated due to speculative demand. Results in cheap imports and expensive
exports. In the short term it reduces domestic inflationary pressures.
Par - Where there is no difference
between the borrowing and deposit interest rates of the two currencies over the
term of the forward contract. The
Forward rates are at Par with the Spot Rate. It is the same rate of exchange.
Pegged Rate - Where a country's FX rate is
'locked-in' to the currency of another country. The Argentine Peso was locked
into the $ until February 2002 at a rate
of Ps1/$US1. Sometimes the pegged rate is flexible, such as during the 's attempted participation in
the European Community's Exchange Rate Mechanism (ERM) when sterling was allowed to flutuate +2.5%
Pooling & Netting - Cash pooling and netting is
the practice of consolidating positive and negative cash balances in order to
offset (net out) balances for interest, risk and currency exposure.
Premium - The difference in the
borrowing and deposit interest rates of the two currencies over the term of the
forward contract. It is the amount deducted from the Spot rate.
Premium - The amount paid by the buyer of Option to the Writer or
to a Seller of the Option for the purchase of the Option contract.
Put Option - The holder has the right to
sell (put) a particular currency and buy another.
Revaluation - This occurs when the Central
Bank decides to increase the external value of the currency. This could happen
when there is persistent demand for its currency that is in short supply. The
value of the currency is increased in relation to others. Exports become more
expensive and imports cheaper. The immediate impact is increased imported
goods. In the medium term there is a deflationary impact on the economy.
Rollover - In the event of payment delay it
may be necessary to extend an FX contract. This is achieved by buying enough
currency at the current Spot Rate to honour the original FX contract, and
re-selling forward to the new expected payment date the delayed receivables.
Short Position - An excess of sales over purchases in a currency.
Soft Currency - A currency that is not
regularly traded internationally nor in constant demand. It is a currency that
an investor would not normally hold nor move into during times of world
economic weakness as it is inclined to lose value. It is often associated with
countries with weak economies and relatively high inflation where too much
money is in circulation.
Spot Rate - The exchange rate applied to
the purchase or sale of a currency for delivery in one or two working days
after the date of the deal.
Spread - Same as Margin. Difference
between Spot buying and selling price.
Strike Price - In currency options the
strike price (or rate) is the same as 'Exercise Price'.
It
is the rate at which an option buyer has the right to call or put a currency.
It is the pre-determined exchange rate at which a purchaser can exchange two
currencies at a certain future date (Expiry Date).
Strong Currency - A currency that is regularly
traded and is in constant demand. It is a currency that an investor would want
to hold during times of world economic weakness as it is inclined to be stable
or strengthen against other traded currencies. Often associated with countries
with stable economies and low rates of inflation.
Swap - When rolling over an FX
contract the bank can swap maturity dates. The original Spot Rate is adjusted
by the difference in the original forward premium (discount) and the new
forward premium (discount).
S.W.I.F.T. - Society for World-wide Financial Telecommunications.
An inter-bank
payment transfer system.
T.A.R.G.E.T. - Trans-European Automated Real-time
Gross Settlement Express Transfer System.
An EU inter-bank real-time payment transfer system.
Tick - In Futures contracts the minimum price movement. For example, with the
three-month interest rate contract of a notional £500,000 deposit, the minimum price
movement (Tick) is 0.01 and is worth £12.50. This is the effect of a movement
of 1/100 of one percent on a three-month deposit of £500,000: £500,000 x 0.01% x 3/12 = £12.50
Time Value - That part of the option premium representing the length of the option remaining until maturity (i.e. the premium less the intrinsic value).
Translation Exposure - Where the local currency
value of an asset or liability on a company's Balance Sheet will alter due to
currency movements.
Transaction Exposure - In the case of exports, the
risk of currency movement between the date that the rate of exchange is
committed in the tender price and the actual date of payment. In the case of
imports, the movement between date of agreeing the purchase price and the date
of payment.
Volatility - Unpredictable movement of
exchange rates up or down, to any extent, at any time.
Weak Currency - A currency that is not
regularly traded nor in constant demand. Has limited demand as it is inclined
to weaken against other traded currencies. Often associated with countries with
unstable economies and high rates of inflation.
Writer - In respect of Options, a party who, for a fee, gives the right to buy (or sell) a currency.
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