Glossary
The glossary with insights and facts
that make it easy to understand FX
and currency hedging
At the money is a term used in options trading. Options are contracts that allow you to buy or sell an asset at a pre-agreed price. For example, you could buy an option that gives you the right to exchange £4,000 into US Dollars at an exchange rate of 1.45.
The base currency is the first currency shown in a foreign exchange quotation. The second currency in the quotation is called the quote currency, or counter currency.
A derivative is a type of financial contract that gets its value from an underlying asset. In foreign exchange transactions, the underlying asset is typically a currency’s exchange rate.
Forward contracts are a type of derivative – a financial contract that gets its value from an underlying asset such as a company share or a loan or coffee beans.
Initial margin is the amount you have to pay a broker to open a trade on the forex market. It’s worked out as a percentage of the total value of your trade.
A carry trade is a type of foreign exchange trade in which you borrow money in one currency at low interest and use it to make high-interest investments in another currency (Yen — Japan’s currency).
A knock-in option is an option that only comes into force — or knocks in — if the underlying asset reaches a certain price. In foreign exchange, the underlying asset is an exchange rate.
Mark-to-market is the accounting process that measures the real-world value of foreign exchange trades. It shows whether you’ve made a profit or a loss on a trade and whether your broker should credit your trading account or make a margin call.
A non-deliverable forward is a forward contract which is settled in your local currency. Like standard forward contracts, non-deliverable forwards are agreements to buy or sell X amount of a certain currency at a predetermined exchange rate on X date in the future.
‘Out of the money’ is one of three terms used to describe an option’s value, or ‘moneyness’. The other two terms are ‘at the money ‘ and ‘in the money’. When an option is out of the money, its strike price — that is, the price at which you’d exercise the option — is lower than the market price.
A participating forward is a Hybrid FX Forward and Option instrument. The amount you want to protect — or hedge — is split into two parts. One part works like a standard forward contract. In other words, you enter a legal obligation to exchange a specified amount of foreign currency on a certain date at a specified rate.
The quarterly roll is a period of heightened market activity that happens every quarter, when forex traders roll their trades.
A ratio forward is a type of structured, or ‘exotic’ option. Exotic options are derivative contracts in which two or more options are combined to create a more complex arrangement.
The US Dollar Index measures the US Dollar’s value relative to a basket of six currencies: Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, Swiss Franc.
Volatility is a measure of how much the price of an instrument moves. It is usually expressed as an annualised %. It is often calculated as the standard deviation of the daily moves in price of an asset from its average.
Xenocurrency is another name for foreign currency — a currency that is traded, invested, deposited, or used outside the country where it’s issued.
A zero-cost hedge is a hedging strategy that doesn’t have upfront costs. The hedge is constructed in such a way that any premium you have to pay to set up the hedge cancels itself out.
