SIMPLE EXPLANATIONS OF

FINANCIAL TERMS

IFM
• Hedging – an operation in order to protect the domestic
currency value of an asset or liability that is denominated
in foreign currency
• Debt-equity swap – a transaction in which a company buys
a country’s bank debt at a discount and swaps this debt
with the central bank for local currency that it uses to
acquire local equity or assets
• Currency swap – an operation in which two parties
exchange specific amounts of loans in two different
currencies at the spot rate
– They exchange interest payment in the two currencies too
– At a fixed future date, the parties reverse the exchange
• Direct Quotation – quotation where the price of one unit or 100 units
of foreign currency is given in terms of local currency units
• Indirect quotation – quotation where the price of one unit of local
currency is given in terms of foreign currency units
• Arbitrage – An operation that consists in making profit without risk
by purchasing currencies or commodities on one market and selling
them on another taking advantage of price differential
• Covered interest arbitrage – process of taking advantage of
differentials in interest rates of two currencies while eliminating
exchange risk though forward contracts
• Cross-rate – price of one currency (other than local currency) against
another foreign currency
– Eg. In India – USD/GBP
• Forward contracts – is a non-standardized contract between two
parties to buy or sell an asset at a specified future time at a price
agreed today
• Forward premiums or discounts – Annualised percentage difference
between spot and forward rates
• Forward rate – a rate quoted today for delivery on a future date of
specified amount of one currency against another
• Futures – contract for future delivery of a specific quantity of a
commodity or a given currency, with price fixed at the time the
contract is signed.
– The contract is traded on organised futures exchanges and the gains and
losses on the contract are settled each day
• Swaps - It is a foreign-exchange agreement between two parties to
exchange aspects (namely the principal and/or interest payments) of a
loan in one currency for equivalent aspects of an equal in net present
value loan in another currency
• Settlement date – the date when value is given for funds
transferred between banks
• Special Drawing Rights (SDR) – an instrument of reserve that
represents a weighted average of four currencies-USD, GBP,
JPY & EUR
– The weights reflect the relative strength of the economies of these
countries
• Spot Rate – the price at which foreign exchange can be bought
or sold with payment done within a maximum of two working
days
• Spread – difference between buying and selling rates in an
exchange rate or interest rate quotation
• Strike price – the price at which the deal will take place when an
option is exercised
• LIBOR – London Inter-bank Offer Rate – the rate which
London banks charge from each other
• Floating rate bonds – the bonds whose interest rate is
indexed to another rate such as LIBOR
• Managed float (Dirty float) – a system of floating
exchange rates with central bank intervention to reduce
fluctuation in the exchange rate
• Transaction exposure – the change in the value of foreign-
currency denominated transactions due to the change in
exchange rate
• Accounting exposure – also known as translational/
balance sheet exposure- is the change in the value of
foreign-currency denominated items in balance sheet due
to a change in exchange rate
• Economic Exposure – measure of sensitivity of future
cash flows and profits of a firm due to a change in
exchange rates