FX Glossary
Plain-language definitions of the foreign exchange terms you will encounter when managing currency risk for your business.
A
- Appreciation
- An increase in the value of one currency relative to another. When the Australian dollar appreciates against the US dollar, each AUD buys more USD. The opposite of depreciation.
- Ask (Offer) Price
- The price at which a dealer will sell a currency to you. When you buy foreign currency, you pay the ask price. The difference between the bid and ask is the spread.
B
- Base Currency
- The first currency in a currency pair. In AUD/USD, the Australian dollar is the base currency. Exchange rates express how much of the quote currency one unit of the base currency will buy.
- Bid Price
- The price at which a dealer will buy a currency from you. When you sell foreign currency, you receive the bid price. Always lower than the ask price.
C
- Cross Rate
- An exchange rate between two currencies that does not involve the US dollar. For example, AUD/EUR or GBP/JPY. Cross rates are derived from each currency's rate against the USD.
- Currency Pair
- Two currencies quoted against each other, written as BASE/QUOTE. The rate tells you how much of the quote currency you need to buy one unit of the base currency. Major pairs include AUD/USD, EUR/USD, and GBP/USD.
D
- Depreciation
- A decrease in the value of one currency relative to another. When the Australian dollar depreciates, your foreign currency costs rise if you are an importer, and your foreign receivables are worth more if you are an exporter.
- Drawdown
- Partial utilisation of a forward contract. If you have a forward for USD 1,000,000, you might draw down USD 250,000 now and the remainder closer to the maturity date, depending on the contract terms.
E
- Exchange Rate
- The price of one currency expressed in terms of another. Rates are determined by supply and demand in the foreign exchange market and fluctuate continuously during trading hours.
- Exposure
- The degree to which a business is affected by changes in exchange rates. Exposure can arise from committed transactions (transaction exposure), balance sheet translation (translation exposure), or competitive position (economic exposure).
F
- Forward Contract
- An agreement to exchange a specific amount of currency at a pre-agreed rate on a future date. Forwards allow businesses to lock in exchange rates and remove uncertainty from future cash flows. Tenors typically range from one week to two years.
- Forward Points
- The difference between the spot rate and the forward rate, reflecting the interest rate differential between the two currencies. Forward points are added to or subtracted from the spot rate to calculate the forward rate.
- Forward Rate
- The exchange rate agreed today for delivery at a future date. The forward rate is not a forecast of where spot will be; it is derived from the current spot rate plus forward points.
- FX Swap
- The simultaneous purchase and sale of one currency for two different value dates. Commonly used to roll a maturing forward contract to a later date or to manage short-term funding needs.
H
- Hedge
- A transaction or strategy designed to reduce or eliminate the risk of adverse exchange rate movements. Common hedging instruments include forward contracts, options, and structured products.
- Hedge Ratio
- The proportion of a foreign currency exposure that is hedged. A 75% hedge ratio on a USD 1,000,000 payable means USD 750,000 is covered by forwards or options, and USD 250,000 remains exposed to spot rate movements.
L
- Limit Order
- An instruction to buy or sell currency at a specified rate or better. The order is executed automatically if the market reaches your target rate. Useful for capturing favourable moves without watching the market continuously.
- Liquidity
- The ease with which a currency can be bought or sold without significantly affecting the exchange rate. Major currency pairs (AUD/USD, EUR/USD) are highly liquid; exotic pairs may have wider spreads and less availability.
M
- Margin
- A deposit required to hold an open forward contract or option position. Margin requirements are typically a percentage of the notional value and may be adjusted if the market moves against your position (a margin call).
- Mark-to-Market
- The process of revaluing an open forward contract or option to its current market value. If the spot rate has moved against you since the contract was struck, the mark-to-market value will be negative, and vice versa.
N
- NDF (Non-Deliverable Forward)
- A forward contract settled in a reference currency (usually USD) rather than the restricted currency. Used for currencies with capital controls where physical delivery is not possible, such as the Chinese yuan (CNH) or Indian rupee (INR).
- Notional Value
- The face value of a forward contract or option, representing the amount of currency to be exchanged. A forward contract with a notional value of USD 500,000 will deliver USD 500,000 at maturity.
O
- Option (FX Option)
- A contract giving the holder the right, but not the obligation, to buy or sell a currency at a specified rate (the strike price) on or before a specified date. Options provide protection against adverse moves while preserving the ability to benefit from favourable ones, in exchange for an upfront premium.
P
- Pip
- The smallest standard price movement in a currency pair, typically the fourth decimal place (0.0001) for most pairs. For AUD/USD, a move from 0.6500 to 0.6501 is one pip. Japanese yen pairs use the second decimal place.
Q
- Quote Currency
- The second currency in a currency pair. In AUD/USD, the US dollar is the quote currency. The exchange rate tells you how many units of the quote currency one unit of the base currency will buy.
R
- Risk Management
- The process of identifying, measuring, and managing foreign exchange exposures to protect business margins and cash flows. A risk management policy typically defines acceptable exposure levels, hedging instruments, hedge ratios, and decision-making authorities.
- Rollover
- The extension of a maturing forward contract to a later settlement date, typically achieved through an FX swap. Rollovers allow businesses to maintain hedge coverage when the underlying commercial transaction is delayed.
S
- Settlement Date (Value Date)
- The date on which currencies are physically exchanged between the parties. For spot transactions, settlement is typically two business days after the trade date (T+2). Forward contracts settle on the agreed future date.
- Spot Rate
- The current market exchange rate for immediate delivery (settled T+2). The spot rate is the benchmark from which forward rates and other derivatives are priced.
- Spot Trading
- Buying or selling currency for settlement within two business days. Spot is the most common type of FX transaction and is used for immediate payment obligations, repatriation of funds, and short-term currency needs.
- Spread
- The difference between the bid price and the ask price, representing the dealer's margin. Tighter spreads mean lower transaction costs. Spreads vary by currency pair, transaction size, and market conditions.
- Stop-Loss Order
- An instruction to buy or sell currency at a specified rate to limit losses if the market moves against you. Unlike a limit order (which targets a favourable rate), a stop-loss is a protective measure.
T
- Tenor
- The time period from trade date to maturity of a forward contract or option. Common tenors include 1 month, 3 months, 6 months, and 12 months, though contracts can be structured for any business day.
- Transaction Exposure
- The risk that exchange rate movements will affect the value of committed future foreign currency cash flows, such as import payments, export receivables, or dividend remittances. The most common type of FX exposure for operating businesses.
- Translation Exposure
- The risk that exchange rate movements will affect the reported value of foreign currency assets, liabilities, or equity when consolidated into the parent company's reporting currency. Primarily a concern for businesses with foreign subsidiaries or significant offshore assets.
V
- Value Date
- See Settlement Date.
- Volatility
- The degree of variation in exchange rate movements over a given period. Higher volatility means greater uncertainty and larger potential gains or losses on unhedged exposures. Volatility is a key input in pricing FX options.
W
- Wholesale Client
- A category of client defined under section 761G of the Corporations Act 2001 (Cth). A person or business is generally a wholesale client when at least one of the following is true: the price or value of the financial product is $500,000 or more; the client has net assets of at least $2.5 million or gross income of at least $250,000 a year for the past two years (certified by a qualified accountant); the client controls gross assets of $10 million or more; or the client is not a small business under the Act (broadly, more than 20 employees, or more than 100 in manufacturing). AFSL holders have different obligations to wholesale and retail clients, including different disclosure requirements.
Need help understanding your FX exposure?
Our advisory team can walk you through the concepts relevant to your business.
Talk to our team