Glossary | Millennium Global

Key investment terms

Absolute Return

An Absolute Return or Alpha strategy aims to deliver attractive uncorrelated returns by actively trading an unconstrained portfolio of currencies, as well as diversifying effects through low correlation with traditional asset classes.
Absolute return programs can be adapted to specific investor needs by scaling volatility targets, changing the currency universe and using various risk control mechanisms.
Currency markets are highly liquid, with daily volumes that dwarf those of equity and bond markets, and positions can be liquidated rapidly if required.
Active Currency Overlay

Active Currency Overlay programmes aim to transform existing currency exposures into a portfolio of currencies with an improved risk-adjusted return profile. They are often implemented in conjunction with passive currency hedging.

For example, an investor may passively hedge the majority of their existing currency exposures and redeploy part of the risk budget that has been saved into an Active Overlay strategy.

Active Overlay strategies may take into account various characteristics of the existing portfolio or they may be unconstrained, meaning that they can take positions in any currency pairs irrespective of their presence in the portfolio’s existing exposures.
Base Currency
Basis Point
Best Execution

Best execution refers to the duty of an investment services firm executing orders on behalf of customers to ensure the best execution conditions possible for their customers' orders. This applies whether these are orders initiated by the customer or by an investment manager. Under MiFID (the European Markets in Financial Instruments Directive), the criteria for best execution may include price, costs, speed and settlement and delivery procedures.

Millennium Global is an independent provider of unbiased and transparent FX currency management and execution services. We execute hundreds of billion dollars in currency transactions every year for institutional clients and adhere to the FX Global Code, a set of global principles of good practice in the foreign exchange market. We have established trading terms with many of the world’s largest FX liquidity providers. Our specialist execution professionals evaluate depth and liquidity in FX markets to determine effective market timing and execution methods. Transaction cost analysis (TCA) provided by an independent third party is offered to all clients.
Bid/Ask Spread

The bid-ask spread is the difference between the best available price to buy (the ask) or sell (the bid) an asset or financial instrument.

In currency markets, prices are generally quoted as net prices inclusive of any charges. The bid-ask spread is therefore an important component of the overall cost of a transaction.

The spread can be an indicator of market liquidity. The foreign exchange market usually has very low spreads relative to equities and bonds, but they may be wider for less liquid currencies and during periods of market stress.
Carry Trade
Cash Flow Hedging

Cash flow hedging refers to a Hedge Accounting concept.

A Cash flow hedge is a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with all or a component of a recognized asset or liability or a highly probable forecast transaction and could affect profit or loss.

Currency forwards or options can be used as cash flow hedges in cases such as hedging the interest payments on a bond issued in a foreign currency or protecting the value of sales in a foreign currency.
Convertible Currency
Counter Currency
Counterparty

Currencies are mainly traded over-the-counter (OTC) directly between two parties, referred to as the ‘counterparties’ of the transaction.

Market participants active in currency markets will wish to have relationships with a sufficient number of counterparty banks willing to transact and provide price quotes.

Millennium Global works with a pool of 10+ major counterparty banks that account for a large proportion of overall foreign exchange market volume.
Covered Interest Parity

Covered interest parity (CIP) is the idea that the interest rate differential between two currencies in the cash money markets should equal the differential between the forward and spot exchange rates. Otherwise, arbitrageurs could make a seemingly riskless profit. This rule held consistently for the main convertible currencies for many years, as banks had the capital and ability to arbitrage any temporary departures from the formula.

However, since the start of the Global Financial Crisis (GFC) CIP has no longer held. This is visible in the persistence of a cross-currency basis since 2007. The cross-currency basis indicates the amount by which the interest paid to borrow one currency by swapping it against another differs from the cost of directly borrowing this currency in the cash market. Thus, a non-zero cross-currency basis indicates a violation of CIP. Since 2007, the basis for lending US dollars against most currencies, notably the euro and yen, has been negative: borrowing dollars through the FX swap market became more expensive than direct funding in the dollar cash market.
Cross-Currency Basis

The cross-currency basis indicates the amount by which the interest paid to borrow one currency by swapping it against another (through a Currency Forward contract or a cross-currency basis swap) differs from the cost of directly borrowing this currency in the cash market. Prior to the Global Financial Crisis (GFC) the cross-currency basis was almost always very close to zero for developed currencies. After the GFC, the cross-currency basis has become much more volatile and has occasionally widened significantly.

Periods of wider spreads often reflect strains in global interbank markets. Specifically, heightened concerns about counterparty risk and constrained bank access to wholesale dollar funding inhibited arbitrage during the GFC, and again during subsequent crises. It is also believed to reflect regulatory constraints on arbitrage activity by market-makers such as banks.

As most cross-currency basis swaps involve the US dollar, by convention the basis is quoted as a spread on the non-dollar leg of the swap. As a result, in periods of stress in the interbank dollar funding market, the Party borrowing the non-dollar currency would pay the interest rate minus a spread.

Large negative spreads (100 basis points or above in some cases) were observed during the early part of the Covid-19 crisis as available funding in dollars became scarce. This was subsequently alleviated thanks to actions by the Fed and other central banks to make dollar funding more easily available for international counterparties.
Currency Codes

Currency codes or country currency codes are three-letter sequence codes representing the world's currencies. The International Organization for Standardization issues currency codes in a list called ISO 4217.

The vast majority of these codes contain two characters relating to the country and a third character relating to the monetary unit. For example, the ISO 4217 for the USA is "USD" - US for United States and D for Dollar. e.g. EUR (euro), CAD (Canadian Dollar), GBP (Great Britain Pound).

In the foreign exchange market, these codes allow traders to avoid the potential confusion caused by names designating more than one currency, such as the dollar, the peso, the pound or the crown.
Currency Forward

Currency forwards are Over-The-Counter (OTC) derivatives that lock in an exchange rate for a currency pair for settlement on an agreed date in the future.

Forward contracts are fully flexible in terms of notional amounts and maturities, although one-month or three-month forwards are most commonly used for hedging purposes.

The difference between a forward rate and the spot exchange rate mainly derives from the interest-rate differential between the two currencies. It can also be affected by the cross-currency basis.

Forward contracts are often closed out before maturity through an off-setting transaction. If the exchange rate has gone up during the life of the transaction, the seller of the base currency has to pay the difference in value to the buyer, and vice versa if the exchange rate has gone down. If the contract is not closed out, the notional amount of the two currencies is exchanged between the parties.
Currency Hedging

Currency hedging refers to any strategy designed to reduce or eliminate the risk of loss for a company or investor due to the impact of currency movements.

Currency hedging generally involves entering into forward contracts or options strategies to offset an existing risk.

Some investors will outsource their hedging requirements to a currency manager through a Passive Hedging or Dynamic Hedging currency overlay program.
Currency Overlay
Currency overlay refers to any currency management strategy that involves using foreign exchange derivatives to modify the currency profile of a portfolio, typically carried out by a specialist firm, the currency overlay manager.

There are several types of currency overlay strategies:
- Passive Hedging, which seeks to neutralise a portfolio’s existing currency risks.
- Dynamic Hedging, which seeks to improve on a passive hedging strategy by varying the amount of hedging.
- Active Overlay, which seeks to obtain positive returns by actively trading a portfolio of currencies, often applied in conjunction with a passive hedging strategy.
Devaluation

A devaluation is an official lowering of the value of a country's currency within a fixed exchange-rate system, in which a monetary authority (typically the central bank) formally sets a lower exchange rate of the national currency in relation to a foreign reference currency or currency basket. The opposite of devaluation, a change in the exchange rate making the domestic currency more expensive, is called a revaluation.
Dynamic Currency Hedging

Dynamic currency hedging is a risk management strategy that aims to vary the amount of hedging in order to provide better results than a static hedging strategy.

The benchmark for dynamic hedging programmes is expressed as a hedge ratio:

If the benchmark is 0% or unhedged, the objective of dynamic hedging will be to add value by increasing the amount of hedging when the exposure currency is going down, with the aim of generating profits from hedging that partially offset losses in the underlying portfolio.

If the benchmark is 100% or fully hedged, the objective of the dynamic hedging will be to add value by reducing the amount of hedging when the exposure currency is going up, with the aim of reducing the losses from hedging while the underlying portfolio experiences gains.

If the benchmark is 50% or another partially hedged ratio, the objective of the dynamic hedging will be to add value by varying the hedge ratio in both directions.
Fair Value Hedging

Fair value hedging refers to a hedge accounting concept.

A fair value hedge is a hedge of the exposure to changes in the fair value of an asset or liability, used to mitigate fluctuations and to protect the fair value of a specific asset, liability or unrecognised company commitment from risks that can affect their profit and loss accounts.

Currency forward or options can be used as fair value hedges in cases such as hedging the exchange rate of a bond issued in a foreign currency, hedging the currency component of an investment in a portfolio of foreign securities or the cost of purchase of a fixed asset at a date in the future.
Forward Points

Forward points represent the difference in price between currency rates for two different delivery dates. Typically, they are expressed as the number of pips added to or subtracted from the current spot rate of a currency pair to obtain the forward rate for delivery on a specific value date in the future. They may also reflect the difference between two forward rates for two different dates in the future.

Forward points are mainly affected by the difference in interest rates between two currencies. This is because forward currency trades are contracts in which one party implicitly borrows one currency from, and simultaneously lends another to, the second party. For example, if someone is selling US dollars against euros for delivery in three months’ time and the US 3-month interest rate is higher than the euro interest rate, the forward rate will normally be lower than the spot rate to offset the interest differential that otherwise benefits the holder of dollars. This relationship is known as the Covered Interest Parity.

Forward points are also affected by the Cross-Currency Basis. The cross-currency basis indicates the amount by which the interest paid to borrow one currency by swapping it against another differs from the cost of directly borrowing this currency in the cash market. Prior to the Global Financial Crisis (GFC) the cross-currency basis was almost always very close to zero for developed currencies. After the GFC, the cross-currency basis has become much more volatile and has occasionally widened significantly. This is often a reflection of strains in global interbank markets. Specifically, heightened concerns about counterparty risk and constrained bank access to wholesale dollar funding inhibited arbitrage during the GFC, and again during subsequent crises. It is also believed to reflect regulatory constraints on arbitrage activity by market-makers such as banks.
Forward Rate
FX Global Code of Conduct

The FX Global Code (Global Code) is a set of global principles of good practice in the foreign exchange market, developed to provide a common set of guidelines to promote the integrity and effective functioning of the wholesale foreign exchange market. It was developed by a partnership between central banks and market participants from 16 jurisdictions around the globe.

The purpose of the Global Code is to promote a robust, fair, liquid, open, and appropriately transparent market in which a diverse set of market participants, supported by resilient infrastructure, are able to confidently and effectively transact at competitive prices that reflect available market information and in a manner that conforms to acceptable standards of behaviour.

The Global Code does not impose legal or regulatory obligations on Market Participants, nor does it substitute for regulation, but rather it is intended to serve as a supplement to any and all local laws, rules and regulations by identifying global good practices and processes.

Millennium Global signed a statement of commitment to the FX Global Code in May 2018 and is committed to implementing best market practices. Millennium Global participated in creating the Global Code. We were represented for many years on the Bank of England's Foreign Exchange Joint Standing Committee, and in that context participated in the work to develop the Code, led by the Bank for International Settlements. The Bank of England asked Millennium Global's representative to be the sole private sector representative for the UK on the supervisory committee during the first phase of implementation of the Code.

https://www.globalfxc.org/fx_global_code.htm
Hedge Accounting

Hedge accounting is an accounting approach in which derivative transactions that are defined as hedges are associated with a specific existing exposure so that the changes in value of the derivative are not necessarily recognised in a company’s profit and loss account.

Fair-value hedging is used for hedging assets and liabilities. Cash flow hedging is used to hedge cash flows arising from transactions such as the sale of a company’s products.

In order to benefit from hedge accounting treatment, certain recognised accounting standards have to be met and the process must be adequately documented. In particular, the hedges have to meet effectiveness tests. When currency forwards are used, the spot component of the forward price is generally considered to be ‘effective’ hedging while the forward points are considered ‘ineffective’ and therefore directly impact a company’s profit and loss account.
Liquidity Providers
Option Skew

"Option skew" refers to the difference between the implied volatility of call and put options with the same delta. It can provide information about market expectations and potential future developments.

Millennium Global considers that option skews are an important early warning indicator of potential sharp market movements. In managing currency exposures such warnings will encourage us to be more risk averse. For example, the GBP/USD spot rate was relatively stable prior to the Brexit vote but the option skew was at an extreme. This told us that if there was a surprise in the vote, there could be a very large market reaction.
Over-the-Counter Derivatives (OTC)

"Over the counter" (OTC) refers to financial transactions that are not traded on an organised market but rather directly between two counterparties. The vast majority of FX transactions are traded OTC, often between an end-user and a market-making bank or other Liquidity Provider.

Many of the terms and conditions are standardised, usually through the use of ISDA contracts or other framework agreements, which reduces the number of variables that have to be agreed for each transaction.
Passive Currency Hedging

Passive hedging refers to a currency management strategy that aims to neutralise all or part of the currency risks of an underlying portfolio.

If a currency overlay manager is used to implement a passive hedging strategy, the manager will normally not be allowed to vary the hedge ratio but may be required to collate and analyse information about the underlying portfolio in order to determine the amounts to be hedged and other variables.
Pips
Spot Rate
Transaction Cost Analysis (TCA)

Transaction cost analysis (TCA) is used by institutional investors and investment managers to analyse trade data to evaluate whether they were executed at fair prices. TCA usually refers to post-trade analysis but may also be carried out pre-trade to choose the procedure to be used to execute a specific transaction or set of transactions.

For post-trade TCA, the starting point is a set of accurate data about the transactions to be analysed including precise trade timing, which is known as the ‘time stamp’. This data can then be compared to benchmark trade prices to calculate the ‘slippage’, which is the difference between the actual trade price and the benchmark price.

TCA is more complex in FX than in equity markets as there are no transparent and complete data sets about all the transaction volumes and prices traded. In addition, fair execution prices will vary considerably depending on the size of a transaction and how fast it needs to be executed. As a result, practitioners may use a variety of benchmarks to get a complete picture of the quality of execution.