Mumbai, Aug 1 (UNI) India's foreign exchange reserves dropped by USD 50 million to USD 306.61 billion on July 25 from 307.11 billion a week earlier, the Reserve Bank of India (RBI) said in its weekly statistical supplement here today.
The forex reserves even shrinked by about Rs 9.60 bn in the last two months, which was a record high at USD 316.17 bn in late May this year.
Market analysts say the decline was due to dollars given by the central bank to refiners in exchange for their oil bonds in order to meet their demand after sharp rise in oil prices.
The suspected intervention in the currency market by the central bank to support the falling rupee through Liquidity Adjustment Facility (LAF) mode also squeezed the reserve kitty in the past two months, analysts said.
Meanwhile, Foreign Currency Assets reserve declined by USD 50 mn to USD 296.87 bn during the week, from USD 297.37 billion in the previous week. However, the gold reserves and special drawing rights (SDR) reserve remained unchanged at USD 9.21 bn and USD 11 mn, respectively. While, reseves with International Monetary Fund (IMF) dropped at USD 515 mn from USD 517 mn, RBI stated.
The central bank said foreign currency assets, expressed in dollar terms, included the effect of appreciation or depreciation of other currencies held in its reserves such as the euro, pound sterling and yen.
The foreign exchange reserves include India's Reserve Tranche Position in the IMF, the central bank said.
Sunday, August 3, 2008
FOREX-Dollar rises to 5-wk high vs euro, buoyed by US data
* Dollar rises after
*
* Yen rises broadly as risk aversion increases (Recasts, updates prices, adds comments, changes byline)
By Gertrude Chavez-Dreyfuss
NEW YORK, Aug 1 (Reuters) - The U.S. dollar climbed to five-week peaks against the euro and three-week highs against the British pound on Friday as better-than-expected economic data allayed worries about a much sharper slowdown.
The yen, on the other hand, gained broadly, benefiting from heightened stress in financial markets on news that General Motors (GM.N: Quote, Profile, Research) had hefty losses in the second quarter. That dragged
"U.S. dollar sentiment has certainly changed for the better over the last couple of weeks," said Mark Frey, head foreign exchange trader at Custom House, a global payments dealer in
"The
Friday's data showed that
ExpressFX Rules
Trading Forex for profit
How do you make money on Forex? Try selling or buying some currency with a free ExpressFX demo account and see how you can make or lose money as currency rates fluctuate.
Selecting the size of the trade
The larger your trade size, the more profits you will make if the price goes in your favor and the more you will lose if it goes against you. The Demo account is a great way to practice making trades of different sizes because you are not putting money at risk.
The minimum trade size is $1,000. But thanks to the leverage of up to 100:1 you can trade $1,000 when you have just $10 in your trading account. It is easy to calculate the maximum trade size. All you need to do is take the amount that is in your account and multiply it by 100.(!!! The high degree of leverage can work against you as well as for you)
Opening and closing a position
When you buy a currency you open a position. When you sell the same amount of the same currency, you close the position. During when your position is open you will be making or losing money depending on how currency rates change. If you bought a USD for EUR (USD/EUR) and its rate goes up, you are making money. If it goes down, you are losing money.
Take Profit and Stop Loss
Market prices move almost every moment, but this does not mean that you have to keep an eye on your positions every second. You can set a Take Profit order, which is a command to the dealing desk to automatically close your position when your profits reach a certain level. You can also set a Stop Loss order, which is a command to the dealing desk to close your position when your losses reach a certain level except for extraordinary market conditions. It is a good idea to set both of these orders simultaneously to establish a price range of how much you are willing to make and how much you are ready to risk.
Take Profit and Stop Loss II
The minimum stop-loss and take-profit limits are is $1.20 for every 1000 units of the base currency. For example, if your position size is $3000, the minimum limit for stop-loss and take-profit is 3 x $1.20 = $3.60. The Company retains the right to reject any trade with limit orders that violate this rule.
When you are changing your take-profit order on an open position that is currently making a profit, the new take-profit level should be set at not less than $1.20 for every 1000 units of the base currency from the current P/L.
When you are changing your stop-loss order on an open position that is currently making a loss, the new stop-loss level should be set at not less than $1.20 for every 1000 units of the base currency from the current P/L.
Commissions
Commission is a one time charge for opening a position. Forex Club charges just 60 cents for every $1,000 traded (or 1,000 pounds; or 1,000 Euro). Forex Club returns commission charges to you automatically and instantaneously on non-profitable trades.
Calculating Profit and Loss
You don't need to worry about doing any math because expressFX will do all calculations for you. However, if you would like to know how profits and losses are calculated there is one simple formula.
For the currency pairs where dollar is the base currency (USD/***):
Where dollar is not the base currency (***/USD):
Carrying positions over to the next day
Even though Forex market works around the clock, technically, each trading day ends at
However, you don't have to close your positions each day as we offer an option of carrying positions over to the next day for a small fee of 15 cents for every 1,000. Please note, fees for carrying positions over are non-refundable.
Adjusting your positions
In addition to closing your position, you can also downsize, upsize or reverse it. To downsize a position you just need to sell some part of the currency that you have purchased. For example, if you have purchased 1000 Euro for dollars (BUY 1,000 EUR/USD) you can downsize your position by selling 500 Euro. You can upsize your position the same way by buying additional 500 Euros for dollars. You can also reverse a position altogether by selling 2000 Euro for dollars. This way your position will become SELL 2,000 EUR/USD. Please note downsizing or upsizing a position is not necessarily beneficial. It is merely a trading strategy.
ExpressFX - zero-spread trading with a particularly user-friendly platform
ExpressFX is one of our most recent innovations. This trading platform features zero-spreads. With this platform, you pay only $0.6 for every $1,000 traded and get commission refunds for non-profitable trades. This features combined mean that you pay commissions to your broker only when you make profits on your trades.
· Zero-spreads
· $0.6 for every $1,000 traded
· Instant commission refunds on non-profitable trades
· And a built-in wizard that teaches you how to make trades, limit losses and make profits.
· Dow Jones news, candle charts and simple orders
How do I know what currencies to buy or sell?
There are two general approaches to understanding the markets, including the Forex market. The first - technical analysis - focuses on price patterns and uses charting tools to discover them. The second - fundamental analysis - regards price behavior as a product of economic and political events.
Why trade Forex?
Global economic and political events have a large impact on currency rates. Take a look at the Forex market today and see how prices fluctuate. If you buy low and sell high, you make profits. If the market moves against you, then you incur losses. Unlike with the stock market, when one currency is going down, there is always a currency that is going up, which makes Forex attractive for banks and hedge funds, businesses and retail investors.
Thursday, June 5, 2008
Forex Broker Reviews and Comparisons
Hello there everyone, found a few sites that will help you find a Forex Broker that’s right for you. Even if you have a broker already, you can use these sites to review your current one or find a better one. Personally, I think I might try out a couple of MT4 (MetaTrader4) compatable brokers from these lists by opening up mini accounts for $250 or less and test out some indicators that I want to try live, but don’t have the nerve (or stomach) to try with big lots. I don’t see anything too risky about this new approach, the initial investments I can easily part with if the markets don’t go my way. Let me know if this is too foolhearty, even if I trade mini lots. just know testing out these expert advisers out, they will be 3:1 win to loss, and losses always smaller than gains, historically. I’m interested in seeing what the spreads will be like, alot of these brokers keep that under wraps unless you ask. Read the story »
Using Fibonacci Levels is the cornerstone of many successful forex traders’ systems and it is based on centuries old mathematical techniques that can be applied to almost everything in nature. The numerous Forex trading systems based on this “Fibonacci numbers sequence” result in billions of dollars in profit annually by traders worldwide, and indeed, after trading Forex for a few years, I have come to use them myself every chance I get.
I’ve learned that the ratio between numbers in the Fibonacci sequence that is significant, rather than the actual numbers in the sequence.
The definition of this Fibonacci sequence is basically formed by a series of numbers where each number is the sum of the two preceding numbers; for example: 1, 1, 2, 3, 5, 8, 13.
Quite simply, the a pair will move up, stop at a point, move back down to another point, “pivot” off of that price and the process continues forever. These “oscillations” in the price of currency pairs are clear indicators of support and resistance. Support occurs when a pair begins to be bought after a move down, and resistance occurs when a pair begins to be sold after a move up. Now, admittedly, these moves occur many times per second, but we should be concerned with support and resistance on longer time frames. Fibonacci levels, when drawn correctly, can be excellent indicators (on almost any time frame) of where a price might go next, Read the story »
Bond Spreads In Forex
Came across a really interesting article by Kathy Lien, Chief Strategist at FXCM about Bond Spreads and Interest and how they affect the Forex Market. Some of this is common sense, but is always good to be reiterated and gone over from time to time. Including the idea that investors will tend to seek higher yields on interest rates and thusly buy currencies with higher rates than the currency they are holding. Read the story »
Trading Platform Release Notes
Here is a list of software releases for our trading platforms. The FXTrade, FXTrade Beta, FXGame and FXGame Beta platforms may contain different versions of our software. Please check this page for the latest release information.
See the latest features on FXTrade, FXTrade Beta, FXGame and FXGame Beta.
Version 2008.05.02 - Currently on FXGame and FXGame Beta
- One-click trading feature added to Quote Panel. This feature must be turned on by clicking on the first button to the right of the Quote Panel tab.
- More compact buy/sell window can be expanded to show additional trade information. Bounds and limits are now specified in pips so they do not need to be adjusted when the quote price changes.
- New look and feel for the Quote Panel.
- Trendlines have be been regrouped into a single button; Advanced Trendlines options have been moved in the chart menu.
- Colour schemes can be customized in Tools->Colour Scheme->Edit Custom Theme
- Added mousewheel support for Quote Panel and Tables.
- Chart Printing available from graph menu.
Version 2008.03.10 - Currently on FXTrade Beta
- All preferences under the Trading tab can be customized per currency
- Close All Trades/Orders is available from the Account menu
- Modify All Stop Loss/Take Profit to the same value is available from a right-click on any Stop Loss or Take Profit
- Stoller Average True Range Channel (STARC) overlay
- Overlays' current values appear in the top left-corner when you move your mouse over the charts
- Individual histograms displayed on the MACD indicator
Version 2007.11.16 - Currently on FXTrade
- You can now customize the columns shown and filter the rows of each table by clicking on the button in the top-right corner.
- As a consequence, the Profit Column Format has been removed from the User Preferences and replaced by new Profit columns for the Trades and Position tables.
- Also, an Exposure column is available for the Position table.
- Each table can be opened multiple times in a new window.
- You can show/hide the major components of the main window in Tools > View.
- Number format is customizable under Tools > User Preferences > Locale (default is U.S. English)
- Please note that the Timezone option has also been moved under the Locale tab.
- Multiple profile support from menu Tools > Profile Manager.
- The time zone used by the Platform can be customized under Tools > User Preferences > Misc.
- Pressing the shortcut keys F2, F3, F4 or F5 in the Buy/Sell window will open a new window with duplicated values. This feature also works when closing or modifying an existing order.
- The Platform can now be locked by clicking on Connection > Lock. There is also an option to automatically lock the Platform after a period of inactivity which can be set under Tools > User Preferences > Misc.
- You can now modify the endpoints of a trendline: click on the trendline and select "Modify Endpoint".
- The rising and falling colors of HLC and OHLC curves can now be modified separately.
- The current number of trades, orders, boxes, etc is now available in the selected table tab.
- The buttons on the 1-click sub-accounts switcher show the name of the account on the status bar when you move your mouse over them. Also, they are displayed in the same order as on the sub-account menu.
- Please note that in the User Preferences window, the Apply button no longer send your settings to the trading server.
- 1-Click sub-account switcher: check "Show Sub-Account Switcher" in the menu Tools > User Preferences > Misc to make it appear between the Ac count Summary and the Quote List/Panel. Sub-accounts will then be indexed after the order in which they appear under Account > Change Sub-Account.
- The Default Order Size option can now be expressed in home currency under Tools > User Preferences > Trading.
- You can now display charts as Heikin-Ashi candlesticks.
- Pivot Points are available either as overlays on the main graph (in the Add Study list) or as trendlines (in the same menu as Fibbonacci trendlines).
- The Kumo (or cloud) of the Ichimoku Kinko Hyo overlay is now filled with the color of the highest Senkou Span to best stick to the usual representation of this curve.
- You can change the rising and falling colors separately for the regular and Heikin-Ashi candlesticks and the Parabolic SAR.
- You can now add Overlays on top of Indicator curves: click on the Indicator's name in the top-left corner of the chart and select the "Add Study" option in the popup menu.
- You can also modify the periods for Overlays and Indicators: click on the curve and select "Modify" in the popup menu.
- A default Trendline Style option is available under Tools > User Preferences > Chart. Note that trendline styles also apply to Fibonacci Trendlines.
- A Magnetic Trendlines option is available under Tools > User Preferences > Chart.
- Trendlines can also be plotted as dots, dashes or thick lines: right-click on a trendline and go to the "Style" menu.
- You can now display trade profits in terms of both home currency and PIPS at the same time: go to Tools > User Preferences > Misc > Profit Column Format and select "Home Currency/PIPS"
- The Awesome Oscillator indicator is available in the Add Study list.
- Sorting sub-accounts alphabetically is now optional and disabled by default. You can turn it on by going to Tools > User Preferences > Misc and checking "Sort Sub-accounts".
- The Buy/Sell window shows expected Stop Loss for new Market Orders.
- The current window layout is now preserved when the trading platform reconnects automatically after connection difficulties
- A new column has been added to the Orders table to show the distance to execution of Limit Orders (in PIPS)
- Expected take profit P&L for new Market Orders, and current P&L for existing Market Orders is now shown in the Buy/Sell window
- Sub-accounts are now sorted alphabetically
- Added 12 new price overlays (under the "Add Studies" drop-down list). This will allow you to display the Opening, Closing, High and Low values for the Bid, Ask and Average prices
- Added a Connection Quality indicator (bottom left corner of the window). This will evaluate your connection to the trading server: the color tells the overall quality (green for good, yellow for average, red for poor) while the progress bar tells the current response time to the server (first quarter: 10s and more, second and third quarters: 1s to 10s, fourth quarter: 10ms to 1s)
- Commas are now automatically added for you in the units field of the buy/sell window
- The Activity Log filters now get saved with your Graph Layout
- The missing 23.6% is added to the Fibonacci Retracements
- The Tab key will now allow you to navigate between the different fields of the Buy/Sell window and the Graph window
- The small window with the logout button no longer appears on FXDesktop
- You can create sub-accounts by selecting Account -> Create Sub-Account from the FXTrade menu or by clicking on the Add a Sub-Account link on the page that loads after you log in. Please note that sub-accounts cannot be renamed nor deleted once created
- You can now view Average Position lines. Click on each graph where you hold a position and select "Show Average Position". A dotted line will appear at the average price of your position. You will need to save your layout to make this change permanent
- The Ichimoku Kinko Hyo overlay is now available in the Add Study list. You can set the colour of its cloud and lines individually by right-clicking on the cloud itself (the green filled or transparent ribbon)
- Some user preferences unrelated to Trade, Quote or Graph were moved to the new Misc tab
- The Ultimate Oscillator chart is now available in the Add Study list
- You can reorganize the order of Quote List and Quote Panel by drag-and-dropping the currencies. Note that you will need to save your layout or user preferences to make this change permanent
- You can display bid and ask prices in their own separate columns in the Quote List. Go to the Trading tab of the User Preferences and check Show Dual Bid/Ask Columns
- You can display your Unrealized P&L in % of your balance in your Account Summary. Go to the Trading tab of the User Preferences and check Show Unrealized P&L Precent
- You can now resize the Account Summary window and the font will adapt accordingly
- The Average Directional Movement Index (ADX) chart now displays 2 other lines; the green one is the Plus Directional Indicator (+DI) and the red one the Minus Directional Indicator (-DI)
- The Market Order window now also displays the Trade Value and the Margin Used
- You can create sub-accounts by selecting Account -> Create Sub-Account from the FXGame menu or by clicking on the Add a Sub-Account link on the page that loads after you log in
- You should be able to save about 3-5 times more trendlines & studies than before
- The buy and sell buttons on the chart will remain visible when using the basic chart view
- The bid/ask price in the current rates window will expand to show the exact number of decimals required to give complete information about a price
Foreign Currency Trading
The CFTC has witnessed increasing numbers, and a growing complexity, of financial investment opportunities in recent years, including a sharp rise in foreign currency (forex) trading scams.
The Commodity Futures Modernization Act of 2000 (CFMA) made clear that the CFTC has jurisdiction and authority to investigate and take legal action to close down a wide assortment of unregulated firms offering or selling foreign currency futures and options contracts to the general public. The CFTC also has jurisdiction to investigate and prosecute foreign currency fraud occuring in its registered firms and their affiliates. The CFTC issued an advisory in 2001 that discussed these CFMA amendments to the Commodity Exchange Act (CEA), 7 USC 1, et seq.
The Division of Trading and Markets (now Division of Clearing and Intermediary Oversight, or DCIO) issued an advisory in 2002 concerning foreign currency trading by retail customers (PDF). The advisory affirms that off-exchange trading of foreign currency futures and options contracts with retail customers by a counterparty that is not a regulated financial entity as set forth in the CFMA is unlawful. The advisory further states that, if there is a lawful counterparty to the transaction, such as a person registered as a futures commission merchant, the persons acting as intermediaries to such a transaction, that is, in the manner of an introducing broker, commodity trading advisor or commodity pool operator, would not need to register under the CEA if that is their only involvement in futures or option transactions.
DCIO issued an additional advisory in 2007 concerning foreign currency trading by retail customers (PDF). The DCIO Advisory addresses the following issues: (1) registration requirements for associated persons of firms registered as introducing brokers (IBs), commodity trading advisors, and commodity pool operators that are involved in forex transactions; (2) the permissibility of certain unregistered affiliates of a futures commission merchant (FCM) to act as proper counterparties in forex transactions; (3) claims that forex customer funds are segregated; (4) introducing entities acting as FCMs; (5) the applicability of the IB guarantee agreement to forex transactions and prohibiting guaranteed IBs from introducing forex transactions to an FCM that is not its guarantor FCM; (6) prohibiting forex account statements of an FCM’s unregistered affiliate from being included in the FCM’s account statements to its customers; and (7) prohibiting retail customers from acting as counterparties to each other in forex transactions.
Monday, May 19, 2008
Currency Options
Forex option is a contract that conveys the right, but not the obligation, to buy or sell a particular item at a certain price for a limited time. Only the seller of the option is obligated to perform.
Simply stated, a buyer of a currency option acquires the right - but not the obligation - to buy (a “call”) or sell (a “put”) a specific amount of one currency for another at a predetermined price and date in the future. The cost of the option is called a ‘premium’ and is paid by the buyer to the seller. The seller determines the price of the premium at which they are willing to grant the option, based on current rates, nominated delivery and expiry dates, the nominated strike rate and option style.
It is entirely up to the buyer whether or not to exercise that right; only the seller of the option is
obligated to perform.
Call Option:
Call Option - an option to BUY an underlying asset (stock or currency) at an agreed upon price (Strike Price or Exercise Price) on or before the expiration date. Since this option has economic value, you have to pay a price, called the Premium.
Example: Microsoft (MSFT) was recently selling at $29.50/share, and there were 4 different options. For example, for $1.00 (premium) you could buy one call option that would allow you to buy a share of MSFT for $30 (strike P) on or before January 16, 2005. You will exercise the option if P > $30, and you will make money if the P > $31.00 ($30 + $1.00). If P = $30, you will not exercise the option, it will expire worthless and you will lose the premium ($1.50).
Next example shows two ways to calculate profit from call option:
You have paid a premium of $187.50 in July that gives you the right to buy SF @ $0.67 on or before September 10. If the SF sells at $.7025 on expiration, you can exercise your right to buy @$0.67 and then sell at $0.7025, for proceeds of $2,031.25. Subtracting the cost of your option premium of $187.50, you have a net profit of $1,843.75 ($2,031.25 - $187.50). The writer (seller) of the call option would lose $1,843.75.
1. Profit = S - (Exercise Price + Premium) x SF62,500
Profit = $.7025 - ($0.670 + $0.003) = $0.0295/SF x SF62,500 = $1,843.75
2. Profit = (S - Exercise Price) x SF62,500 - PREMIUM
Profit = ($0.7025 - $0.67) x SF62,500 = $2,031.25 - $187.50 = $1,843.75
ROI:
Your return on investment (ROI) would be $1843.75 / $187.50 (Profit / Investment) = 983% for 2 months! Illustrates leverage. You control about $42,000 worth of SFs (SF62,500 x $.67/SF) with only $187.50, or less than 1% of the underlying value of the currency.
If spot rate at expiration is only $.6607/SF (or any rate < $.67/SF), the option expires worthless, you lose the premium of $187.50, which would be the gain to the writer (seller) of the call.
Note: If the spot rate was between $.67 and $.673, you would exercise, but lose money. For example, if S = $0.671, you would lose ($.671 - .673) x SF62,500 = -$125 by exercising, vs. -$187.50 without exercising.
Like futures trading, option trading is a zero-sum game. The buyer of the option purchases it from the seller or the person who "writes" the call. Options are traded in units of 100 shares.
Put Option:
Put Option - gives the owner the right, but not the obligation to sell an underlying asset at a stated price on or before the expiration date.
Example: MSFT $30 January 2005 puts were selling for $2 (premium). You will make money if the P < $28. You will exercise if P < $30, exercise but lose money if P $28-30. If P > $30, put will expire worthless.
The option extends only until the expiration date. The rate at which one currency can be purchased or sold is one of the terms of the option and is called the exercise price or strike price. The total description of a currency option includes the underlying currencies, the contract size, the expiration date, the exercise price and another important detail: that is whether the option is an option to purchase the underlying currency - a call - or an option to sell the underlying currency - a put.
A Currency Option is a bilateral contract between two counterparties, and therefore each party is responsible for assessing the credit standing and capacity of the other party, before entering into a transaction.
There are two types of option expirations -
American-style
European-style
American-style options can be exercised on any business day prior to the expiration date. European-style options can be exercised at expiration only.
Currency options give the holder the right, but not the obligation, to buy or sell a fixed amount of foreign currency at a specified price. 'American' options are exercisable at any time prior to the expiration date, while 'European' options are exercisable only on the expiration date. Most currency options have 'American' exercise features. Call options give the holder the right to buy foreign currency, while put options give the holder the right to sell foreign currency.
Call options make money when the exchange rate rises above the exercise price (allowing the holder to buy foreign currency at a lower rate), while put options make money when the exchange rate falls below the exercise price (allowing the holder to sell foreign currency at a higher rate). If the exchange rate doesn't reach a level at which the option makes money prior to expiration, it expires worthless – unlike forwards and futures, the holder of an option does not have an obligation to buy or sell if it is not advantageous to do so.
Other types of currency options:
Average Rate Option
Unlike a conventional option, which is settled by comparing the strike with the spot rate at expiration, an average rate option is settled by comparing the strike with the average of the spot rate over the option period. This hedges against price movements without locking in a fixed price or rate upfront. The average can be geometric or arithmetic and can begin at any point during the option period. The sampling process frequency and interval of underlying price observations can be tailored to suit the user.
Unlike a straight American or European-style option, an average rate option can be settled more than once over its life. So for example, the holder of a one-year average rate option can choose to settle the option monthly versus the average price or rate of the underlying the previous month. Average rate options are cheaper than conventional options because the averaging process smooths out the underlying price movements thereby reducing volatility and hence the premium of the option. Typically the volatility of an average rate option is about half the volatility of a conventional option. Also known as an Average Price or Asian option. Averaging has been applied to a wide range of swaps and options.
Average Strike Option
An Average strike option is similar to a standard option except that the strike price is taken to be the arithmetic average of the price of the underlying asset during the life of the option.
Currency options were originally traded OTC (dealer network), not on organized exchanges. Currency traders were intl. banks, investment banks, brokerage houses.
Options in OTC can be customized for the traders - maturity, contract size, exercise price, usually in large amounts of $1m, the size of most currency trades in the spot market.
Since 1982, currency options have been traded on the Philadelphia Stock Exchange, see Exhibit 9.6 on p. 210 for contracts. Option contract sizes are half of the futures contracts, e.g., £31,250 instead of £62,500, approx $56,000. Contracts are traded on a March, June, Sept, Dec cycle with original maturities of 3, 6, 9, 12 months. In addition, one and two month contracts are also traded so that there are always 1, 2 and 3 month contracts. Also, long term option contracts are traded for 18, 24, 30, 36 months.
OTC trading dominates currency options trading on the Philadelphia exchange, $60B/day OTC vs. $1.5B/day for exchange-traded contracts. See WSJ story on p. 211. Big currency traders (banks) prefer OTC market, it operates 24 hours/day (necessary now in global market - time zone differences in Asia, Europe/currency crises), contract size is much bigger ($1m vs. $45,000 avg. PHLX), more efficient, lower transactions cost. PHLX limits traders to 100,000 max contracts. Also, trading is thin in exchange-traded currency derivative markets (3% of worldwide total), so prices tend to be less reliable, more volatile. For a $100m trade, it would be cheaper OTC vs. exchange trade.
Currency swaps
Currency swap is the type of forex derivative. It is an agreement between two parties to buy or sell currency at spot rates, which reverts at the end of an agreed period for a specified price (the forward rate). The forward rate is calculated from the spot rate, forward points (premium on the spot rate based on the interest rate differential between the currencies) and length of the agreement in days.
In a currency swap, the holder of an unwanted currency exchanges that currency for an equivalent amount of another currency to improve the market liquidity of a currency owned or to obtain bank financing at a lower rate. For example, company ONE obtains five-year below market financing from a German bank, and swaps deutschmarks for dollars with company TWO, which has more U.S. Dollars than it needs. At maturity, the swap is reversed. A cross-currency swap involves the exchange of a fixed rate obligation in one currency for a floating rate obligation in another. swaps are technically borrowings, but unlike bank loans they are not ordinarily disclosed on the balance sheet.
Currency swaps can be negotiated for a variety of maturities up to at least 10 years. Unlike a back-to-back loan, a currency swap is not considered to be a loan by
Currency swaps are often combined with interest rate swaps. For example, one company would seek to swap a cash flow for their fixed rate debt denominated in US dollars for a floating-rate debt denominated in Euro. This is especially common in
Interest Rate swaps is a financial interest rate contracts whereby the buyer and seller swap interest rate exposure over the term of the contract. The most common swap contract is the fixed-to-float swap whereby the swap buyer receives a floating rate from the swap seller, and the swap seller receives a fixed rate from the swap buyer. Other types of swap include fixed-to-fixed and float-to-float. Interest rate swaps are more often utilized by commercials to re-allocate interest rate risk exposure.
In other words, a currency swap involves two principal amounts, one for each currency. There is an exchange of the principal amounts and the rate generally used to determine the two principal amounts is the then prevailing spot rate. Alternatively, the parties to the swap transaction can also enter into delayed/forward start swaps by agreeing to use the forward rate.
A currency swap is similar to a series of foreign exchange forward contracts, which are agreements to exchange two streams of cash flows in different currencies. Like all forward contracts, the currency swap exposes the user to foreign exchange risk. The swap leg the party agrees to pay is a liability in one currency and the swap leg the party agrees to receive is an asset in the other currency.
The first mentioned swap is generally the preferred swap. In the stated case, the customer enters into the swap with the bank to receive floating interest rate (USD Libor) payments and USD principal and simultaneously pays INR fixed interest rate and equivalent INR principal amount arrived at based on the spot rate prevailing on the transaction date.
FOREX Types ( All Types with full detail )
FOREX Types ( All Types with full detail )
Currency futures
Futures Contract is a legally binding agreement to buy or sell a commodity or financial instrument at a later date. Futures contracts are standardized according to the quality, quantity and delivery time and location for each commodity. Futures contracts have secondary markets, can be traded many times during life of contract, like a bond (vs. bank loan).
A futures contract is a standardized commitment that describes the key features of a transaction:
The quantity and quality of the commodity being exchanged
The date on which the exchange is to take place
The method of delivery
The price at which the commodity will be purchased
Examples: Yen contracts: ¥12.5m (approx $116,000), Pound: £62,500 (approx. $112,500), Euro: 125,000 (approx $160,000), SF: 125,000 (approx $104,000), etc. Expiration dates: March, June, Sept, Dec. on the 3rd Wednesday.
Currency futures started trading in 1972 at the
Fixed exchanges rates until 1973 meant no currency risk.
Interest rates were fixed by federal law for savings accounts (Reg. Q) and checking accounts (i = 0%), and some mortgages (led to "points").
Inflation was low and stable, 2-3% in the 50s, 60s and early 70s.
Interest rates on T-bills were low and stable 1-2%.
Price of oil was low and stable stable.
Economic and financial volatility increased dramatically in the 1970s. Fixed ex-rates were abandoned, started to float. Req Q was eventually repealed. Inflation and int. rates rose and became volatile in the 1970s. Oil prices doubled and tripled in the two oil shocks of the 1970s (74-75 and 79-80). Led to an explosion in the derivative markets for futures contracts.
Unlike the purchase or sale of a security, no price is paid or received upon the purchase or sale of a futures contract. Initially, the Account will be required to deposit in a custodial account an amount of cash, United States Treasury securities, or other permissible assets equal to approximately 5% of the contract amount. This amount is known as “initial margin.” The nature of initial margin in futures transactions is different from that of margin in security transactions in that futures contract margin does not involve the borrowing of funds by the customer to finance the transactions. Rather, the initial margin is in the nature of a performance bond or good faith deposit on the contract, which is returned to the Account upon termination of the futures contract assuming all contractual obligations have been satisfied.
The initial investment required to establish a futures position, usually 3-5% of the contract value. To buy one U.K. pound contract, you would have to put up about $4500 ($112,500 x 4%). You would also have to keep a "maintenance margin" usually about 75% of the initial margin. In this case, you could never let your account go below $3375 (75% of $4500). If you can't make margin call, your contract is liquidated by broker.
There are two types of futures contracts, those that provide for physical delivery of a particular commodity and those that call for an even tual cash settlement. The commodity itself is specifically defined, as is the month when delivery or settlement is to occur. A July futures contract, for example, provides for delivery or settlement in July.
It should be noted that even in the case of delivery-type futures contracts, very few actually result in delivery. Not many speculators want to take or make delivery of 5,000 bushels of grain or 40,000 pounds of pork. Rather, the vast majority of both speculators and hedgers choose to realize their gains or losses by buying or selling an offsetting futures contract prior to the delivery date.
Selling a contract that was previously pur chased liquidates a futures position in exactly the same way that selling 100 shares of IBM stock liquidates an earlier purchase of 100 shares of IBM stock. Similarly, a futures contract that was initially sold can be liquidated by making an offsetting purchase. In either case, profit or loss is the difference between the buying price and the selling price, less transaction expenses.
Cash settlement futures contracts are precisely that, contracts that are settled in cash rather than by delivery at the time the contract expires. Stock index futures contracts, for example, are settled in cash on the basis of the index number at the close of the final day of trading.
Participants of currency futures market
Speculators - pure speculative bet/investment, with no business interest in the underlying commodity/currency.
Hedgers - someone with a business/personal interest in the underlying currency, and is using futures trading to minimize, eliminate or control currency risk, e.g., MNCs, banks, exporters, importers, etc.
If a hedger is short (long) and a speculator is long (short), the hedger is "selling" their risk to the speculator.
Hedgers
The details of hedging can be somewhat complex but the principle is simple. By buying or selling in the futures market now, individuals and firms are able to establish a known price level for something they intend to buy or sell later in the cash market. Buyers are thus able to protect themselves against—that is, hedge against—higher prices and sellers are able to hedge against lower prices. Hedgers can also use futures to lock in an acceptable margin between their purchase cost and their selling price.
A jewelry manufacturer will need to buy additional gold from its supplier in six months to produce jewelry that it is already offering in its catalog at a published price. An increase in the cost of gold could reduce or wipe out any profit margin. To minimize this risk, the manufacturer buys futures contracts for delivery of gold in six months at a price of $300 an ounce.
If, six months later, the cash market price of gold has risen to $320, the manufacturer will have to pay that amount to its supplier to acquire gold. But the $20 an ounce price increase will be offset by a $20 an ounce profit if the futures contract bought at a price of $300 is sold for $320.
The hedge, in affect, provided protection against an increase in the cost of gold. It locked in a cost of $300, regardless of what happened to the cash market price. Had the price of gold declined, the hedger would have incurred a loss on the futures position but this would have been offset by the lower cost of acquiring gold in the cash market.
Whatever the hedging strategy, the common denominator is that hedgers are willing to give up the opportunity to benefit from favorable price changes in order to achieve protection against unfavorable price changes.
Risk Minimizing Hedge strategy
As stated earlier, the objective of hedging is to minimize risk, not to maximize profits from currency speculation. Using futures contracts, this is typically accomplished by taking a short position in the futures market to offset any gains or losses in the spot market. From a portfolio perspective, the hedger would have a portfolio consisting of a long position in the cash market, and a short position in the futures market. The return on the portfolio is equal to the return on the spot position (denoted S) plus the return on the futures position (denoted F):
Return = S + hFwhereh - denotes the number of futures contracts held in the portfolio, or the 'hedge ratio'. In most instances, h will be negative, depicting a short position. The optimal value for h is the one that minimizes the variance of the portfolio:Var(S + hF) = Var(S) + h2Var(F) + 2hCov(S,F)Taking the first derivative with respect to h and setting it equal to zero yields the hedge ratio that minimizes the portfolio variance:2hVar(F) + 2Cov(S,F) = 0h* = -2Cov(S,F)/Var(F)whereh* - is the variance-minimizing hedge ratio. Because spot prices and futures prices are highly correlated, h* should be fairly close to –1.
The hedge ratio is calculated using historical returns in the cash and futures market. Since exchange rate levels exhibit non-stationarity (i.e. they can deviate from their long-term mean level for prolonged periods of time), means and variances are not meaningful unless returns are used. The covariance between cash returns and futures returns is assumed to be relatively stable over the hedging horizon, although hedge ratios can be dynamically updated over the hedging horizon if one wants a more precise hedge.
Speculators
Were you to speculate in futures contracts by buying to profit from a price increase or selling to profit from a price decrease, the party taking the opposite side of your trade on any given occasion could possibly be a hedger or it might be another speculator, someone whose opinion about the probable direction and timing of prices differs from your own.
Buying futures contracts with the hope of later being able to sell them at a higher price is known as "going long." Conversely, selling futures contracts with the hope of being able to buy back identical and offsetting futures contracts at a lower price is known as "going short." An attraction of futures trading is that it is equally as easy to profit from declining prices (by selling) as it is to profit from rising prices (by buying).
The difference between the price of a commodity in the cash (or 'spot') market and the currency futures market is called the 'basis', and is determined by relative interest rates for financial futures. The price is established by an arbitrage argument which asserts that the payoff from converting a unit of domestic currency at the spot rate, lending in another currency and converting the proceeds in the forward market should yield the same profit as lending the unit of domestic currency at home – provided he or she can borrow and lend at the risk-free rate. Using S as the spot rate, F as the forward rate – both in terms of domestic currency per unit of foreign currency – r as the domestic effective interest rate and rf as the foreign effective interest rate, the above equality produces the identity:
(1+r) = (1/S)*(1+rf)*F, orF = S*(1+r)/(1+rf)
If this condition does not hold, then arbitrageurs would take advantage of the opportunity by borrowing unlimited amounts in the country with low interest rate, investing in the country with the high interest rate and converting at the forward rate for a risk-free profit. This would lead to an adjustment in the exchange rate until the opportunity was no longer profitable. This relationship is more commonly known as 'interest rate parity'. Slight deviations from parity may be apparent in the market due to transaction costs.
Currency forwards:
Forward (Cash) Contract is a cash contract in which a seller agrees to deliver a specific cash commodity to a buyer sometime in the future. Forward contracts, in contrast to futures contracts, are privately negotiated and are not standardized.
Many market participants want to exchange currencies at a time other than two days in advance but would like to know the rate of exchange now. Forward foreign exchange contracts are generally used by importers, exporters and investors who seek to lock in exchange rates for a future date in order to hedge their foreign currency cash flows.
For example, if a company had contracted to purchase equipment for the price of GBP 1 million payable in 3 months time but was concerned that the GBP would rise against the Australian dollar in the interim, the company could agree today to buy the USD for delivery in 3 months time. In other words, the company could negotiate a rate at which it could buy GBP at some time in the future, setting the amount of GBP needed, the date needed etc. and hence be sure of the Australian Dollar purchasing price now.
There are two components to the price in forward transaction and they are the spot price and the forward rate adjustment.
The spot rate is simply the current market rate as determined by supply and demand. The forward rate adjustment is a slightly more complicated calculation that involves the applicable interest rates of the currencies involved.
Forward Exchange Contracts, both Buying and Selling, may be either fixed or optional term contracts.
Fixed Term Contracts:
With a Fixed Term Contract the customer specifies the date on which delivery of the overseas currency is to take place. An earlier delivery can be arranged but it may involve a marginal adjustment to the Forward Contract Rate.
Optional Term Contracts:
Optional Term Contracts can be entered into for a specific period, and the customer states the period within which delivery is to be made (normally for periods not more than one month) eg. a contract may be entered into for a six month period with the customer having the option of delivery at anytime during the last week.
In each case there is a firm contract to effect delivery by both the Bank and the customer. An optional delivery contract does not give the customer an option to not deliver the Forward Exchange Contract. It is only the period during which delivery may occur that is optional.
Forward rates are quoted for transactions where settlement is to take place more than two business days after the transaction date. Forward Contract rates consist of the Spot rate for the currency concerned adjusted by the relative Forward Margin.
Forward Margins are a reflection of the interest rate differentials between currencies, and not necessarily a forecast of what the spot rate will be at the future date.
The Forward rate may be expressed as being at parity (par), or at a Premium (dearer) or at a Discount (cheaper), when related to the spot rate. It follows therefore that premiums are deducted from the spot rate and discounts are added to the spot rate.
Forward Rates incorporating a 'Premium' are more favourable to exporters and less favourable to importers than the relative spot rates on which they are based. Similarly, Forward rates incorporating a 'Discount' are more favourable to importers and less favourable to exporters that the relative spot rates on which they are based.
The general rule in determining whether a currency will be quoted at a premium or a discount is as follows:
The currency with the higher interest rate will be at a discount on a forward basis against the currency with the lower interest rate.
The currency with the lower interest rate will be at a premium on a forward basis against the currency with the high interest rate.
As the interest differential between the currencies widens then the premium or discount margin increases (i.e. moves farther from parity) and similarly as the interest differential narrows then the premium or discount margin decreases (ie moves towards parity).
Differences/similarities between futures and forward contracts:
Similarities:
1. Both are derivative securities for future delivery/receipt. Agree on P and Q today for future settlement or delivery in 1 week to 10 years.
2. Both are used to hedge currency risk, interest rate risk or commodity price risk.
3. In principal they are very similar, used to accomplish the same goal of risk management.
Differences:
1. Forward contracts are private, customized contracts between a bank and its clients (MNCs, exporters, importers, etc.) depending on the client's needs. There is no secondary market for forward contracts since it is a private contractual agreement, like most bank loans (vs. bond).
2. Forward contracts are settled at expiration, futures contracts are continually settled, daily settlement.
3. Most (90%) of forward contracts are settled with delivery/receipt of the asset. Most futures contracts (99%) are settled with cash, NOT the commodity/asset.
4. Futures markets have daily price limits.
Forward Exchange Contract is a bilateral contract between two counterparties, and therefore each party is responsible for assessing the credit standing and capacity of the other party, before entering into a transaction.
The deals are totally flexible as to the maturity date, the size of the transaction and the currency involve
Derivatives-Forex Theory and Types ( full Information )
Derivatives
Derivatives play an important and useful role in the economy, but they also pose several dangers to the stability of financial markets and the overall economy. Derivatives are often employed for the useful purpose of hedging and risk management, and this role becomes more important as financial markets grow more volatile. Derivatives are also used to commit fraud and to manipulate markets.
Derivatives are powerful tools that can be used to hedge the risks normally associated with production, commerce and finance. Derivatives facilitate risk management by allowing a person to reduce his exposure to certain kinds of risk by transferring those risks to another person that is more willing and able to bear such risks.
Today, derivatives are traded in most parts of the world, and the size of these markets is enormous. Data for 2002 by the Bank of International Settlements puts the amount of outstanding derivatives in excess of $151 trillion and the trading volume on organized derivatives exchanges at $694 trillion. By comparison, the IMF’s figure for worldwide output, or GDP, is $32.1 trillion.
A derivative is a financial contract whose value is linked to the price of an underlying commodity, asset, rate, index or the occurrence or magnitude of an event. The term derivative refers to how the price of these contracts is derived from the price the underlying item. Typical examples of derivatives include futures, forwards, swaps and options, and these can be combined with traditional securities and loans in order to create structured securities which are also known as hybrid instruments.
Forward deals are a form of insurance against the risk that exchange rates will change between now and the delivery date of the contract. A forward is a simple kind of a derivative - a financial instrument whose price is based on another underlying asset. The price in a forward contract is known as the delivery price and allows the investor to lock in the current exchange rate and thus avoid subsequent forex fluctuations.
Futures contracts are like forwards, except that they are highly standardized. The futures contracts traded on most organized exchanges are so standardized that they are fungible - meaning that they are substitutable one for another. This fungibility facilitates trading and results in greater trading volume and greater market liquidity.
While futures and forward contracts are both a contract to trade on a future date, key differences include:
Futures are always traded on an exchange, whereas forwards always trade over-the-counter
Futures are highly standardized, whereas each forward is unique
The price at which the contract is finally settled is different:
Futures are settled at the settlement price fixed on the last trading date of the contract (i.e. at the end)
Forwards are settled at the forward price agreed on the trade date (i.e. at the start)
The credit risk of futures is much lower than that of forwards:
The profit or loss on a futures position is exchanged in cash every day. After this the credit exposure is again zero.
The profit or loss on a forward contract is only realised at the time of settlement, so the credit exposure can keep increasing
In case of physical delivery, the forward contract specifies to whom to make the delivery. The counterparty on a futures contract is chosen randomly by the exchange.
In a forward there are no cash flows until delivery, whereas in futures there are margin requirements and periodic margin calls.
Foreign currency swaps can be defined as a financial foreign currency contract whereby the buyer and seller exchange equal initial principal amounts of two different currencies at the spot rate. It is worth mentioning in this regard that the buyer and seller exchange fixed or floating rate interest payments in there respective swapped currencies over the term of the contract.
According to experts upon the maturity, the principal amount is effectively re-swapped at a predetermined exchange rate so that the parties end up with their original currencies. Foreign currency swaps are more often than not been used by commercials as a foreign currency-hedging vehicle rather than by retail forex traders.
Options allow investors even greater flexibility. Although more expensive than futures contracts, options are valued because they allow investors to choose whether to exercise a futures contract or not. The option-holder is under no obligation to buy or sell the underlying asset. Call options give an investor the right, but not the obligation, to purchase the indicated asset at a specified (strike) price by a certain date.
An investor who buys a call option is hoping, or betting, that the price of the asset will rise above the strike price. Put options give the option-holder the right, but not the obligation, to sell the security by a certain date. The purchaser of a put option is hoping or betting that the price of the asset will fall below the contract’s strike price. An option contract gives the its holder the “option” (or the right) to buy (or sell) the underlying item at a specific price at a specific time period in the future. There are two kinds of options. Buying a call option provides an investor the right to buy an asset while a put option gives the investor the right to sell the asset.
Balance of payments model
Balance of payments model
This model holds that a foreign exchange rate must be at its equilibrium level - the rate which produces a stable current account balance. A nation with a trade deficit will experience reduction in its foreign exchange reserves which ultimately lowers (depreciates) the value of its currency. The cheaper currency renders the nation's goods (exports) more affordable in the global market place while making imports more expensive. After an intermediate period, imports are forced down and exports rise, thus stabilizing the trade balance and the currency towards equilibrium.
Like PPP, the balance of payments model focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. In other words, money is not only chasing goods and services, but to a larger extent, financial assets such as stocks and bonds. Their flows go into the capital account item of the balance of payments, thus, balancing the deficit in the current account. The increase in capital flows has given rise to the asset market model.
Asset market model
The explosion in trading of financial assets (stocks and bonds) has reshaped the way analysts and traders look at currencies. Economic variables such as economic growth, inflation and productivity are no longer the only drivers of currency movements. The proportion of foreign exchange transactions stemming from cross border-trading of financial assets has dwarfed the extent of currency transactions generated from trading in goods and services.
The asset market approach views currencies as asset prices traded in an efficient financial market. Consequently, currencies are increasingly demonstrating a strong correlation with other markets, particularly equities.
Like the stock exchange, money can be made or lost on the foreign exchange market by investors and speculators buying and selling at the right times. Currencies can be traded at spot and foreign exchange options markets. The spot market represents current exchange rates, whereas options are derivatives of exchange rates.
Fluctuations in exchange rates
A market based exchange rate will change whenever the values of either of the two component currencies change. A currency will tend to become more valuable whenever demand for it is greater than the available supply. It will become less valuable whenever demand is less than available supply (this does not mean people no longer want money, it just means they prefer holding their wealth in some other form, possibly another currency).
Increased demand for a currency is due to either an increased transaction demand for money, or an increased speculative demand for money. The transaction demand for money is highly correlated to the country's level of business activity, gross domestic product (GDP), and employment levels. The more people there are unemployed, the less the public as a whole will spend on goods and services. Central banks typically have little difficulty adjusting the available money supply to accommodate changes in the demand for money due to business transactions.
The speculative demand for money is much harder for a central bank to accommodate but they try to do this by adjusting interest rates. An investor may choose to buy a currency if the return (that is the interest rate) is high enough. The higher a country's interest rates, the greater the demand for that currency. It has been argued that currency speculation can undermine real economic growth, in particular since large currency speculators may deliberately create downward pressure on a currency in order to force that central bank to sell their currency to keep it stable (once this happens, the speculator can buy the currency back from the bank at a lower price, close out their position, and thereby take a profit).
In choosing what type of asset to is officially pegged, synthetic markets have emerged that can behave as if the yuan were floating).
Exchange Rate ( Full Defination, Notes and Tutorials)
Exchange Rate
In finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how much one currency is worth in terms of the other. For example an exchange rate of 123 Japanese yen (JPY, ¥) to the United States dollar (USD, $) means that JPY 123 is worth the same as USD 1. The foreign exchange market is one of the largest markets in the world. By some estimates, about 2 trillion USD worth of currency changes hands every day.
The spot exchange rate refers to the current exchange rate. The forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.
Contents[
1 Quotations
2 Free or pegged
3 Nominal and real exchange rates
4 Bilateral vs effective exchange rate
5 Uncovered interest rate parity
6 Balance of payments model
7 Asset market model
8 Fluctuations in exchange rates
9 See also
10 References
11 External links
Quotations
An exchange rate quotation is given by stating the number of units of "term currency" or "price currency" that can be bought in terms of 1 unit currency (also called base currency). For example, in a quotation that says the EURUSD exchange rate is 1.3 (1.3 USD per EUR), the term currency is USD and the base currency is EUR.
There is a market convention that determines which is the base currency and which is the term currency. In most parts of the world, the order is:EUR - GBP - AUD - NZD - USD - *** (where *** is any other currency).Thus if you are doing a conversion from EUR into AUD, EUR is the base currency, AUD is the term currency and the exchange rate tells you how many Australian dollars you would pay or receive for 1 euro.
Quotes using a country's home currency as the price currency (e.g., EUR 1.00 = $1.45 in the US) are known as direct quotation or price quotation (from that country's perspective) ([1]) and are used by most countries.
Quotes using a country's home currency as the unit currency (e.g., £0.4762 = $1.00 in the US) are known as indirect quotation or quantity quotation and are used in British newspapers and are also common in Australia, New Zealand and the eurozone.
direct quotation: 1 foreign currency unit = x home currency units
indirect quotation: 1 home currency unit = x foreign currency units
Note that, using direct quotation, if the home currency is strengthening (i.e., appreciating, or becoming more valuable) then the exchange rate number decreases. Conversely if the foreign currency is strengthening, the exchange rate number increases and the home currency is depreciating.
When looking at a currency pair such as EURUSD, the first component (EUR in this case) will be called the base currency. The second is called the term currency. For example : EURUSD = 1.33866, means EUR is the base and USD the term, so 1 EUR = 1.33866 USD.
Currency pairs are often incorrectly quoted with a "/" (forward slash). In fact if the slash is inserted, the order of the currencies should be reversed. This gives the exchange rate. e.g. if EUR1 is worth USD1.35, euro is the base currency and dollar is the term currency so the exchange rate is stated EURUSD or USD/EUR. To get the exchange rate divide the USD amount by the euro amount e.g. 1.35/1.00 = 1.35
Market convention from the early 1980s to 2006 was that most currency pairs were quoted to 4 decimal places for spot transactions and up to 6 decimal places for forward outrights or swaps. (The fourth decimal place is usually referred to as a "pip.") An exception to this was exchange rates with a value of less than 1.000 which were usually quoted to 5 or 6 decimal places. Although there is no fixed rule, exchange rates with a value greater than around 20 were usually quoted to 3 decimal places and currencies with a value greater than 80 were quoted to 2 decimal places. Currencies over 5000 were usually quoted with no decimal places (e.g. the former Turkish Lira). e.g. (GBPOMR : 0.765432 - EURUSD : 1.3386 - GBPBEF : 58.234 - EURJPY : 165.29). In other words, quotes are given with 5 digits. Where rates are below 1, quotes frequently include 5 decimal places.
In 2006 Barclays Capital broke with convention by offering spot exchange rates with 5 or 6 decimal places. The contraction of spreads (the difference between the bid and offer rates) arguably necessitated finer pricing and gave the banks the ability to try and win transaction on multibank trading platforms where all banks may otherwise have been quoting the same price. A number of other banks have now followed this.
Free or pegged
Main article: Exchange rate regime
If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly as quoted on financial markets, mainly by banks, around the world. A movable or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a currency. For example, between 1994 and 2005, the Chinese yuan renminbi (RMB) was pegged to the United States dollar at RMB 8.2768 to $1. China was not the only country to do this; from the end of World War II until 1966, Western European countries all maintained fixed exchange rates with the US dollar based on the Bretton Woods system. [2]
and real exchange rates
The nominal exchange rate e is the price in domestic currency of one unit of a foreign currency.
The real exchange rate (RER) is defined as , where P is the domestic price level and P * the foreign price level. P and P * must have the same arbitrary value in some chosen base year. Hence in the base year, RER = e.
The RER is only a theoretical ideal. In practice, there are many foreign currencies and price level values to take into consideration. Correspondingly, the model calculations become increasingly more complex. Furthermore, the model is based on purchasing power parity (PPP), which implies a constant RER. The empirical determination of a constant RER value could never be realised, due to limitations on data collection. PPP would imply that the RER is the rate at which an organization can trade goods and services of one economy (e.g. country) for those of another. For example, if the price of a good increases 10% in the UK, and the Japanese currency simultaneously appreciates 10% against the UK currency, then the price of the good remains constant for someone in Japan. The people in the UK, however, would still have to deal with the 10% increase in domestic prices. It is also worth mentioning that government-enacted tariffs can affect the actual rate of exchange, helping to reduce price pressures. PPP appears to hold only in the long term (3–5 years) when prices eventually correct towards parity.
More recent approaches in modelling the RER employ a set of macroeconomic variables, such as relative productivity and the real interest rate differential.
Bilateral vs effective exchange rate
Bilateral exchange rate involves a currency pair, while effective exchange rate is weighted average of a basket of foreign currencies, and it can be viewed as an overall measure of the country's external competitiveness. A nominal effective exchange rate (NEER) is weighted with trade weights. a real effective exchange rate (REER) adjust NEER by appropriate foreign price level and deflates by the home country price level. Compared to NEER, a GDP weighted effective exchange rate might be more appropriate considering the global investment phenomenon.
Uncovered interest rate parity
See also: Interest rate parity#Uncovered interest rate parity
Uncovered interest rate parity (UIRP) states that an appreciation or depreciation of one currency against another currency might be neutralized by a change in the interest rate differential. If US interest rates exceed Japanese interest rates then the US dollar should depreciate against the Japanese yen by an amount that prevents arbitrage. The future exchange rate is reflected into the forward exchange rate stated today. In our example, the forward exchange rate of the dollar is said to be at a discount because it buys fewer Japanese yen in the forward rate than it does in the spot rate. The yen is said to be at a premium.
UIRP showed no proof of working after 1990s. Contrary to the theory, currencies with high interest rates characteristically appreciated rather than depreciated on the reward of the containment of inflation and a higher-yielding currency..
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