Wednesday, July 22, 2009

Forex Market:Major Players

The Forex market consists of a network of dealers and traders grouped around the world.

The Major Dealing Centers.

While there is no true center, the Forex market has major dealing centers located in London, New York, and Tokyo. These are labeled 'major centers' because the activity in these places hold tremendous influence on the market. There are other centers labeled 'minor centers,' which also play a significant, albeit smaller, role in the market. These 'minor centers' Hong Kong, Singapore, Sydney, Frankfurt and Zurich. The 8 regions are very influential when it comes to the trading practice of the Forex market.

Central Banks

The majority of developed market economies have a central bank, whose role differs from country to country. Central banks play an important role in the Forex market. They try to maintain the money supply, interest rates, inflation, and other market factors. A nation's central bank also has the fundamental responsibility of maintaining the market for its national currency. This entails monitoring and checking the prices dealt in the Forex market. Banks
Both small and large banks, working for themselves and their clients (institutions, individual investors), participate in the Forex markets. According to the Bank for International Settlements, approximately 50% of all Forex transactions are strictly interbank (See Key terms section) trades. Some of the more active large banks may trade up to one billion dollars daily.

Market Makers

Forex market makers are the banks and brokerage companies that facilitate the 24 hour trading capabilities of the Forex market. Market makers literally "make the market" for the currencies. They ensure that the market is always functional and that the currencies in it will always obtain the market rate. To achieve this level and efficiency of trading, Forex market makers update their prices at least two times per minute allowing the trader to get the most complete up to date price and information as possible.

Small and large companies also play an important role in the Forex market. Compared to banks and hedge funds, corporations trade less amounts of currency. Although they also do not hold the influence of banks and hedge funds, they keep the market strong through international trade and foreign currency exchange between multinational companies.

Fund Managers

Forex fund manager are similar to money managers in the investment field. However, fund managers do business in both the domestic and international arena for individual investors, corporate pension funds, governments, and even central banks. Hedge Funds
Hedge funds have a reputation for aggressive currency speculation. Hedge funds oversee billions of dollars of equity, and, due their tremendous borrowing power, may have rivaled the power and influence of central banks, if investments and market rends are in their favor. As opposed to banks and fund managers, hedge funds are primarily more concerned with managing the total risk of their investment pools.

Investment Management Firms

Investment management firms typically manage large accounts on behalf of corporate pension funds, trusts, charity organization and similar institutions. They use the Forex market to facilitate transactions in foreign securities. An example of an investment firm's activity in the Forex market is given by trading markets.com: an investment manager in charge of an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases. Like hedge funds, investment firms are concerned with limiting risk (while, of course, maximizing returns).

Brokers and Electronic Brokers

The Forex broker is very similar to a stockbroker. One difference, though, is that Forex brokers only deal with banks. They, in a very efficient manner, act as the primary agent for bank transactions of the Forex market. Due to technological innovations in the market, many traditional brokering duties have been computerized, decreasing the need for human handling of the orders.

This technological takeover of the brokerage aspect of the Forex market, has led to the emergence of 'straight through processing.' This has opened up Forex trading to a new, wide range of individuals and companies.

Forex : Spot And Forward rates

Exchange Rates

Exchange rates (Foreign-exchange rate, Forex rate or FX rate) between two currencies specify how much one currency is worth in terms of the other.

The exchange rate value is found by stating the number of units of the "term currency" that can be bought in terms of 1 unit of the "base currency."

For example, for the quotation EUR/USD the exchange rate is 1.5877. This translates into 1.5877 U.S. Dollars per Euro, the term currency is USD and the base currency is EUR.

Fixed Exchange Rate

A fixed exchange rate (also called a pegged exchange rate) is a type of exchange rate where a currency's value is matched to the value of another single currency or to a basket (a collection of currencies whose value is used as a benchmark for value) of other currencies.
Many times the purpose of the fixed exchange rate is to steady the value of a currency, via the currency it is "pegged" to. Spot Exchange Rate

The spot exchange rate also refers to the current exchange rate. Spot exchange rates are the price a buyer expects to pay for a foreign currency in another currency. Other names for the spot exchange rate are "straightforward rates," "benchmark rates," or "outright rate."

Forward Exchange Rate

The forward exchange rate is the exchange rate that is quoted today but used for delivery and payment on a future date.

Saturday, July 18, 2009

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Tuesday, July 14, 2009

Forex: Basics

The main function of the foreign exchange market is to support the trading of assorted global currencies. Although the majority of trades concern only a small number of currencies, including the U.S. Dollar, Yen, Euro, Swiss Franc, Pound Sterling, Australian Dollar, and Canadian Dollar, many other different types of currency are exchanged on a smaller scale. Over 90% of all exchanges on the forex markets involve the U.S. Dollar.

The forex market is, despite the popular impression, a composite of several contrasting markets, each of which sustains its own rules and regulations, with no one centred market in which all currency trading takes place. The major markets, the U.S., London, and Tokyo, open during different hours because of the different time zones. When the New York market opens, and while the European markets are still operating, is when trading is heaviest and nearly two thirds of the trading action happens during this convergence.

An individual exchange rate for a given currency does not subsist since there is no centred market. The bid and ask rates for a currency whilst normally reasonably close to each other, can, because of the over-the-counter (OTC) nature of the markets, deviate among dissimilar geographic markets and market makers.

Three letters express an international currency code for every currency and because the price of a currency must be applied in reference to another currency, it is displayed in the form XXX/YYY. The price of the British Pound in U.S. Dollars is recorded as GBP/USD, for instance. Acknowledged as the base currency, and the securest currency when the pair was made, is the first in the pair while the other currency is known as the counter currency. Presented in decimal form the real prices themselves are normally rounded to the nearest ten-thousandth of a unit.

Close to $2 trillion is exchanged each day in the forex market and it comprises the largest market in the world. With more than three quarters of deals surviving less than a week forex trading is, for the most part, a high-risk, short-term market. It is a highly fluid market, a good deal more so than equities, with the many traders worldwide and the very high daily turnover rate.

The top ten most active traders, however, are responsible for nearly three quarters of total dealing volume. The trading activity that happens within the interbank market, which is formed by international banks, provide the market with bid and ask prices that are far closer than retail customers can get.

In 1972, at the Chicago Mercantile Exchange, forex futures contracts, that are derivatives, were introduced and now make up around seven percent of the all foreign exchange volume.

Something else that has also taken hold and is another popular hedging strategy is foreign exchange options. Investors often buy these derivatives, which are contracts to purchase currency at a certain price on a future date, to counterbalance the decline in the price of a currency and any possible losses they might endure.

An additional means by which traders are capable of mitigating risk is through an exchange, in which both parties agree to switch one currency for another for a set period of time, and will then reverse the transaction after the period runs out.

Amongst financial markets the foreign exchange market is without competition and is a fast-paced, international currency exchange. International companies, prominent banks and financial organizations will ensure its huge popularity continues and its growth is guaranteed into the future.

Forex: A Beginner's Guide

Like most other rates in economics, the exchange rate is essentially a price and can be analyzed in the same way we would a price. Take a typical supermarket price, say lemons are selling at the price of 3 for a dollar or 33 cents each. Then we can think of the dollar-to-lemon exchange rate as being 3 lemons because if we give up one dollar, we can get three lemons in return. Similarly, the lemon-to-dollar exchange rate is 1/3 of a dollar or 33 cents, because if you sell a lemon, you will get 33 cents in return.

If we want to know the Y-to-X exchange rate, we calculate it using the simple exchange rate formula:

Y-to-X exchange rate = 1 / X-to-Y exchange rate

Instead they're relative prices for different currencies, but they work in the same fashion. On February 26, 2003 the U.S.-to-Japan exchange rate was 117 yen, so this means that you can purchase 117 Japanese yen in exchange for 1 U.S. dollar. Japan-to-U.S. exchange rate = 1 / U.S.-to-Japan exchange rate

Japan-to-U.S. exchange rate = 1 / 117 = .00854

Similarly if the Canadian dollar is worth .67 U.S. dollars, we have a Canada-to-U.S exchange rate of .67. U.S.-to-Canada exchange rate = 1/Canada-to-U.S. Exchange rate

U.S.-to-Canada exchange rate = 1/0.67 = 1.4925

Suppose the Algerian dinars-to-Bulgarian leva exchange rate is 2. Instead assume that the current market Bulgarian-to-Algerian exchange rate is 0.6. Then an investor could take five Algerian dinars and exchange them for 10 Bulgarian leva. At the Bulgarian-to-Algerian exchange rate, she'd give up 10 leva and get back 6 dinars. This type of exchange is known as arbitrage. Since our investor gained a dinar, and since we're not creating or destroying any currency, the rest of the market must have lost a dinar. We would expect that the other agents in the currency exchange market will change the exchange rates that they offer so these opportunities to get exploited are taken away. Suppose that the Algerian dinars-to-Bulgarian leva exchange rate is 2 and the Bulgarian leva-to-Chilean peso is 3. To figure out what the Algerian-to-Chilean exchange rate needs to be, we just multiply the two exchange rates together:

This property of exchange rates is known as transitivity. To avoid arbitrage we would need the Algerian-to-Chilean exchange rate to be 6 and the Chilean-to-Algerian exchange rate needs to be 1/6. Then our investor could again take five Algerian dinars and exchange them for 10 Bulgarian leva. She could then take her 10 leva and get 30 Chilean pesos at the Bulgarian-to-Chilean exchange rate of 3. If she then exchanged her 30 Chilean pesos at the Chilean-to-Algerian rate of 1/5, she'd get 6 Algerian dinars in return. The A-to-C exchange rate not only places restrictions on the C-to-A exchange rate, but it also places restriction on the A-to-B and B-to-C pair of exchange rates. The relative prices of currencies are not set just to ensure that profitable currency cycles do not exist. Arbitrageurs only play a small, but important, role in the value of a currency. Currencies are simply a commodity, like any other, which has a price. Since the exchange rate is simply a price, it has the same basic determinants that any other price has: supply and demand. First we'll look at supply.

If the supply of a country's currency increases, we should see that it takes more of that currency to purchase a different currency than it did before. Suppose there was a big jump in the supply of the Canadian dollar. We would expect to see the Canadian dollar become less valuable relative to other currencies. So the Canadian-to-U.S. Exchange rate should decrease, from 67 cents down to, say, 50 cents. Each Canadian dollar would give us less American dollars than it did before. Similarly, the U.S.-to-Canadian exchange rate would increase from $1.49 to $2.00, so each U.S. dollar would give us more Canadian dollars than it did before, as a Canadian dollar is less valuable than it used to be.
Why would the supply of a currency increase?

Currencies are traded on the foreign exchange market, and the supply of a currency on that market will change over time. There are a few different organizations whose actions will cause a rise in the supply of the foreign exchange market:
Export Companies

Suppose a South African farm sells the cashews it produces to a large Japanese firm. Since the company needs to pay it's employees in the local currency, namely the South African rand, the company would sell its yen on a foreign exchange market and buy rands. The supply of Japanese yen on the foreign exchange market will increase, and the supply of South African rands will decrease. This will cause the rand to appreciate in value (become more valuable) relative to other currencies and the yen to depreciate.
Foreign Investors

To purchase the land, hire construction workers, etc., the firm will need Canadian dollars. The company will be forced to go to the foreign exchange market, sell some of its euros, and buy Canadian dollars. The supply of euros on the foreign exchange market goes up, and the supply of Canadian dollars goes down. This will cause Canadian dollars to appreciate and euros to depreciate.

If German investors buy Canadian stocks, such as stocks listed on the Toronto Stock Exchange or purchase Canadian dollar bonds, we will have the same situation as above.
Speculators

Suppose a currency investor thinks that the Mexican peso will depreciate in the future, so it will be less valuable than other currencies than it is now. In that case, she is likely to sell her pesos on the foreign exchange market and buy a different currency instead, such as the South Korean won. The supply of pesos goes up and the supply of won goes down.

Note the self-fulfilling nature of the beliefs investors hold. If investors feel that a currency will depreciate in the future, they will try to sell it today. Since the currency is being sold by investors, the supply of it will go up, and the price of it will decrease. The investor thought that the currency would depreciate, she acted on that belief and sold her currency, and the act of selling caused the depreciation to take place.
Central Bankers

The most obvious way to increase the supply of money is to simply print more currency, though there are much more sophisticated ways of changing the money supply. If the Fed prints more 10 and 20 dollar bills, the money supply will increase. When the government increases the money supply, it is likely some of this new money will make its way to the foreign exchange market, so the supply of U.S. dollars will increase there as well.

A central bank will often directly increase the supply of money on the foreign exchange markets. Central banks like the Fed keep a supply of most (if not all) currencies in reserve and will often use them to influence the exchange rate. If the Fed decides that the U.S. dollar has appreciated in value too much relative to the Japanese yen, it will sell some of the U.S. dollars it has in reserve and buy Japanese yen. This will increase the supply of dollars on the foreign exchange market, and decrease the supply of yen, causing a depreciation in the value of the dollar relative to the yen. As well, the Japanese central bank (named the Bank of Japan) could decide that the Fed is manipulating the price of the yen too much and the Bank of Japan could counteract the Fed by selling yen and by buying dollars.

These are the organizations who will increase the supply of currency on the exchange market. Now we'll investigate the demand side of foreign exchange markets.
Why would the demand for a currency increase?

Not surprisingly pretty much the same organizations who caused supply changes will cause demand changes. So if the popularity of Chinese goods goes up in other countries the demand for Chinese yuan will go up as retailers purchase yuan to make purchases from Chinese wholesalers and manufacturers.
Foreign Investors

To purchase the land, hire construction workers, etc., the firm will need Canadian dollars. So the demand for Canadian dollars will rise.

This increased demand leads to an increased price for pesos.
Central Bankers

A central bank might decide that its holdings of a particular currency are too low, so they decide to buy that currency on the open market. They might also want to have the exchange rate for their currency decline relative to another currency. So they put their currency on the open market and use it to buy another currency. So Central Banks can play a role in the demand for currency.