introduction fx new

8/6/2019 Introduction FX New

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Introduction:

This document contains a brief introduction to Forex and Forex trading along withexamples of Forex Swap and Forex Options trade. The document also explains in brief about the advantages of the Forex market and the Forex market participants.By going through this document reader is expected to get a brief idea about Forex and

general business terminologies, understanding of reading Forex quotes, the most activelytraded FX currency pair etc.,The document is designed for the new entrants to the Forex support services in the GCCIT team. It is to be noted that the Forex market and the related aspects are vast in natureand the points briefed in the document are only a synopsis of a few main aspects of theFOREX. The document will help a new joiner to grasp the business/technical aspects of the project quickly.

₪ -Israeli new shekel -Philippines Peso

$-Dollar ¢-Cents

€-Euro ¥-Japanese Yen

Rs. Rupees £ - British Pound

A very brief introduction to Forex and Forex trading:

Foreign Exchange (FOREX) is the arena where a nation's currency is exchanged for thatof another. Unlike other financial markets, the Forex market has no physical location andno central exchange (off-exchange). It operates through a global network of banks,corporations and individuals trading one currency for another. The lack of a physicalexchange enables the Forex market to operate on a 24-hour basis, spanning from onezone to another in all the major financial centers.

Foreign currency exchange (Forex) market is the largest trading market in the world. Ityields an average turnover of $1.9 trillion daily. The figure is nearly 30 times larger thanthe total volume of equity trades in United States.



Forex is actually the short form of the word Foreign Exchange. It refers to thesimultaneous buying and selling of a currency pair. In Forex, currencies are alwaystraded against one another and quoted in pairs. For example, USD/JPY refers to the USdollars and Japanese Yen pair. Some of the major currencies being traded on the Forexmarket are Swiss Franc (CHF), Euro (EUR), British Pound (GBP) and the Japanese Yen

(JPY). All these currencies are traded against the US dollar (USD).

All currencies are traded in pairs. Within the pair itself, the first currency is known as the

base currency while the second currency is known as the quote or counter currency. Allquotes for Forex are quoted in terms of the base currency. When you ask for a currencyquote, you will be given two prices, the bid price and the ask price. The Bid price is the price that you will get for selling a currency while the Ask price is the price that you willget for buying a currency. Both these prices are expressed in terms of the base currency.Let us say that the exchange rate for the USD/CHF currency pair is 1.6550. This meansthat one dollar is equivalent to 1.6550 Swiss francs.

As mentioned earlier, all currency quotes have two prices. For example if you requested aquote for EUR/USD, you will be given a quote like EUR/USD 1.4673/75. The price onthe left side of the quote is the Bid price (1.4673) while the price on the right side is the

Ask Price (1.4675). In Forex, any fluctuation of the rates is referred to by how many“pips”. A pip is actually the smallest movement a currency quote can have. For example,if the EUR/USD Bid price moves to 1.4675, this means the rate had move by 2 pips from1.4673. In this case, depending on the account type that you are trading with, a pip canworth $1 (for a mini account) or $10 (for a 100K account).

BaseCurrenc

yUSD

QuoteCurrencyJPY



Advantages in Forex currency trading

Equal Prospective in Rising or Falling Market Trend

There is no structural bias to the market and there are no restrictions on short selling inFX market. Trading in Forex gives you an equal prospective in rising and falling market.As trades are always done in pair of currency pairs, Forex traders can always find chance

to make money in anytime, regardless on the fall or rise period of one single countrycurrency.

Trade Forex 24 hours a day

Forex market never sleeps. In Forex trading, you do not need to wait the market to open;you can always response to world latest movement and news immediately.

Every Sunday 5.00pm in New York, Forex market starts its week from Sydney, followed by Tokyo, Singapore, Hong Kong, London, and New York. In Forex trading, you canalways response to the market trend a lot faster than in any other trading market.Leverage trading in Forex market

Also, with the flexibility of Forex market trading time, you can work on your trade inForex during your free time. This means you can start small and work as part time trader before going full time on FX trading.

High Leverage Margin

Forex brokers offer trade margin of 50, 100, 150, or even 200 to 1 of trade margin.Forex traders often find themselves controlling a huge sum of money with little cashoutlay on the table. For example, a $1,000 in a 150:1 Forex account will gives you the purchase power of $150,000 in the currency market.While certainly not for everyone, the substantial leverage available from online currency

trading firms is a powerful, moneymaking tool. Rather than merely loading up on risk asmany people incorrectly assume, leverage is essential in the Forex market.This is because the average daily percentage move of a major currency is less than 1%,whereas a stock can easily have a 10% price move on any given day.



Table below demonstrates how a high trading margin can impact on the trades ROI.

Trade Forex anywhere from the world virtually

Forex market - 24/7 trading via computer A computer with Internet connection plus an active Forex account are sufficient for youto execute a trade in Forex market.Professional Forex traders have the privilege to travel around the world but yet stillconnected to the market anytime, anywhere. The freedom of this is something you couldnot get else where by being an employee of a corporation.

High Liquidity Market

Turnover value in Forex is $1.9 trillion per day. It is the largest trade market in the worldand the liquidity of the market is huge. Traders can easily cash in or cash out their capitalin Forex market

Ability to Profit from a Bull’s or Bear’s Market

Regardless of whether the market is moving up or down, a trader is able to profit from themarket situation depending on whether he undertakes a “Short” or “Long position”. No Commission Charges Payable.

In the Forex market there is no commission charges payable when you buy or sell acurrency. Instead what you pay is a “spread”. This is the difference between the Bid andAsk price.

Understanding Forex Quotes

Quoting Foreign Currency

Currencies are always quoted in pairs. Each pair of currencies thus constitutes anindividual product and is traditionally noted XXX/YYY, where YYY is the ISO 4217international three-letter code of the currency into which the price of one unit of XXXcurrency is expressed. The first currency in the quotes act as the 'base currency'.

For example USD/JPY, EUR/GBP, and GBP/AUD, in such cases, USD, Euro Dollar, andBritish Pound are acting as the base currency. The Base currency in a Forex quote will



always have a value of 1. USD/JPY indicates how much Japanese Yens you can buy with1 United States Dollar; similarly EUR/GBP indicates the exchange rate of Great BritainPound with 1 Euro Dollar.

FX Quoting: Bid/Ask and Spread

Sometimes you only see one number in the quote but often currency exchange prices aredisplayed in pairs with the 'bid price and the ask price'.

For example EUR/USD 1.2385/1.2390, 1.2385 is known as the bidding price, while

1.2390 is the asking price. Bidding price is the price that you sell the base currency(EUR in our case here); asking price is the price that you buy the base currency. Thedifferent of the bidding and the asking price is called 'spread'.

You might notice that bidding price is always lower than the asking price. Ever wonder why? The different of the bid-ask price (so called 'spread') is how currency brokers make profits without charging commissions to their clients (sell high and buy low in the same

time.)

What's a pip?

A pip is the smallest value in a Forex quote. Take our example earlier on EUR/USD. If the exchange rate goes from 1.2385 to 1.2386; that's one pip. In mathematical definition,a pip means the last decimal place of a quotation.

Note that as each currency has its own value, the value of a pip is different from oneanother. Say USD/JPY rate at 120.75, a pip would be 0.01 (the second decimal place);while for EUR/USD 1.2385, a pip would be 0.0001 (the fourth decimal place).

EUR/USD 1.2385/1.2390

• Base currency= Eur • Bid price= 1.2385; Ask price= 1.2390• When selling Euros, 1 Euro = USD$1.2385; when buying Euros, USD$1.2390 =

1 Euro.• Spread = | 1.2385 - 1.2390 | = 0.0005• Pip value= 0.0001

EUR/JPY 127.95/128.00

• Base currency= Eur • Bid price= 127.95; Ask price= 128.00• When selling Euros, 1 Euro = JPY127.95; when buying Euros, JPY128.00 = 1

Euro.• Spread = | 127.95 - 128.00 | = 0.05• Pip value= 0.01



GBP/USD 1.7400/1.7410

• Base currency= GBP• Bid price= 1.7400; Ask price= 1.7410• When selling Pound, 1 Pound = USD$1.7400; when buying Pound, USD$1.7410

= 1 Pound.• Spread = | 1.7400 - 1.7410 | = 0.001• Pip value= 0.0001

USD/JPY 119.8

• Base currency= USD• No bid-ask price is displayed, spread value not available.• Pip value= 0.1

Example of a USD/INR trade whereby the trader is of a view that USD would appreciate

against INR.

USD/INR Bid Ask

Current Day 40.7500 40.7504

A Week Later 41.7590 41.7594

Market conditions predict that the USD would appreciate/strengthen against INR.Hence adecision to buy is made.

Buying will be at ASK rate which is 40.7504 in this case

So the buy value would be 100,000*40.7504=40,75,040

Few days later the USD value raises to 41.7590 , now the trader can book profit byselling USD to INR whereby he will be receiving more INR.

The sell is made at Bid price, so the sell value would be 100,000*41.7590=41,75,900

The profit for this trade will be 41,75,900 - 40,75,040 = 1,00,860

Leveraging your money in Forex margin trades

In Forex, the concept of leverage refers to the situation where a trader borrows the moneyof the Forex brokerage firm and uses that money specifically for trading in the Forexmarket. Because of leveraging, a trader with just a small capital outlay is able to invest insignificantly larger value contracts.



It is common to find Forex brokerage firms offering up to a ratio of 1:100 for an accountholder. In contrast, in the equity market, a trader needs to come with 50% of thetransaction value for every trade that they make. Leveraging is all about profitmaximization as well as risk minimization.

With leverage, the Forex trader is able to profit more with each trade that he makes. Atthe same time, the risk factor of his transaction is also multiplied many times over andhence the need for proper risk management. Margin trading refers to the leverage amountgiven to the traders to trade in the market.One of the best features in Forex trading is that traders are able to trade foreign currencieswith high margin.

You get 1:1 margin for stock exchanges, 2:1 margin for equity trading, 15:1 margin for futures market; but in Forex, normal trade margins are 100:1 and 150:1, or even 200:1trade margins.

Typically the broker will require a minimum account size, also known as account marginor initial margin. Once you have deposited your money you will then be able to trade.The broker will also specify how much they require per position (lot) traded.

For example, for every $1,000 you have, you can trade 1 lot of $100,000. So if you have$5,000 they may allow you to trade up to $500,000 of Forex.

The minimum security (margin) for each lot will vary from broker to broker. In theexample above, the broker required a one percent margin. This means that for every$100,000 traded, the broker wants $1,000 as a deposit on the position.

Trading Forex in huge margin with allows traders to control a large sum of money withlittle cash put on the tables. This in turns magnify the ROI dramatically. Beware that justas the profits are magnified by using “margin” the same holds good for the losses too..!!

The major traded currencies

Major traded currencies are United States dollars, Australian Dollars, Japanese Yens,British Pounds, Swiss Francs, Canadian Dollars, and the Euro Dollars.

The major players in Forex trading

According to Wall Street Journal Europe, 73% of the trade volume is covered byDeutsche Bank, who covered 17% of the total currency trades; followed by UBS,Citi Group, HSBC, Barclays, Merril Lynch, J. P. Morgan Chase, Goldman Sachs, ABNAmro, and Morgan Stanley.



Participants to Forex Market

There are four major players in the forex market which are listed below1. Banks – Interbank and Central banks2. Commercial Companies3. Customer brokers

4. Individual traders and Speculators

Banks –

Interbank : It is not uncommon for a large bank to trade billions of dollars on a daily basis. Some of this trading activity is undertaken on behalf of customers, but a largeamount of trading is also conducted by proprietary desks, where dealers trade to make the bank profits. The interbank market has become increasingly competitive in the foreignexchange market.Central Bank : The national central banks play an important role in the foreign exchangemarkets. Ultimately, the central banks seek to control money supply and often haveofficial or unofficial target rates for their currencies. As many central banks have very

substantial foreign exchange reserves, the intervention power is significant. Among themost important responsibilities of a central bank is the restoration of an orderly market intimes of excessive exchange rate volatility and the control of the inflationary impact of aweakening currency. Frequently, the mere expectation of central bank intervention issufficient to stabilize a currency, but in the event of aggressive intervention the actualimpact on the short term supply/demand balance can lead to the desired moves inexchange rates.

Commercial Companies: The backbone of foreign exchange markets is currencyspeculation. However, a minor part of the market liquidity is derived from the financialactivities of companies seeking foreign exchange to pay for goods or services.

Commercial companies often trade in sizes that are insignificant to short-term marketmoves; however, as the main currency markets can quite easily absorb hundreds of millions of dollars without any big impact. But it also clear that one of the decisivefactors determining the long-term direction of a currency's exchange rate is the overalltrade flow. Some multinational companies can have an unpredictable impact when verylarge positions are covered however due to exposures that are not commonly known tothe majority of market participants.

Customer Brokers: For many commercial and private clients, there is a need to receivespecialized foreign exchange services. There are a fair number of non-banks offeringdealing services, analysis and strategic advice to such clients. Many banks do notundertake trading for private clients at all, and do not have the necessary resources or inclination to support medium sized commercial clients adequately. The services of such brokers are more similar in nature to other investment brokers and typically provide aservice-oriented approach to their clients. For such brokers, the main source of revenue isthe spread - the difference between bids and asks prices.



Individual traders and Speculators: Individual traders are increasingly active in the FXmarkets. This is driven by the ready access to the market through the Internet and theopportunities available to earn significant profits with a relatively low capital investment.Individual traders are often unsuccessful. In fact, about 90% of individual traders lose

money during their time in the FX markets. Individual traders often don’t have systems,and don’t manage risk well.In addition, individual traders face higher transaction costs than professional traders asthey don’t have direct access to the market and have to use a broker. Also, individualtraders can’t watch the market all the time as they usually have other commitments suchas work or family life.These factors are a disadvantage, but the advantage is that the individual trader canchoose whether to participate in the market at any given point in time. Professionaltraders are pretty much obliged to trade all the time by the nature of their jobs whichmeans that they may not be able to be as selective about the trades that they enter.Hedge funds -Hedge funds are professional investment firms that usually manage funds

on behalf of high net worth investors. They may invest in a variety of financialinstruments, including foreign currencies. Their motivation is speculative profit for their investors, as they earn their money from a percentage of profits earned.

Synopsis about Trading

Having learnt about market participants now let’s go through Trade lifecycle. Trading is simply buying and selling of financial instruments with a view to make profitsor transfer risks to another party. Below is the illustrative view of a trade cycle in general



1. Decision to Trade/ Invest: This is the first phase in any trade. A trader

who wants to begin trading should have a good knowledge about thefinancial product he is going to trade. Else there is very lot of scope toloose money. At this stage it’s necessary to know about 2 main kinds of traders’ viz., Speculators and Investors.

Speculators are a kind of traders who will look opportunity in both raising and fallingmarkets. They generally invest for 1 day to make profits.Investors are the other type of traders who as the name suggests invests in the stock for duration generally more than 1 year with a view to earn dividend/bonus on theinvestments along with increase in the value of the shares.A trader should do a thorough study of the stock / financial instrument on which he will be investing. Once the preliminary research is done its now time to place orders in the

market. This will be the next phase of trade cycle.

2. Placing Orders: In order to place an order trader should be having a demat account.This will help trader to place orders in the Electronic media without actually going for exchanges to trade. The firm which will provide you a demat account will be a member of the stock exchanges which will act as a middle-men between trader and the exchange.Orders are mainly of two types’ viz., Market order and Limit order.Market order- These orders take whatever is the value of the stock trading in the marketas its target price and will execute the order. In this type of order, an investor will nothave any chance of controlling the price because as the name suggests it’s a market order.Limit order- In this order the trader will specify the price on which the trade should beexecuted. This kind of order will wait for the specific price mentioned and will notexecute until the specified price is reached.

3. Trader order Execution: Once the order is placed based on the type of order thetrades will be executed. Generally in case of market orders the trade will be executedwithin a few seconds and in case of Limit orders the order will not be executed until thespecific price target is reached and will lapse on the end of trading hours.

4. Trade confirmation: Once the order is executed the next step is to get/generateconfirmation for the trade. The trade confirmation usually is a practice widely used inOTC market thought its also used in normal exchange trades too.OTC market means over –the-counter market meaning the traders will not be meeting inthe designated exchange floor to place the orders. Trade usually happens over the phone.Hence there is a requirement of written communication to be signed by both parties totrade in order to avoid discrepancies later at settlement stage.

5. Clearing and Settlement: This is the last phase of the trade lifecycle. In this stage allthe trades entered into are further taken by clearing corporations which will do the stock clearance by book entry. Clearing organization acts just like a central bank of a country



wherein the cheque of all the local banks are sent and the central bank just does a book entry of transferring the funds on a net basis. Similarly the clearing corporation will do anet transfer of the security/script to respective members account.Settlement- this is the stage wherein the actual money moves in /out of members /tradersaccount in exchange for the stock they have traded. Before the settlement happens its

necessary that all the trade details are agree upon by both the parties to trade. Once thesettlement of a trade is done its irrevocable.

Pictorial view of the trade cycle:



Examples of different kinds of FOREX Trades

Having understood the general trade cycle of a Spot trade lets relate with FOREX Swapand Options

Foreign Exchange Swap:

You may use a Foreign Exchange Swap (FX Swap) if you need to exchange one currencyfor another currency on one day and then re-exchange those currencies at a later date.

A FX Swap is effectively two foreign exchange transactions packaged together.In the first stage of the transaction, there is an exchange of one currency amount (the firstcurrency) for a pre-agreed amount of another currency (the second currency).In the second stage of the transaction occurs at a later date. On that date, there is anexchange of an agreed amount of the second currency for an agreed amount of the firstcurrency.

The two currencies to be exchanged are the same in both stages of the transaction and arereferred to as the currency pair.

Assume you are an Australian-based importer who has committed to pay US dollars(USD) for goods in two business days. There is a contract to sell these goods in threemonths' time. The buyer will pay you on delivery in USD. Whilst your net USD positionafter three months is square, there is a timing difference in cash flows. You are thereforeexposed to exchange rate movements between two business days and three months.

The AUD/USD spot rate=0.6455 meaning, 1 AUD can fetch 0.6455 USD or conversely1USD =1.549187 AUD (1/0.6455)

So on the trading day you would give out 100,000/0.6455=154,918.7 AUD.The counterparty usually a bank will give you $100,000 in return for 154,918.7 AUD.

Let’s assume that the AUD has appreciated over the following days and the rate rises to0.6700 then at the close of the contract you would receive:100,000/0.6700=149,253.73AUD

On the contrary, lets assume that AUD has depreciated over the following days and therate falls down to 0.6000. Now in this scenario, you would receive more AUD as the ratehas decreased. The AUD you would receive in this scenario would be:100,000/0.6000=166,666.7 AUD.

In order to minimize this uncertainty, you can choose to enter into a Forex Swap.

You can arrange a FX Swap to buy USD / sell AUD, Value Spot (in two business days),and sell USD / buy AUD, Value three months' time.



The exchange rate applied to the first stage of the swap will be the spot exchange rate.The exchange rate applied to the second stage will be the forward exchange rate based onthe same spot exchange rate used for the first stage together with the forward margin.

Assuming that the spot exchange rate for AUD/USD=0.6455 and the forward margin is

(0.0054).The first exchange of currency happens at 0.6455 and you will be paying:100,000/0.6455=154,918.67 AUD to receive $100,000.

And the Spot exchange rate for the second stage i.e., after 3 months would be:Spot rate at first stage + forward margin

0.6455 + (0.0054) = 0.6401

There for the rate at which the currency would be exchanged irrespective of whatever may be the spot rate for AUD/USD on or after 3 months would be 0.6401.

After 3 months you would receive 100,000/0.6401=156,225.6 AUD.

[The currency with the higher interest rate will be at a discount on a forward basis againstthe currency with the lower interest rate.In the scenario explained above its assumed that the interest rate for AUD for 3monthslending would be 4.65% and for USD its 1.20%Since the bank has earned more interest on the AUD which you have given, it is thereforenecessary for the bank to compensate for the difference in the interest rate and hence theforward rate has to be negative.This is because when the forward rate is negative the Spot rate would decrease and youwould receive more AUD when the 2nd phase of the trade happens.]



Forex optionsA plain Options contract means “A contract that gives the buyer right, but not theobligation to buy/sell the contract value”.In simple terms it means that if and only if a buyer sees a profit in the contract enteredinto, he can exercise the option. Else he can ignore the option to expire worthless.

The same logic holds good even in the Forex Options.Let’s try to understand the same with help of a simple option.

The current spot price for GBPUSD is 2.0230.The trader is very bullish on the rate and expects the rates to move up. But at the same

time he doesn’t want to put in risk his entire portfolio. Hence the trader decides to go for a Call option by paying a stipulated amount of premium to acquire the right to buy at astrike price of 2.0250.

Scenario-1The traders assumption was wrong and the currency rate moved downwards (2.0000).In this scenario the trader can let the contract expire without actually exercising it.The loss in this transaction is limited only up to the premium amount paid.

Scenario-2The traders view in the currency rate works out well and the rate moved way ahead to2.9500. In this scenario the trader can execute the contract at 2.0250 whatever may be thespot rate for the currency pair in the market.



Forex Futures

Example in the attached xls

MarginExample_New.xls



Spot-Foreign exchange spot trading is buying one currency with a different currency for immediate delivery, rather than for future delivery.The standard settlement timeframe for Foreign Exchange Spot trades is T+2 days;i.e., 2 days from the date of trade execution. A notable exception is the USD/CAD

currency pair which settles T+1.

Trade Date-The date on which the trade is executed/entered into between buyer/seller.

Settlement Date-the date on which the trades are actually settled. It is the date on whichcash will move out of the buyers account to seller and the security will be movedfrom sellers account to buyers account

Forward-A forward contract or simply a forward is an agreement between two parties to buy or sell an asset at a certain future time for a certain price agreed today.

Future Contract-Futures contract, in finance, refers to a standardized contract to buy or sell a specified commodity of standardized quality at a certain date in the future,at a market determined price (the futures price). The contracts are traded on afutures exchange.

Options-In finance, an option is a contract between a buyer and a seller that gives the buyer the right—but not the obligation—to buy or to sell a particular asset (theunderlying asset) at a later day at an agreed price. In return for granting theoption, the seller collects a payment (the premium) from the buyer

Call Option-Buying a Call option provides the right to buy a specified quantity of a

security at a set agreed amount, known as the 'strike price' at some time on or before expiration.

Put Option- Buying Put option provides the buyer right to sell a specified quantity of asecurity at a set agreed amount, known as the 'strike price' at some time on or before expiration

Strike Price- The fixed price at which the owner of an option can purchase, in the case of



a call, or sell, in the case of a put, the underlying security or commodity. It's the price at which the stock will be bought or sold when the option is exercised.

Premium- The option premium is the price the buyer of the options contract pays for theright to buy or sell a security at a specified price in the future.

Bid Price- The price at which a broker is willing to buy a certain security.

Ask Price- The price at which a broker is willing to sell a certain security.

Derivative-A financial contract whose value is based on, or "derived" from, a traditionalsecurity (such as a stock or bond), an asset (such as a commodity), or a marketindex.

Swap - An exchange of streams of payments over time according to specified terms.

Pip - A pip is the smallest value change in a Forex quote.

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