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The foreign exchange market (forex, FX, or currency market) is a global, worldwide decentralized financial market for trading

currencies

Meaning of Foreign Exchange Market


The term market has been interpreted in Economics as the place where both the buyers as well as the sellers meet and they buy and or sell goods. The foreign exchange market is a place where the transactions in foreign exchange are conducted. In practical world the external transaction requires the use of foreign purchasing power i.e. foreign currency. The foreign exchange market facilitates such transactions by performing number of functions. The FX market is unique because of

its huge trading volume representing the largest asset class in the world leading to high liquidity; its geographical dispersion; its continuous operation: 24 hours a day except weekends the variety of factors that affect exchange rates; the low margins of relative profit compared with other markets of fixed income; and the use of leverage to enhance profit and loss margins and with respect to account size.

What is the primary purpose?


The primary purpose of the foreign exchange is to assist international trade and investment, by allowing businesses to convert one currency to another currency. For example, it permits a US business to import British goods and pay Pound Sterling, even though the business' income is in US dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation on the change in interest rates in two currencies

Market participants Banks The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. Many large banks may trade billions of dollars, daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, which are trading desks for the bank's own account Commercial companies An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often

trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates Central banks National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies Forex Fixing Forex fixing is the daily monetary exchange rate fixed by the national bank of each country Hedge funds as speculators Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favour. Investment management firms Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities

Retail foreign exchange traders Individual Retail speculative traders constitute a growing segment of this market with the advent of retail forex platforms, both in size and importance. Currently, they participate indirectly through brokers or banks Non-bank foreign exchange companies Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not offer speculative trading but rather currency exchange with payments Money transfer/remittance companies and bureaux de change Money transfer companies/ remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country

Who are the Market Participants?


Exporters
This group consists of many of Australia's largest companies. Within group you find a diverse range of companies exporting goods and services from Australia to the rest of the world. Australia's export volumes give an excellent indication of the volumes of foreign exchange transacted by the sub sets of this group with resource sector companies taking centre stage. In general exporters have a positive impact on the value of the Australian Dollar.

Importers
This group of companies and individuals uses the foreign exchange markets to purchase foreign currency to make payments for the goods and services they have bought in other countries. In general they have a negative impact on the value of the Australian Dollar.

Australian Fund Managers


This industry has burgeoned over the last two decades underpinned by a regulatory environment that encourages private household saving. The net effect of the group depends on the investment decisions they make but in general as the industry grows they have been investing heavily offshore which generates a negative impact on the Australian Dollar. However they can hedge these investments which often sees them enter the market as buyers of forwards contracts and options.

Global Fund Managers


This group's influence changes depending on their interest in Australian asset markets. During periods where Australian stocks and bonds are attractive, Australia gets substantial allocations of global capital which drives up the value of the Australian Dollar. However when they wish to hedge existing investments in Australia this can generate selling flows.

Central Banks
In Australia the Reserve Bank of Australia generally lets the market determine the value of the Australian Dollar however there are a few exceptions to this policy. Firstly the Reserve Bank of Australia will intervene to buy or sell Australian Dollars if they believe it is substantially under or overvalued and that it is having a negative effect on the economy.

Other Government Agencies


Many government agencies have foreign exchange risk either as exporters, importers or borrowers.

The Foreign Exchange Market is the best way to trade currency around the world. Known by the nickname Forex, more than 100 types of currency are traded each day and more than $3 trillion is exchanged daily. There are plenty of participants in the Forex, including those that serve investors, middle men for currency purchase and companies in need of international funds. 1.
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Banks

Banks participate in the Forex in order to manage the foreign exchange risks of their bank and their clients, according to Peter Pontikis, who writes for Forex Journal Magazine. They can also speculate in the market. Their main goal is to make profits through direct trade of currency and through managing their clients' trading positions. This gives the bank access to both the buying and selling interests of their clients.
Banks and other financial institutions are the biggest participants. They earn profits by buying and selling currencies from and to each other. Roughly two-thirds of all FX transactions involve banks dealing directly with each other.

2. Brokers

Brokers in the Forex are the middle men between banks who trade currency on a daily basis. Their role is no different than a trader on the floor of the stock market. Brokers spend their day matching buy and sell orders between clients. Many of their functions are computerized, which means deals are done fast. Banks pay a fee to have these brokers handle their transactions.

Brokers act as intermediaries between banks. Dealers call them to find out where they can get the best price for currencies. Such arrangements are beneficial since they afford anonymity to the buyer/seller. Brokers earn profit by charging a commission on the transactions they arrange.

3. Central Banks
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most developed countries have central banks, whose main role is to maintain the validity of the national currency. Central banks usually monitor and test prices on the Forex, and have a great deal of sway with banks, brokers and other players in the Forex market. The reason? Central banks print the money. For that reason alone, their opinions are always respected and rarely ignored.
Central banks, which act on behalf of their governments, sometimes participate in the FX market to influence the value of their currencies. With more than $1.2 trillion changing hands every day, the activity of these participants affects the value of every dollar, pound, yen or euro. The participants in the FX market trade for a variety of reasons:

To earn short-term profits from fluctuations in exchange rates, To protect themselves from loss due to changes in exchange rates, and To acquire the foreign currency necessary to buy goods and services from other countries.

4. Corporations
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When a corporation in the United States makes a purchase in France, that company must find a way to make that purchase in foreign currency. That's where the Forex comes in. The U.S. corporation uses the market to purchase the foreign currency they need to complete the transaction.

5. Fund Managers
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There are two types. The fund managers are money managers who deal in funds that amount to hundreds of millions of dollars. They invest that money across a range of investments and a diverse list of clients, including pensions, individuals and governments. Those who manage hedge funds take bigger risks, as they're seeking to realize leverage potential and will exploit the use of derivatives,
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Customers, mainly large companies, require foreign currency in the course of doing business
or making investments. Some even have their own trading desks if their requirements are large. Other types of customers are individuals who buy foreign exchange to travel abroad or make purchases in foreign countries.

Determinants of FX rates (Determinants Of Currency Exchange Market Rates )


FX rates are decided by its government

Economic factors
These include: (a)economic policy, disseminated by government agencies and central banks, (b)economic conditions, generally revealed through economic reports, and other economic indicators. Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates). Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency. Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency. Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation. Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be. Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Its effects are more prominent if the increase is in the traded sector [1].

Political conditions
Internal, regional, and international political conditions and events can have a profound effect on currency markets.

All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive/negative interest in a neighboring country and, in the process, affect its currency.

Market psychology
Market psychology and trader perceptions influence the foreign exchange market in a variety of ways: Flights to quality: Unsettling international events can lead to a "flight to quality", a type of capital flight whereby investors move their assets to a perceived "safe haven". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The U.S. dollar, Swiss franc and gold have been traditional safe havens during times of political or economic uncertainty.
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Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends.
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"Buy the rumor, sell the fact": This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought".
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To buy the rumor or sell the fact can also be an

example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices. Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight. Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that

traders may attempt to use. Many traders study price charts in order to identify such patterns.
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Determinants Of Currency Exchange Market Rates


There are so many forex rate determinants that play a major role in forex rates. As there is no single supply and demand for any given currency, and thus its value not influenced by any single element, but rather by several. The determinants of currency exchange market rates are generally divided into three major categories such as economic factors, political conditions and market psychology. Economic Factors The economic forex rate determinants include economic policies of government agencies and central banks of the country. The basis of economic conditions is generally the economic reports and other economic indicators. The countrys economic policy comprises government fiscal policy i.e. budget/spending practices and monetary policy. The major economic conditions which influence the forex rate determinants are productivity of an economy, government budget deficits or surpluses, Inflation levels and trends, Balance of trade levels and trends and economic growth and health. Political conditions Political conditions are important determinants of currency market rates of foreign exchange rates. International political conditions, internal and regional events within a country affect the currency markets greatly. All exchange rates are sensitive to political instability and speculations about the new ruling party. Political upheaval and instability can play a negative role in a nation's economy. Similarly, any country facing financial difficulties, is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may initiate positive or negative interest in a neighboring country. And in the process, affect its currency rates. Market psychology Market psychology along with the perception of currency traders are also one of the important determinants of currency market rates. These factors influence the currency trading market in following ways. 1.Flights to quality: This phenomenon of currency exchange market states that the various international events taking place in different nations of the world affect the forex rates. A flight to quality means the traders moving their capital away from the risky investments to the safer investment options. In other words, traders look forward to safer economic currencies and prefer that currency investment where the demand is on higher side thus resulting in a higher price for currencies. The safest currency is considered to be The Swiss franc during the times of political or economic uncertainty. 2. Long-term trends: Long term trends can also be seen as forex rate determinants. The forex currency trading markets usually move in visible long-term trends. These trends are analyzed and studied by currency exchange professionals to predict the effect of these events on the future currency rates. 3. Economic numbers: The economic numbers are determinants of currency market rates as they are based on economic reports of a country thus indicating the economic condition of a particular company. These economic numbers greatly influence the market psychology and they may affect the short-term market moves. 4.Technical trading considerations:

Technical trading considerations such as the price charts are also determinants of market exchange rate. Because many investors analyze these price charts in order to identify various pattern over the period of time. It is an important Forex currency rate determinant.

6 Factors That Influence Exchange Rates


Aside from factors such as interest rates and inflation, the exchange rate is one of the most important determinants of a country's relative level of economic health. Exchange rates play a vital role in a country's level of trade, which is critical to most every free market economy in the world. For this reason, exchange rates are among the most watched, analyzed and governmentally manipulated economic measures. But exchange rates matter on a smaller scale as well: they impact the real return of an investor's portfolio. Here we look at some of the major forces behind exchange rate movements. Overview Before we look at these forces, we should sketch out how exchange rate movements affect a nation's trading relationships with other nations. A higher currency makes a country's exports more expensive and imports cheaper in foreign markets; a lower currency makes a country's exports cheaper and its imports more expensive in foreign markets. A higher exchange rate can be expected to lower the country's balance of trade, while a lower exchange rate would increase it.

Determinants of Exchange Rates


Numerous factors determine exchange rates, and all are related to the trading relationship between two countries. Remember, exchange rates are relative, and are expressed as a comparison of the currencies of two countries. The following are some of the principal determinants of the exchange rate between two countries. Note that these factors are in no particular order; like many aspects of economics, the relative importance of these factors is subject to much debate. 1. Differentials in Inflation As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. During the last half of the twentieth century, the countries with low inflation included Japan, Germany and Switzerland, while the U.S. and Canada achieved low inflation only later. Those countries with higher inflation typically see depreciation in their currency in relation to the currencies of their trading partners. This is also usually accompanied by higher interest rates. (To learn more, see Cost-Push Inflation Versus Demand-Pull

Inflation.) 2. Differentials in Interest Rates Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and currency values. Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if inflation in the country is much higher than in others, or if additional factors serve to drive the currency down. The opposite relationship exists for decreasing interest rates - that is, lower interest rates tend to decrease exchange rates. (For further reading, see What Is Fiscal Policy?) 3. Current-Account Deficits The current account is the balance of trade between a country and its trading partners, reflecting all payments between countries for goods, services, interest and dividends. A deficit in the current account shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up the deficit. In other words, the country requires more foreign currency than it receives through sales of exports, and it supplies more of its own currency than foreigners demand for its products. The excess demand for foreign currency lowers the country's exchange rate until domestic goods and services are cheap enough for foreigners, and foreign assets are too expensive to generate sales for domestic interests. (For more, see Understanding The Current Account In The Balance Of Payments.) 4. Public Debt Countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity motivates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. The reason? A large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future. In the worst case scenario, a government may print money to pay part of a large debt, but increasing the money supply inevitably causes inflation. Moreover, if a government is not able to service its deficit through domestic means (selling domestic bonds, increasing the money supply), then it must increase the supply of securities for sale to foreigners, thereby lowering their prices. Finally, a large debt may prove worrisome to foreigners if they believe the country risks defaulting on its obligations. Foreigners will

be less willing to own securities denominated in that currency if the risk of default is great. For this reason, the country's debt rating (as determined by Moody's or Standard & Poor's, for example) is a crucial determinant of its exchange rate. 5. Terms of Trade A ratio comparing export prices to import prices, the terms of trade is related to current accounts and the balance of payments. If the price of a country's exports rises by a greater rate than that of its imports, its terms of trade have favorably improved. Increasing terms of trade shows greater demand for the country's exports. This, in turn, results in rising revenues from exports, which provides increased demand for the country's currency (and an increase in the currency's value). If the price of exports rises by a smaller rate than that of its imports, the currency's value will decrease in relation to its trading partners. 6. Political Stability and Economic Performance Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries. Conclusion The exchange rate of the currency in which a portfolio holds the bulk of its investments determines that portfolio's real return. A declining exchange rate obviously decreases the purchasing power of income and capital gains derived from any returns. Moreover, the exchange rate influences other income factors such as interest rates, inflation and even capital gains from domestic securities. While exchange rates are determined by numerous complex factors that often leave even the most experienced economists flummoxed, investors should still have some understanding of how currency values and exchange rates play an important role in the rate of return on their investments.

Foreign Exchange being a commodity likes any other commodities the exchange rates tend to fluctuate from time to time. There are various factors that cause the fluctuation in the rates of exchange. These factors can be divided into several following groups. These groups can affect the exchange rates on a short term as well as long-term basis.

1. Fundamental Factors:

The fundamental factors include all such events that affect the basic economic and fiscal policies of the concerned government. These factors normally affect the long-term exchange rates of any currency. On short-term basis on many occasions, these factors are found to be rather inactive unless the market attention has turned to fundamentals. However, in the long run exchange rates of all the currencies are linked to fundamental causes. The fundamental factors are basic economic policies followed by the government in relation to inflation, balance of payment position, unemployment, capacity utilization, trends in import and export, etc. Normally, other things remaining constant the currencies of the countries that follow the sound economic policies will always be stronger. Similar for the countries which are having balance of payment surplus, the exchange rate will always be favourable. Conversely, for countries facing balance of payment deficit, the exchange rate will be adverse. Continuous and ever growing deficit in balance of payment indicates over valuation of the currency concerned and the dis-equilibrium created can be remedied through devaluation.

2. Political and Psychological factors:

Political and psychological factors are believed to have an influence on exchange rates. Many currencies have a tradition of behaving in a particular way for e.g. Swiss franc as a refuge currency. The US Dollar is also considered a safer haven currency whenever there is a political crisis anywhere in the world.

3. Technical Factors:

The various technical factors that affect exchange rates can be mentioned as under:

(a) Capital Movement: The phenomenon of capital movement affecting the exchange rate has a very recent origin. Huge surplus of petroleum exporting countries due to sudden burst in the oil prices could not be utilized by these countries for home consumption entirely and needed to be invested elsewhere productively. Movement of these petro dollars, started affecting the exchange rates of various currencies. Capital tended to move from lower yielding to higher yielding currencies and as a result the exchange rates moved.

(b) Relative Inflation Rates: It was generally believed until recently that one prima-facie direction for exchange rates to move was in the direction adjusted to compensate the relative inflation rates. For instance, if a currency is already overvalued, i.e., stronger than what is warranted by relative inflation rates, depreciation sufficient enough to correct that position can be expected and

vice versa. It is necessary to note that exchange rate is a relative price and hence the market weighs all the relevant factors in a relative term, (in relation to the counterpart countries). The underlying reasoning behind this conviction was that a relatively high rate of inflation reduces a country's competitiveness in international markets and weakens its ability to sell in foreign markets. This will weaken the expected demand for foreign currency (increase in supply of domestic currency and decrease in supply of foreign currency). But during 1981-85 period exchange rates of major currencies did not confirm the direction of relative inflation rates. The rise of the dollar persistently for such a long period discredited this principle.

(c) Exchange rate policy and intervention: Exchange rates are also influenced in no small measure by expectation of changes in regulation relating to exchange markets and official intervention. Official intervention can smoothen an otherwise disorderly market but it is also the experience that if the authorities attempt half-heartedly to counter the market sentiments through intervention in the market, ultimately more steep and sudden exchange rate swings can occur. In the second quarter of 1985 the movement of exchange rates of major currencies reflected the change in the US policy in favour of co-ordinated exchange market intervention as a measure to bring down the value of dollar.

(d) Interest Rates: An important factor for movements in exchange rates in recent years has been difference in interest rates; i.e. interest differential between major countries. In this respect the growing integration of the financial markets of major currencies, the revolution in telecommunication facilities, the growth of specialized asset managing agencies, the deregulation of financial markets by major countries, the emergence of foreign exchange trading etc. having accelerated the potential for exchange rates volatility.

4. Speculation

Speculation or the anticipation of the market participants many a times is the prime reason for exchange rate movements. The total foreign exchange turnover worldwide is many a times the actual goods and services related turnover indicating the grip of speculators over the market. Those speculators anticipate the events even before the actual data is out and position themselves accordingly in order to take advantage when the actual data confirms the anticipations. The initial positioning and final profit taking make exchange rates volatile. These speculators many a times concentrate only on one factor affecting the exchange rate and as a result the market psychology tends to concentrate only on that factor neglecting all other factors that have equal bearing on the exchange rate movement. Under these circumstances even when all other factors may indicate negative impact on the exchange rate of the currency if the one factor that the market is concentrating comes out positive the currency strengthens.

5. Others The turnover of the market is not entirely trade related and hence the funds placed at the disposal of foreign exchange dealers by various banks, the amount which the dealers can raise in various ways, banks' attitude towards keeping open position during the course of a day, at the end of the day, on the eve of weekends and holidays, window dressing operations as at the end of the half year to year, end of the month considerations to cover operations for the returns that the banks have to submit the central monetary authorities etc. - all affect the exchange rate movement of the currencies.

Top 5 Factors Affecting Exchange Rates


Exchange rates change by the second. Understand the dynamics that affect them.
Currency changes affect you, whether you are actively trading in the foreign exchange market, planning your next vacation, shopping online for goods from another countryor just buying food and staples imported from abroad. Like any commodity, the value of a currency rises and falls in response to the forces of supply and demand. Everyone needs to spend, and consumer spending directly affects the money supply (and vice versa). The supply and demand of a countrys money is reflected in its foreign exchange rate. When a countrys economy falters, consumer spending declines and trading sentiment for its currency turns sour, leading to a decline in that countrys currency against other currencies with stronger economies. On the other hand, a booming economy will lift the value of its currency, if there is no government intervention to restrain it. Consumer spending is influenced by a number of factors: the price of goods and services (inflation), employment, interest rates, government initiatives, and so on. Here are some economic factors you can follow to identify economic trends and their effect on currencies.

1. Interest Rates
"Benchmark" interest rates from central banks influence the retail rates financial institutions charge customers to borrow money. For instance, if the economy is under-performing, central banks may lower interest rates to make it cheaper to borrow; this often boosts consumer spending, which may help expand the economy. To slow the rate of inflation in an overheated economy, central banks raise the benchmark so borrowing is more expensive. Interest rates are of particular concern to investors seeking a balance between yield returns and safety of funds. When interest rates go up, so do yields for assets denominated in that currency;

this leads to increased demand by investors and causes an increase in the value of the currency in question. If interest rates go down, this may lead to a flight from that currency to another. Official economic figures Access more than 150 economic figures from the world's major markets. Latest figures are graphed against years of previous economic data. Economic indicators

2. Employment Outlook
Employment levels have an immediate impact on economic growth. Asunemployment increases, consumer spending falls because jobless workers have less money to spend on non-essentials. Those still employed worry for the future and also tend to reduce spending and save more of their income. An increase in unemployment signals a slowdown in the economy and possible devaluation of a country's currency because of declining confidence and lower demand. If demand continues to decline, the currency supply builds and further exchange rate depreciation is likely. One of the most anticipated employment reports is the U.S. Non-Farm Payroll (NFP), a reliable indicator of U.S. employmentissued the first Friday of every month.

3. Economic Growth Expectations


To meet the needs of a growing population, an economy must expand. However, if growth occurs too rapidly, price increases will outpace wage advances so that even if workers earn more on average, their actual buying power decreases. Most countries target economic growth at a rate of about 2% per year. With higher growth comes higher inflation, and in this situation central banks typically raise interest rates to increase the cost of borrowing in an attempt to slow spending within the economy. A change in interest rates may signal a change in currency rates. Deflation is the opposite of inflation; it occurs during times of recession and is a sign of economic stagnation. Central banks often lower interest rates to boost consumer spending in hopes of reversing this trend.

4. Trade Balance
A country's balance of trade is the total value of its exports, minus the total value of its imports. If this number is positive, the country is said to have a favorable balance of trade. If the difference is negative, the country has a trade gap, or tradedeficit. Trade balance impacts supply and demand for a currency. When a country has a trade surplus, demand for its currency increases because foreign buyers must exchange more of their home currency in order to buy its goods. A trade deficit, on the other hand, increases the supply of a countrys currency and could lead to devaluation if supply greatly exceeds demand.

5. Central Bank Actions


With interest rates in several major economies already very low (and set to stay that way for the time being), central bank and government officials are now resorting to other, less commonly used measures to directly intervene in the market and influence economic growth.

For example, quantitative easing is being used to increase the money supply within an economy. It involves the purchase of government bonds and other assets from financial institutions to provide the banking system with additional liquidity. Quantitative easing is considered a last resort when the more typical responselowering interest ratesfails to boost the economy. It comes with some risk: increasing the supply of a currency could result in a devaluation of the currency.

Functions of Foreign Exchange Market


(A) Transfer Function : As mentioned above, the foreign exchange markets are exchange markets engaged in transferring the purchasing power between two nations and two currencies. It is prime function of this market. In simple terms, it is conversion of one currency into another such as converting Indian Rs. into U.S. $ and vice versa at some rate. Various instruments like bank drafts, exchange bills, are used for transferring the purchasing power. In this regard international clearing to both the direction is important to because it simplifies the conduct of international trade as well as capital movements from one country to another. (B) Credit Function : Under this function the foreign exchange market provides credit to the traders such as exporters and importers. Exporters can get credit such as reshipment and postshipment credit. Recently started Euro-Dollar market is a leading credit market at international level. This function of making credit available plays a crucial role in growth and expansion of the international trade. (C) Hedging : Hedging is a specific function. Under this function the foreign exchange market tries to protect the interest of the persons dealing in the market from any unforeseen changes in the exchange rate. The exchange rates (price of one currency expressed in another currency) under free market situation can go up and down. This can either bring gains or losses to the concerned parties. Foreign exchange market guards the interest of both exports as well as importers, against any changes in the exchange rate. Thus, these are various functions performed by the foreign exchange market. To perform above functions it uses the following instruments.

1. The foreign exchange market serves two functions: converting currencies and reducing risk. There are four major reasons firms need to convert currencies.

2. First, the payments firms receive from exports, foreign investments, foreign profits, or licensing agreements may all be in a foreign currency. In order to use these funds in its home country, an international firm has to convert funds from foreign to domestic currencies. 3. Second, a firm may purchase supplies from firms in foreign countries, and pay these suppliers in their domestic currency. 4. Third, a firm may want to invest in a different country from that in which it currently holds underused funds. 5. Fourth, a firm may want to speculate on exchange rate movements, and earn profits on the changes it expects. If it expects a foreign currency to appreciate relative to its domestic currency, it will convert its domestic funds into the foreign currency. Alternately stated, it expects its domestic currency to depreciate relative to the foreign currency. An example similar to the one in the book can help illustrate how money can be made on exchange rate speculation. The management focus on George Soros shows how one fund has benefited from currency speculation. 6. Exchange rates change on a daily basis. The price at any given time is called the spot rate, and is the rate for currency exchanges at that particular time. One can obtain the current exchange rates from a newspaper or online. 7. The fact that exchange rates can change on a daily basis depending upon the relative supply and demand for different currencies increases the risks for firms entering into contracts where they must be paid or pay in a foreign currency at some time in the future. 8. Forward exchange rates allow a firm to lock in a future exchange rate for the time when it needs to convert currencies. Forward exchange occurs when two parties agree to exchange currency and execute a deal at some specific date in the future. The book presents an example of a laptop computer purchase where using the forward market helps assure the firm that will won't lose money on what it feels is a good deal. It can be good to point out that from a firm's perspective, while it can set prices and agree to pay certain costs, and can reasonably plan to earn a profit; it has virtually no control over the exchange rate. When spot exchange rate changes entirely wipe out the profits on what appear to be profitable deals, the firm has no recourse. 9. When a currency is worth less with the forward rate than it is with the spot rate, it is selling at forward discount. Likewise, when a currency is worth more in the future than it is on the spot market, it is said to be selling at a forward premium, and is hence expected to appreciate. These points can be illustrated with several of the currencies. 10. A currency swap is the simultaneous purchase and sale of a given amount of currency at two different dates and values.

6.2 The Nature And Functions Of The Foreign Exchange Market


The word 'market' means a place where goods are offered for sale but it also means the business of buying and selling a specified commodity. Nearly all international business activity requires the transfer of money from one country to another, so 'foreign exchange market' means a place where one form of money (for example $A) is changed for another form (for example $US). The term also encompasses the business of converting from one currency to another. Thus we speak of the major trading centres ( London , New York and Tokyo ) and the secondary trading centres ( Zurich , Frankfurt, Paris , Hong Kong , Singapore , San Francisco and Sydney ). When we speak of converting one currency to another, we mean the business of changing pounds or yen into dollars, regardless of the place where the transaction occurs. We are then in the foreign exchange market . The exchange rate is the rate at which that market converts one currency into another. For example, in January 2005, it took $A1.00 to buy $US0.76. Alternatively, $US1 would buy $A1.32.

Foreign exchange (FX) transactions normally take place between commercial banks and their customers, and among commercial banks themselves which buy and sell foreign currencies either locally or internationally.

A foreign exchange market is a place in which foreign exchange transactions take place. In other words it is a market where foreign money are bought and sold. It is a part of money market in the financial center. The basic and primary function of a foreign exchange market is to transfer purchasing power between countries. The transfer function is performed through T.T, M.T, Draft, Bill of exchange, Letters of credit, etc. the bill of exchange is the most important and effective method of transferring purchasing power between two parties located in different countries. Another important function of foreign exchange market is to provide credit to the importer debtor. The exporters draw the bill of exchange on importers on their bankers. On acceptance of the bills by the importer or their bankers, the exporter will get the money realized on the maturity of the bills. In case the exporters are anxious to receive the payment earlier, the bills can be discounted from their bankers, or foreign exchange banks or discount houses. The foreign exchange market performs the hedging function covering the risks on foreignexchange transactions. There are frequent fluctuations in exchange rates. If the rate is favourable, the exporter will gain and vice verse. In order to avoid the risk involved, the foreign exchange market provides hedges or actual claims through forward contracts in exchange against such fluctuations. The agencies of foreign currencies guarantee payment

of foreign exchange at a fixed rate. The exchange agencies bear the risks of fluctuation ofexchange rates.

Market Research Reports


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The foreign exchange market serves two main functions in the country. The main and primary motive of the foreign exchange market is to convert the money of one country into the money of another country. The second purpose of the foreign exchange is to provide the security of the risk against the foreign exchange. Which are the results of constantly changing exchange rates. Every country has its own currency which is used to quote the price of goods and services. For example dollar is used in the United States of America, pound is used in the United Kingdom, in the European member countries Euro is the common currency which is used between the European nations and similarly yen in the Japan. So every country must have their own currency which is essential to trade international across the different countries of the world. When any tourist goes to any other country for any purpose he has to change his currency with the currency of country where he needs the money for carrying different functions. The exchange rate is the phenomena by which the currency of one country is converted to the currency of another country. So the foreign exchange market serves the country in many ways.

Instruments of Foreign Exchange Market


1. Cheques and Bank Drafts : Persons dealing with foreign exchanges can use bank cheques as well as bank drafts in order to make payments. The cheque is drawn on particular bank instead of a person. 2. Bills of Exchange : It is also called as foreign bill of exchange which is an unconditional order in writing addressed by one person to another. It mentions the person to whom a certain sum is to be paid either on demand or on specific date. 3. Mail Transfer (MT) : Under this, funds are transferred from one account of a destination to the another destination in the nation by mail. For international payments air-mail is used. 4. Telegraphic Transfers (TT) : By this method a sum can be transferred from one place to another place in the world by cable or telex. This is the quickest method of transferring fund from one place to another..

Two Fundamental Types of the Exchange Rates

Spot Exchange Rate : This refers to the price of foreign exchange in terms of domestic money payable for the immediate delivery of particular foreigncurrency. It is an existing or day-to-day exchange rate. It is an exchange of currencies on the spot. In simple words that rate of exchange, which is effective for spot transactions is known as the spot exchange rate. Forward Exchange Rate : There are several future transactions whose delivery would be made sometime in the future. The rates at which these transactions are consummated are called as forward rate of exchange. It is the rate fulfilling the agreement between two parties based on future delivery of goods. The exchange rate which is applicable for forward transaction is called as forward exchange rate. The forward rate is expressed at par, at premium and at a discount.

Determination of Exchange Rate


Mint Parity Theory (Gold Standard) : However, the gold standard had collapsed during the First World War (1914 - 1918). Under the mint parity the exchange rate was determined on a weight-to-weight basis of the two currencies. However, after the break-down of the gold standard, there was confusion in determination of the exchange rate. Purchasing Power Parity (PPP) Theory. . Balance of Payment (BOP) Theory.

The Functions of the Foreign Exchange Market


1. The foreign exchange market serves two functions: converting currencies and reducing risk. There are four major reasons firms need to convert currencies. 2. First, the payments firms receive from exports, foreign investments, foreign profits, or licensing agreements may all be in a foreign currency. In order to use these funds in its home country, an international firm has to convert funds from foreign to domestic currencies. 3. Second, a firm may purchase supplies from firms in foreign countries, and pay these suppliers in their domestic currency. 4. Third, a firm may want to invest in a different country from that in which it currently holds underused funds. 5. Fourth, a firm may want to speculate on exchange rate movements, and earn profits on the changes it expects. If it expects a foreign currency to appreciate relative to its domestic currency, it will convert its domestic funds into the foreign currency. Alternately stated, it expects its domestic currency to depreciate relative to the foreign currency. An example similar to the one in the book can help illustrate how money can be made on exchange rate speculation. The management focus on George Soros shows how one fund has benefited from currency speculation. Important function of foreign exchange market is to provide credit to the importer debtor. The exporters draw the bill of exchange on importers on their bankers. On

acceptance of the bills by the importer or their bankers, the exporter will get the money realized on the maturity of the bills. In case the exporters are anxious to receive the payment earlier, the bills can be discounted from their bankers, or foreign exchange banks or discount houses. The foreign exchange market performs the hedging function covering the risks on foreign exchange transactions. There are frequent fluctuations in exchange rates. If the rate is favourable, the exporter will gain and vice verse. In order to avoid the risk involved, the foreign exchange market provides hedges or actual claims through forward contracts in exchange against such fluctuations. The agencies of foreign currencies guarantee payment of foreign exchange at a fixed rate. The exchange agencies bear the risks of fluctuation of exchange rates.

Forex Trading - Advantages


1. Bid/Ask Spread rates Spread rates have tightened dramatically in the last years. Most online forex brokers offer a spread of 5 pips on EURUSD which is the most widely traded and liquid currency pair. In the futures market spreads can vary anywhere between 5 and 9 pips and can become even larger under illiquid market conditions (which tends to happen substantially more often in futures currencies). 2. Margins requirements Usually a foreign exchange trading with a 1% margin is available. In layman's terms that means a trader can control a position of a value of USD 1'000'000 with a mere USD 10'000 in his account. By comparison, futures margins are not only constantly changing but are also often quite sizeable. Stocks are generally traded on a non-margined basis and when they are, it can be as restrictive as 50% or so. 3. 24 hour market Foreign exchange market trading occurs over a 24 hour period picking up in Asia around 24:00 CET Sunday evening and coming to an end in the United States on Friday around 23:00 CET. Although ECNs (electronic communications networks) exist for stock markets and futures markets (like Globex) that supply after hours trading, liquidity is often low and prices offered can often be uncompetitive. 4. No Limit up / limit down Futures markets contain certain constraints that limit the number and type of transactions a trader can make under certain price conditions. When the price of a certain currency rises or falls beyond a certain pre-determined daily level traders are restricted from initiating new positions and are limited only to liquidating existing positions if they so desire. This mechanism is meant to control daily price volatility but in effect since the futures currency

market follows the spot market anyway, the following day the futures market may undergo what is called a 'gap' or in other words the futures price will re-adjust to the spot price the next day. In the OTC market no such trading constraints exist permitting the trader to truly implement his trading strategy to the fullest extent. Since a trader can protect his position from large unexpected price movements with stop-loss orders the high volatility in the spot market can be fully controlled. 5. Sell before you buy Equity brokers offer very restrictive short-selling margin requirements to customers. This means that a customer does not possess the liquidity to be able to sell stock before he buys it. Margin wise, a trader has exactly the same capacity when initiating a selling or buying position in the spot market. In spot trading when you're selling one currency, you're necessarily buying another.

Automatic balance of payments adjustment - Any balance of payments disequilibrium will tend to be rectified by a change in the exchange rate. For example, if a country has a balance of payments deficit then the currency should depreciate. This is because imports will be greater than exports meaning the supply of sterling on the foreign exchanges will be increasing as importers sell pounds to pay for the imports. This will drive the value of the pound down. The effect of the depreciation should be to make your exports cheaper and imports more expensive, thus increasing demand for your goods abroad and reducing demand for foreign goods in your own country, therefore dealing with the balance of payments problem. Conversely, a balance of payments surplus should be eliminated by an appreciation of the currency. Freeing internal policy - With a floating exchange rate, balance of payments disequilibrium should be rectified by a change in the external price of the currency. However, with a fixed rate, curing a deficit could involve a general deflationary policy resulting in unpleasant consequences for the whole economy such as unemployment. The floating rate allows governments freedom to pursue their own internal policy objectives such as growth and full employment without external constraints. Absence of crises - Fixed rates are often characterised by crises as pressure mounts on a currency to devalue or revalue. The fact that, with a floating rate, such changes are automatic should remove the element of crisis from international relations. Flexibility - Post-1973 there were great changes in the pattern of world trade as well as a major change in world economics as a result of the OPEC oil shock. A fixed exchange rate would have caused major problems at this time as some countries would be uncompetitive given their inflation rate. The floating rate allows a country to re-adjust more flexibly to external shocks. Lower foreign exchange reserves - A country with a fixed rate usually has to hold large amounts of foreign currency in order to prepare for a time when they have to defend that fixed rate. These reserves have an opportunity cost.

Disadvantages of the Floating Rate

Uncertainty - The fact that a currency changes in value from day to day introduces instability or uncertainty into trade. Sellers may be unsure of how much money they

will receive when they sell abroad or what their price actually is abroad. Of course the rate changing will affect price and thus sales. In a similar way importers never know how much it is going to cost them to import a given amount of foreign goods. This uncertainty can be reduced by hedging the foreign exchange risk on the forward market. Lack of investment - The uncertainty can lead to a lack of investment internally as well as from abroad. Speculation - Speculation will tend to be an inherent part of a floating system and it can be damaging and destabilising for the economy, as the speculative flows may often differ from the underlying pattern of trade flows. Lack of discipline in economic management - As inflation is not punished there is a danger that governments will follow inflationary economic policies that then lead to a level of inflation that can cause problems for the economy. The presence of an inflation target should help overcome this. Does a floating rate automatically remedy a deficit? - UK experience indicates that a floating exchange rate probably does not automatically cure a balance of payments deficit. Much depends on the price elasticity of demand for imports and exports. The Marshall-Lerner condition says that a depreciation in the exchange rate will help improve the balance of payments if the sum of the price elasticities for imports and exports is greater than one. Inflation - The floating exchange rate can be inflationary. Apart from not punishing inflationary economies, which, in itself, encourages inflation, the float can cause inflation by allowing import prices to rise as the exchange rate falls. This is, undoubtedly, the case for countries such as UK where we are dependent on imports of food and raw materials.

TYPES OF MARKET: Foreign exchange markets exist to allow business owners to purchase currency in another country so they can do business in that country. The "FX" market, also called the Forex market, is a worldwide network of currency traders who work around the clock to complete these transactions, and their work drives the exchange rate for currencies around the world. Spot Market

These are the quickest transactions involving currency in foreign markets. These transactions involve immediate payment at the current exchange rate, which is also called the spot rate. The Federal Reserve says the spot market accounts for one-third of all currency exchange, and trades usually take place within two days of the agreement. This does leave the traders open to the volatility of the currency market, which can raise or lower the price between the agreement and the trade.

Futures Market

As the name implies, these transactions involve future payment and future delivery at an agreed exchange rate, also called the future rate. These contracts are standardized,

which means the elements of the agreement are set and non-negotiable. It also takes the volatility of the currency market, specifically the spot market, out of the equation. These are popular among traders who make large currency transactions and are seeking a steady return on their investments Forward Market

These transactions are identical to the Futures Market except for one important difference---the terms are negotiable between the two parties. This way, the terms can be negotiated and tailored to the needs of the participants. It allows for more flexibility. In many instances, this type of market involves a currency swap, where two entities swap currency for an agreed-upon amount of time, and then return the currency at the end of the contract.

Financial instruments

The Forex Market is one of the busiest financial markets in the world with millions and millions of money being traded every day. A lot of Corporates, banks and other foreign exchange institutions play a pivotal part in making the Forex Market a huge success. There are a lot of financial instruments that are made use of, in the Forex market. They are: 1. Spot 2. Forward 3. Futures 4. Swap 5. Option 6. Exchange Traded fund Spot This is quickest financial instruments of the Forex market and the tenure of this is only two days. The transaction happens within two days. It is the most voluminous financial transaction in terms of trades processed. A spot price is decided for settlement of a currency or security and the transaction is closed in two business days. Forward - A forward contract is one of the most sought after financial instruments in the Forex market, because risk can be minimized. Both the seller and the buyer agree to carry out a transaction at a future date and time and there is no financial exchange between the parties until the specified date comes up. On the particular date of the transaction, the goods and services are brought or sold irrespective of the currency trading on that day. Forward contracts are not limited by time. A transaction can be agreed to carry out on a future date which are a few days or a few years later than the current date. Futures Future contracts are similar to forward contracts. The only difference between a forward contract and a futures contract is that, in a futures contract, a transaction can be agreed to be carried out at a time, which is not more than 3 months from the current date. There is a time boundary within which the transaction must be closed. The size and the time period of the transaction are fixed in a

futures contract unlike a forward contract. Swap This is another type of forward transaction. Here both the parties agree to do a currency swap for a specified period of time. They also agree to reverse this swap and revert to their original positions at a future point of time. It is not necessary that a swap transaction has to be carried out only in an exchange. It is just an agreement between two parties. This is one of the most common forms of forward transaction. Option Options are rights given to the owners to exchange their currencies to other denomination. However it is only a right and not an obligation for the owner to exchange his currency. Exchange Traded Fund They are open ended financial instruments which can be traded anytime during the course of the trading day. These basically follow stock movements or price movements of renowned currencies and then increase or decrease the value of their currency based on the trend of price movements.

---------------------------What is the definition of a financial instrument where the forex market is concerned? Simply stated, it is any type of a financial medium such as bills of exchange, bonds, currencies, stocks, etc., that are used for borrowing purposes in financial markets. When you are discussing the forex market, the following six entities are designated as financial instruments: 1. Exchange-traded fund 2. Forward 3. Future 4. Option 5. Spot 6. Swap Exchange-traded Fund - referred to as ETF's. These are open-ended investment companies that have the characteristic of being traded at any time throughout the day. These will oftentimes attempt duplicating stock market indices such as the S&P 500. The ETF's gain strength as the United States Dollar (USD) weakens against a different currency and therefore replicatecurrency market investments. Certain funds can track the price fluctuations of the various world currencies as they compare to the USD, and will oftentimes increase in value to counter the direction that the USD moves in. This creates increased interest in the USD for investors and speculators. Ads by Google

Forward - the agreement established between two parties wherein they purchase, sell, or trade an asset at a pre-agreed upon price is called a forward or a forward contract. Normally, there is no exchange of money until a pre-established future date has been arrived at. Forwards are normally performed as a hedging instrument used to either deter or alleviate risk in the investment activity. Future - a forward transaction that contains standard contract sizes and maturity dates are considered futures. Futures are traded on exchanges that have been created for that purpose exclusively. Just like with commodity markets, a future in the forex market normally designates a contract length of 3 months in duration. Interest amounts are also included in a futures contract.

Option - commonly shortened to FX option from foreign exchange option. Options are derivatives (financial instruments whose values fluctuate based on underlying variables) wherein the owner has the right to, but is not necessarily obligated to, exchange one currency for another at a preagreed upon rate and a specified date. When you talk about options in any form (stock market, forex, or any other market), the forex market is the deepest and largest, as well as the most liquid market of any options in the world. Spot - where futures contracts normally employ a 3-month timeframe, spot transactions encompass a 48-hour delivery transaction period. There are four characteristics that all spot transactions have in common, namely: 1. A direct exchange between two currencies 2. Involves only cash, never contracts 3. No interest is included in the agreed upon transaction 4. Shortest of all transaction timeframes Swap - currency swaps are the most common type of forward transactions. A swap is a trade between two parties wherein they exchange currencies for a pre-determined length of time. The transaction then is reversed at a pre-agreed upon future date. Currency swaps can be negotiated to mature up to 30 years in the future, and involve the swapping of the principle amount. Interest rates are not "netted" since they are denominated in different currencies.

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Spot A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira, EURO and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a direct exchange between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. Forward One way to deal with the foreignexchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties. Swap The most common type of forward transaction is the FX swap. In an FX swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. Future

Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts. Option A foreignexchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world.

Financial Instruments Of Currency Exchange Market


The currency exchange market is quite large and it trades around billions of dollars everyday. There is much type of financial instruments of currency exchange market which facilitates different currency trading transactions between traders and participating institutions. Let us have brief look at the financial instruments of forex market. Spot A spot transaction means a two-day delivery transaction as opposed to the futures contracts which are usually three months. However, it is important to mention here that in case the spot transaction is between the US Dollar, Canadian Dollar, Turkish Lira and Russian Ruble, it gets settle the nest business day. The spot is a financial instrument of currency exchange market which represents a direct exchange between two currencies. Spot is a forex financial instrument with the shortest time frame and it involves cash rather than a contract. The interest is also not included in the agreed-upon transaction. The Spot transaction is a financial instrument of forex market which has the second largest turnover by volume after swap transactions among all foreign exchange currency trading transactions in the global forex market. Forward Forward is a financial instruments of forex market which is used to deal with the foreign exchange risk by involving in a forward transaction. In this kind of transaction, money does not get traded until some future date which is agreed upon. In this currency exchange market financial instrument, both the buyer and the seller agree on an exchange rate for any date in the future, and the transaction occurs on that particular date regardless of what the market rates are then. The duration of the trade is usually decided by both the parties involved. It can be a one day, a few days, months or years. Future Another popular financial instrument in currency exchange market is Future. Forex future is an exchange traded forward transactions with standard contract sizes and maturity dates. Futures contracts are usually inclusive of any interest amounts. Swap Swap is the financial instruments of forex market in which the most common type of transaction is the currency swap. In this, two parties exchange currencies for a set duration of time and agree to reverse the transaction at a later date. Swap is not a standardized financial instrument of forex market contracts and is not traded through an exchange. Option A currency exchange option is a derivative where the owner has the right but not the compulsion to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the largest and most volatile market for options of any kind in the world. Exchange-Traded Fund Other financial instruments of forex market is the exchange traded funds or ETFs. These are open ended investment companies which can trade at any time throughout the course of the business day.

HOW TO CALCULATE EXCHANGE RATE Ifyou need to exchange one countrys currency for that of anothers, youll need to calculate the exchange rate. A currency exchange rate shows the relative value, or ratio, of one unit of currency compared to one unit of another currency. Any bank can make short work of the transaction for you. But if youre planning your travel and trying to compare travel values, youll want to calculate the exchange rate beforehand to plan your travel budget. Depending on the exchange rate, there can be a considerable up- or down-side for your wallet. Calculate the exchange rate using this equation: value of currency A * exchange rate for currency B = exchanged value of currency B. For example, lets say that the exchange rate to convert one U.S. dollar to euros is 0.69. That means each U.S. dollar is worth $0.69 U.S. cents per euro.

A Beginner's Guide to Exchange Rates and the Foreign Exchange Market


[Part 1: Exchange Rates - What are they and how are they calculated?] by Mike Moffatt

More of this Feature

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 lemonto-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.

Part 1: Exchange Rates - What are they and how are they calculated? Part 2: Exchange Rates - Arbitrage Part 3: Exchange Rates - Supply Part 4: Exchange Rates - Demand Part 5: Case Study: Canada - Introduction Part 6: Case Study: Canada - Commodity Prices Part 7: Case Study: Canada - Interest Rates Part 8: Case Study: Canada - International Factors

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Exchange RatesLooking for Currency Converter? Use it Free on Economictimes!Economictimes.Indiatimes.com Forex Currency CalculatorJoin The Forex Peace Army & Use Our Free Currency Strength Calculator!ConvertCurrency.ForexPeaceArmy.com Online Trading Account@ Zero Account opening charges* with ICICIdirect.com *T&C apply.www.icicidirect.com/zeroacopening So when we speak of an X-to-Y exchange rate of Z, this means that if we give up 1 unit of X, we get Z units of Y 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


Of course, the exchange rates we read in the paper or hear on radio or TV are not prices for X and Y or for oranges and lemons. 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. To figure out how many U.S. dollars you can get for 1 Japanese yen, we can just use the formula:

Japan-to-U.S. exchange rate = 1 / U.S.-to-Japan exchange rate Japan-to-U.S. exchange rate = 1 / 117 = .00854
So this tells us that one Japanese yen is worth .00854 U.S. dollars, which is less than a penny. Similarly if the Canadian dollar is worth .67 U.S. dollars, we have a Canada-to-U.S exchange rate of .67. If we want to know how many Canadian dollars we can buy with 1 U.S. dollar, we use the formula:

U.S.-to-Canada exchange rate = 1/Canada-to-U.S. Exchange rate U.S.-to-Canada exchange rate = 1/0.67 = 1.4925
So one U.S. dollar can get us $1.49 in Canadian funds. To see why these relationships must hold, we'll look at the wonderful world of arbitrage.

Introduction Foreign Exchange The simultaneous transaction of one currency for another. Foreign Exchange Market The Foreign exchange market is a large, growing and liquid financial market that operates 24 hours a day. It is not a market in the traditional sense because there is no central trading location or exchange". Most of the trading is conducted by telephone or through electronic trading

networks. The primary market for currencies is the interbank market where banks, insurance companies, large corporations and other large financial institutions manage the risks associated with fluctuations in currency rates. Spot Market The market for buying and selling currencies at the current market rate. Rollover A spot transaction is generally due for settlement within two business days (the value date). The cost of rolling over a transaction is based on the interest rate differential between the two currencies in a transaction. If you are long (bought) the currency with a higher rate of interest you will earn interest. If you are short (sold) the currency with a higher rate of interest you will pay interest. Most brokers will automatically roll over your open positions allowing you to hold your position indefinitely.

How to calculate rollover interest Rollovers in Forex

Exchange Rate The value of one currency expressed in terms of another. For example, if EUR/USD is 1.3200, 1 Euro is worth US$1.3200. Currency Pair The two currencies that make up an exchange rate. When one is bought, the other is sold, and vice versa. Base Currency The first currency in the pair. Also the currency your account is denominated in. Counter Currency The second currency in the pair. Also known as the terms currency. ISO Currency Codes USD = US Dollar EUR = Euro JPY = Japanese Yen GBP = British Pound CHF = Swiss Franc

CAD = Canadian Dollar AUD = Australian Dollar NZD = New Zealand Dollar For a full list, see ISO Currency Codes Currency Pair Terminology EUR/USD = "Euro" USD/JPY = "Dollar Yen" GBP/USD = "Cable" or "Sterling" USD/CHF = "Swissy" USD/CAD = "Dollar Canada" (CAD referred to as the "Loonie") AUD/USD = "Aussie Dollar" NZD/USD = "Kiwi" FCM Futures Commission Merchant. An individual or organisation licensed by the U.S. Commodities Futures Trading Commission (CFTC) to deal in futures products and accept monies from clients to trade them. Dealing Desk A dealing desk provides pricing, liquidity and execution of trades. Market Maker A market maker provides pricing and liquidity for a particular currency pair and stands ready to buy or sell that currency at the quoted price. A market maker takes the opposite side of your trade and has the option of either holding that position or partially or fully offsetting it with other market participants, managing their aggregate exposure to their clients. If a market maker chooses to keep the trader's position without offsetting it in the market, the trader's profit is the market maker's loss and vice versa, leading to a possible conflict of interest between the trader and his market maker. A market maker earns their commission from the spread between the bid and offer price.

Example of Market Makers

NDD An acronym for 'No Dealing Desk'. A no-dealing desk broker does not have a dealing desk but instead uses external liquidity providers to provide pricing and liquidity for its clients. The liquidity providers send in competing bids and offers into the platform, resulting in the best bid and offer being displayed to the client. Some no-dealing desk brokers may

display the market depth which is the amount of liquidity available at each price. A greater number of liquidity providers providing pricing to the no-dealing desk broker leads to tighter spreads. A no-dealing desk broker may increase the spread to earn its commission.

Example of No Dealing Desk Brokers

Forex ECN Broker ECN is an acronym for Electronic Communications Network. A Forex ECN broker does not have a dealing desk but instead provides a marketplace where multiple market makers, banks and traders can enter in competing bids and offers into the platform and have their trades filled by multiple liquidity providers in an anonymous trading environment. The trades are done in the name of your ECN broker, thereby providing you with complete anonymity. A trader might have their buy order filled by liquidity provider "A", and close the same order against liquidity provider "B", or have their trade matched internally by the bid or offer of another trader. The best bid and offer is displayed to the trader along with the market depth which is the combined volume available at each price. A greater number of marketplace participants providing pricing to the ECN broker leads to tighter spreads. ECN's typically charge a small fee for matching trades between their clients and liquidity providers.

Example of ECN Brokers

Counterparty One of the participants in a transaction. Sell Quote / Bid Price The sell quote is displayed on the left and is the price at which you can sell the base currency. It is also referred to as the market maker's bid price. For example, if the EUR/USD quotes 1.3200/03, you can sell 1 Euro at the bid price of US$1.3200. Buy Quote / Offer Price The buy quote is displayed on the right and is the price at which you can buy the base currency. It is also referred to as the market maker's ask or offer price. For example, if the EUR/USD quotes 1.3200/03, you can buy 1 Euro at the offer price of US$1.3203. Spread The difference between the sell quote and the buy quote or the bid and offer price. For example, if EUR/USD quotes read 1.3200/03, the spread

is the difference between 1.3200 and 1.3203, or 3 pips. In order to break even on a trade, a position must move in the direction of the trade by an amount equal to the spread. Pip The smallest price increment a currency can make. Also known as points. For example, 1 pip = 0.0001 for EUR/USD, or 0.01 for USD/JPY. Pip Value The value of a pip. Pip value can be either fixed or variable depending on the currency pair. e.g. The pip value for EUR/USD is always $10 for standard lots, $1 for mini-lots and $0.10 for micro lots.

How to Calculate Pip Values Pip Value Calculator

Lot The standard unit size of a transaction. Typically, one standard lot is equal to 100,000 units of the base currency, 10,000 units if it's a mini, or 1,000 units if it's a micro. Some dealers offer the ability to trade in any unit size, down to as little as 1 unit. Standard Account Trading with standard lot sizes, generally 100,000 units of the base currency. e.g. The pip value is $10 for EUR/USD. Mini Account Trading with mini lot sizes, generally 10,000 units of the base currency. e.g. The pip value is $1 for EUR/USD. Micro Account Trading with micro lot sizes, generally 1,000 units of the base currency. e.g. The pip value is $0.10 for EUR/USD. Margin The deposit required to open or maintain a position. Margin can be either "free" or "used". Used margin is that amount which is being used to maintain an open position, whereas free margin is the amount available to open new positions. With a $1,000 margin balance in your account and a 1% margin requirement to open a position, you can buy or sell a position worth up to a notional $100,000. This allows a trader to leverage

his account by up to 100 times or a leverage ratio of 100:1. If a trader's account falls below the minimum amount required to maintain an open position, he will receive a "margin call" requiring him to either add more money into his or her account or to close the open position. Most brokers will automatically close a trade when the margin balance falls below the amount required to keep it open. The amount required to maintain an open position is dependent on the broker and could be 50% of the original margin required to open the trade. Leverage Leverage is the ability to gear your account into a position greater than your total account margin. For instance, if a trader has $1,000 of margin in his account and he opens a $100,000 position, he leverages his account by 100 times, or 100:1. If he opens a $200,000 position with $1,000 of margin in his account, his leverage is 200 times, or 200:1. Increasing your leverage magnifies both gains and losses. To calculate the leverage used, divide the total value of your open positions by the total margin balance in your account. For example, if you have $10,000 of margin in your account and you open one standard lot of USD/JPY (100,000 units of the base currency) for $100,000, your leverage ratio is 10:1 ($100,000 / $10,000). If you open one standard lot of EUR/USD for $150,000 (100,000 x EURUSD 1.5000) your leverage ratio is 15:1 ($150,000 / $10,000).

Understanding leverage Part I Understanding leverage Part II Calculate Leverage

Manual Execution An order which is executed by dealer intervention. Automatic Execution The order is executed automatically without dealer intervention or involvement. Slippage The difference between the order price and the executed price, measured in pips. Slippage often occurs in fast moving and volatile markets, or where there is manual execution of trades. Drawdown The decline in account balance from peak to valley, measured until a new

high is reached, usually reported in percentage terms. Support Support is a technical price level where buyers outweigh sellers, causing prices to bounce off a temporary price floor. Resistance Resistance is a technical price level where sellers outweigh buyers, causing prices to bounce off a temporary price ceiling. Common Order Types Market Order An order to buy or sell at the current market price. Limit Order An order to buy or sell at a pre-specified price level. Stop-Loss Order An order to restrict losses at a pre-specified price level. Limit Entry Order An order to buy below the market or sell above the market at a prespecified level, believing that the price will reverse direction from that point. Stop-Entry Order An order to buy above the market or sell below the market at a prespecified level, believing that the price will continue in the same direction. OCO Order One Cancels Other. An order whereby if one is executed, the other is cancelled. GTC Order Good Till Cancelled. An order stays in the market until it is either filled or cancelled. Common Trade Types

Long Position A position in which the trader attempts to profit from an increase in price. i.e. Buy low, sell high. Short Position A position in which the trader attempts to profit from a decrease in price. i.e. Sell high, buy low. Common Trading Styles Technical Analysis A style of trading that involves analysing price charts for technical patterns of behaviour.

Technical Analysis Books

Fundamental Analysis A style of trading that involves analysing the macroeconomic factors of an economy underpinning the value of a currency and placing trades that support the trader's long or short-term outlook. Trend Trading A style of trading that attempts to profit from riding short, medium or long term trends in price.

Sniper Forex Trend Trading System

Range Trading A style of trading that attempts to profit from buying and selling currencies between a lower level of support and an upper level of resistance. The upper level of resistance and the lower level of support defines the range. The range forms a price channel where the price can be seen to oscillate between the two levels of support and resistance.

Article: Identifying Trending & Range Bound Currencies

News Trading A style of trading whereby a trader attempts to profit from fundamental news announcements on a country's economy that may affect the value of a currency, usually seeking short term profit immediately after the

announcement is released. Scalping A style of trading that involves frequent trading seeking small gains over a very short period of time. Trades can last from seconds to minutes. Day Trading A style of trading that involves multiple trades on an intra-day basis. Trades can last from minutes to hours.

Forex Day Trading Systems

Swing Trading A style of trading that involves seeking to profit from short to medium term swings in trend. Trades can last from hours to days. Carry Trading A style of trading whereby the trader attempts to profit from holding a currency with a higher rate of interest and selling a currency with a lower rate of interest, profiting from the daily interest rate differential of the position. Position Trading A style of trading that involves taking a longer term position that reflects a longer term outlook. Trades can last from weeks to months. Discretionary Trading A style of trading that uses human judgement and decision making in every trade.

Managed Discretionary Accounts

Automated Trading A style of trading that involves neither human decision making nor involvement, but uses a pre-programmed strategy based on technical or fundamental analysis to automatically execute trades via an automated software programme.

Automated Trading Systems Managed Automated Accounts

Example Trade Assume you have a trading account at a broker that requires a 1% margin deposit for every trade. The current quote for EUR/USD is 1.3225/28 and you want to place a market order to buy 1 standard lot of 100,000 Euros at 1.3228, for a total value of US$132,280 (100,000 * $1.3228). The broker requires you to deposit 1% of the total, or $1322.80 to open the trade. At the same time you place a take-profit order at 1.3278, 50 pips above your order price. In taking this trade you expect the Euro to strengthen against the U.S. dollar. As you expected, the Euro strengthens against the U.S. dollar and you take your profit at 1.3278, closing out the trade. As each pip is worth US$10, your total profit for this trade is $500, for a total return of 38%.