Unique Source of Forex

Covered Interest Arbitrage

i = one-year interest rate on (Eurocurrency ) deposits denominated
i* = one-year interest rate on (Eurocurrency) deposits denominated in the foreign currency
e = spot price of the home currency in terms of the foreign currency
f = one-year forward price of the home currency in terms of the foreign currency

by Stock Specialist ~ Wednesday, November 18, 2009 0 comments

Historical Background

The Eurodollar market arose in the 1950s. The Soviet Union had large amounts of dollars from their oil sales. They did not want to hold them in the United States because of fears that the US would freeze them.
They found European banks that would accept their dollars as deposits. It is said that one was a French bank with the cable address eurobank, hence the name. Thus, there arose a large pool of dollars outside the United States and outside the control of US authorities.
In 1958 the British government introduced a restrictions on capital flows. British banks tried to get around these regulations by issuing loans dollar loans.
Euro markets were particularly attractive because they had far fewer regulations and offered higher yields. From the late 1980s onwards, US companies began to borrow and hold money offshore. British banks found it attractive to make loans in dollars.
London is the most important centre.

by Stock Specialist ~ Tuesday, November 17, 2009 0 comments

Eurocurrency Markets

Eurocurrency refers to deposits in a commercial bank which are denominated in a currency other than the currency issued by the country the bank is resident in. For example, a bank deposit denominated in dollars in a bank located in London is a Eurodollar deposit. It does not matter whether the bank is Barclays or an American bank.

by Stock Specialist ~ Monday, November 16, 2009 0 comments

The Timing of the Contract

At time zero: All of the details of the contract were worked out
At time zero plus two months and two days: The exchange is carried out.

by Stock Specialist ~ Sunday, November 15, 2009 0 comments

Example of a Forward Contract

Frank Dollar, the foreign exchange manager at the Big American Automobile Company was informed that the BAAC is importing parts from Japan at a cost of 600 million yen, to be paid upon delivery in two months time. To protect the BAAC from exchange rate fluctuations, Frank Dollar arranged to purchase 600 million yen forward from Mega Bank. The two-month forward price was 120.00 yen/dollar. In two months and two days, Dollar paid 5 million dollars and received 600 million yen.

by Stock Specialist ~ Saturday, November 14, 2009 0 comments

Types of Contracts

Spot contracts -- a price and quantity are agreed upon. The two currencies are typically exchanged two business days later.
Forward contracts -- a fixed price contract made today for delivery of a certain amount of a currency at a specified future date. The specified date is the settlement date and the agreed price is the forward rate. More precisely, the two currencies are exchanged on an agreed upon date which is a certain number of days or months after the spot date. Thus, a three-month forward contract is conventionally settled in three months plus two days. Typically, no money changes hands at the time the contract is written

by Stock Specialist ~ Friday, November 13, 2009 0 comments

We can find cross rates with spreads

In European form: The Swiss franc is 1.5020 – 1.5088 and the Swedish krona is 10.0025 – 10.0075. Find the kronar/franc cross rates.
The dealer will buy 1 Swiss franc for 1/1.5088 dollars. He will buy 1/1.5020 dollars for 10.0025/1.5088 = 6.6294 kronar. So, he will buy 1 Swiss franc for 6.6294 kronar.
The dealer will sell one Swiss franc for 1/1.5020 dollars. He will sell 1/1.5020 dollars for 10.0075/1.5020 =6.6628 kronar.
The kronar/franc cross rates are 6.6294 – 6.6628.

by Stock Specialist ~ Thursday, November 12, 2009 0 comments

The Spread

Foreign exchange dealers quote two rates: the rate at which they will buy the currency and the rate at which they will sell the currency.
Example: A newspaper may report that the Swiss franc had a central rate of 1.5024 francs /$ and a bid/offer spread of 020 – 028.
This means that the two exchange rates were 1.5020 and 1.5028. The dealer would buy dollars (sell Swiss francs) for 1.5020 Swiss francs per dollar. He would sell dollars (buy Swiss francs) for 1.5028 Swiss francs per dollar.
When expressed as units of currency per dollar, the smaller rate is the bid rate: the rate at which the dealer will buy (bid for) dollars. The higher rate is the offer rate: the rate at which the dealer will sell (offer) dollars.

by Stock Specialist ~ Wednesday, November 11, 2009 0 comments

Learn how to compute cross rates

Suppose you are given exchange rates for currencies A and B in terms of currency C and that you are told to find the price of currency B in terms of currency A (or equivalently, units of currency A / currency B).
First, find the exchange rates for A and B in the form: units of A / units of C and units of B / units of C.
Then: units of A / units B = (units of A/units of C) / (units of B/units of C)

by Stock Specialist ~ Tuesday, November 10, 2009 1 comments

Another example:

The Bhutan ngultrum is trading at 39.3020 Ngultrums per dollar.
The Mauritania ouguiya is trading at 251.620.
The cross rate is ngultrums / ouguiya = (ngultrums /$) / (ouguiya /$) = 39.3020/ 251.620 = .156196.

by Stock Specialist ~ Sunday, November 8, 2009 0 comments

To find what the cross rate must be:

Suppose the pound is quoted at 2.0000 dollars per pound.
Suppose that the euro is quoted at 1.3000 euros per dollar
Then, euros / pound = (euros /dollar) / (pounds/dollar) = 1.3000/.5000 = 2.6000

by Stock Specialist ~ Saturday, November 7, 2009 0 comments

Example of Triangular Arbitrage

Suppose the pound is quoted at 2.0000 dollars per pound.
Suppose that the euro is quoted at 1.3000 euros per dollar
Suppose that the pound is quoted at 2.5000 euros per pound
Trade 1 dollar for 1.3 euros. Trade 1.3 euros for 1.3/2.5 = .52 pounds. Trade for more than 1 dollar and make a profit.

by Stock Specialist ~ Friday, November 6, 2009 0 comments

Triangular Arbitrage

Opportunities for triangular arbitrage arise when direct quotations (exchange rates in terms of the dollar - this is another sense of this word) and cross-rate quotations (two other currencies against each other) allow for profit making.
This entails using one currency to buy a second, a second currency to buy a third, and a third currency to buy the first.

by Stock Specialist ~ Thursday, November 5, 2009 0 comments

Def. An exchange rate is the price of one currency in terms of another.

A complication is that there are two ways to express any exchange rate.

Direct quote: the number of units of home currency necessary to buy one unit of foreign currency - the home currency price of foreign currency

Indirect quote: the number of units of foreign currency necessary to buy one unit of home currency - the foreign currency price of home currency

In terms of the dollar we have

American terms: dollars per other currency unit

European terms: other currency units per dollar

For example, suppose that the pound is trading at 2.0000 dollars per pound. We could also express the exchange rate at .5000 pounds per dollar.

Direct quote: the number of units of home currency necessary to buy one unit of foreign currency - the home currency price of foreign currency : .5000

Indirect quote: the number of units of foreign currency necessary to buy one unit of home currency - the foreign currency price of home currency: 2.0000

In terms of the dollar we have

American terms: dollars per other currency unit: 2.0000

European terms: other currency units per dollar: .5000

by Stock Specialist ~ Wednesday, November 4, 2009 0 comments

The dollar is the most important currency

Many central banks hold the bulk of their reserves in the form of dollars; many central banks conduct much of their intervention in dollars; many international transactions are done using dollars; many contracts are invoiced in dollars.
The dollar is the major “vehicle” currency: if a dealer wants to trade Swiss francs for Mexican pesos, he will probably trade the francs for dollars and the dollars for pesos.

by Stock Specialist ~ Tuesday, November 3, 2009 0 comments

Central Banks

Central Banks intervene in the foreign exchange market to influence the value of their currency.
Many central banks serve as the primary banker for their government and for other public enterprises.
Some central banks (for example, the Federal Reserve Bank of New York) act as agent for other central banks.
Some central banks actively manage their foreign exchange reserves.

by Stock Specialist ~ Monday, November 2, 2009 0 comments

Market Makers

A market maker for a currency is a dealer who regularly quotes the rates at which he is willing to buy and to sell that currency.
During normal hours, he creates a two-sided market for its customers. He is willing (within reason) to both buy and sell at the rates he quotes.
He makes a profit from the spread; that is the difference between the selling and buying rates.

by Stock Specialist ~ Sunday, November 1, 2009 0 comments

Foreign Exchange Dealers

The market is made up of 2000 foreign exchange dealers. These are mostly commercial banks and investment banks. They trade with customers and with each other.
They are linked through telephones, computers and other electronic means.
There are about 100 – 200 market-making banks that account for the bulk of the trading.
The dealers don’t trade physical currency; they trade bank accounts denominated in different currencies.

by Stock Specialist ~ Saturday, October 31, 2009 0 comments

London is the largest market

London’s size as a financial centre is partially due to its historical importance and it relative lack of regulation.
London benefits from its proximity to major Eurocurrency markets.
London benefits from its time zone: London’s morning overlaps with late trading in the Far East and London’s afternoon overlaps with New York.
Most of the trading in London is done by foreign-owned institutions.

by Stock Specialist ~ Friday, October 30, 2009 0 comments

It is a 24-hour market

The business day opens in Wellington, New Zealand, followed by Sydney, Tokyo, Hong Kong and Singapore.
A few hours later, trading begins in Bahrain.
Late in the Tokyo day, markets open in Europe.
In the early afternoon in Europe, markets open in the United States.
In the mid to late afternoon in New York, markets open in the Asia-Pacific area.
Most of the activity takes place when European markets are open.

by Stock Specialist ~ Thursday, October 29, 2009 0 comments

Reasons for the Changes

The fall in 2001 was due to: the introduction of the euro, consolidation in the banking sector, mergers in the corporate sector.
The recent rise is more difficult to explain in terms of fundamentals.

by Stock Specialist ~ Wednesday, October 28, 2009 0 comments

From a 1998 publication by the NY Fed:

Individual trades of $200 – 500 million are not uncommon.
Quoted prices change as often as 20 times a minute.
It is estimated that the world’s most active exchange rates can change 18,000 times a day.

by Stock Specialist ~ Tuesday, October 27, 2009 0 comments

The Foreign Exchange Market

The foreign exchange market is by far the largest and most liquid financial market in the world.
It is many times larger than the next largest market: the US government securities market.
Despite its size and importance of the foreign exchange market, it is largely unregulated. No international organization supervises it; no international institution sets rules.

by Stock Specialist ~ Monday, October 26, 2009 0 comments

Theory #4: Expectations theory of forward rates

Main idea:
The forward rate equals expected spot exchange rate

With risk, the forward rate may not equal the spot rate

If Group 1 predominates, then E(s€/$) < f€/$
If Group 2 predominates, then E(s€/$) > f€/$

by Stock Specialist ~ Sunday, October 25, 2009 0 comments

Example of capital market equilibrium

Fisher condition in U.S. and France:
(1 + r$(Real)) = (1 + r$) / (1 + i$)
(1 + r€(Real)) = (1 + r€) / (1 + i€)

If real rates are equal, then the Fisher condition implies:

The difference in interest rates is equal to the expected difference in inflation rates

by Stock Specialist ~ Saturday, October 24, 2009 0 comments

Theory #3: The Fisher condition

Main idea: Market forces tend to allocate resources to their most productive uses

So all countries should have equal real rates of interest

Relation between real and nominal interest rates:

(1 + rNominal) = (1 + rReal)(1 + i )

(1 + rReal) = (1 + rNominal) / (1 + i )

by Stock Specialist ~ Friday, October 23, 2009 0 comments

Evidence on interest rate parity

Does interest rate parity hold?
Which way will funds flow?
How will this affect exchange rates?

Evidence on interest rate parity

Generally, it holds
Why would interest rate parity hold better than PPP?
Lower transactions costs in moving currencies than real goods
Financial markets are more efficient than real goods markets

by Stock Specialist ~ Thursday, October 22, 2009 0 comments

Interest rate parity

Main idea: Either strategy gets you the 100,000€ when you need it.
This implies that the difference in interest rates must reflect the difference between forward and spot exchange rates

by Stock Specialist ~ Wednesday, October 21, 2009 0 comments

Example of a forward market transaction

Suppose you will need 100,000€ in one year

Through a forward contract, you can commit to lock in the exchange rate

f$/€ : forward rate of exchange
Currently, f$/€ = 1.19854 Þ 1 € buys $1.19854
Þ 1 $ buys 0.83435 €

At this forward rate, you need to provide $119,854 in 12 months.

by Stock Specialist ~ Tuesday, October 20, 2009 0 comments

Theory #2: Interest rate parity

Main idea: There is no fundamental advantage to borrowing or lending in one currency over another

This establishes a relation between interest rates, spot exchange rates, and forward exchange rates

Forward market: Transaction occurs at some point in future
BUY: Agree to purchase the underlying currency at a predetermined exchange rate at a specific time in the future
SELL: Agree to deliver the underlying currency at a predetermined exchange rate at a specific time in the future

by Stock Specialist ~ Monday, October 19, 2009 0 comments

What is the evidence?

The Law of One Price frequently does not hold.
Absolute PPP does not hold, at least in the short run.
See The Economist’s Big McCurrencies
The data largely are consistent with Relative PPP, at least over longer periods.

by Stock Specialist ~ Sunday, October 18, 2009 0 comments

Relative PPP

Absolute PPP:

For PPP to hold in one year:

P€ (1 + i€) = E(s€/$) · P$ (1 + i$),

or: P€ (1 + i€) = s€/$ [E(s€/$)/s€/$ )] · P$ (1 + i$)

Using absolute PPP to cancel terms and rearranging:

Relative PPP:
Relative PPP
Main idea – The difference between (expected) inflation rates equals the (expected) rate of change in exchange rates:

by Stock Specialist ~ Saturday, October 17, 2009 0 comments

Absolute PPP

If the price of the basket in the U.S. rises relative to the price in Euros, the U.S. dollar depreciates:
May 21 : s€/$ = P€ / PUS
= 1235.75 € / $1482.07 = 0.8338 €/$

May 24: s€/$ = 1235.75 € / $1485.01 = 0.83215 €/$

by Stock Specialist ~ Friday, October 16, 2009 0 comments

Absolute PPP

Extension of law of one price to a basket of goods
Absolute PPP examines price levels
Apply the law of one price to a basket of goods with price P€ and PUS (use upper-case P for the price of the basket):

where P€ = Si (wFR,i · p€,i )
PUS = Si (wUS,i · pUS,i )

by Stock Specialist ~ Thursday, October 15, 2009 0 comments

The Law of One Price

Example:
Price of wheat in France per bushel (p€) = 3.45 €
Price of wheat in U.S. per bushel (p$) = $4.15
S€/$ = 0.83215 (s$/€ = 1.2017)

Dollar equivalent price
of wheat in France = s$/€ x p€
= 1.2017 $/€ x 3.45 € = $4.15

Þ When law of one price does not hold, supply and demand forces help restore the equality

by Stock Specialist ~ Wednesday, October 14, 2009 0 comments

Theory #1: Purchasing power parity

The Law of One Price

A commodity will have the same price in terms of common currency in every country
In the absence of frictions (e.g. shipping costs, tariffs,..)

Example
Price of wheat in France (per bushel): P€
Price of wheat in U.S. (per bushel): P$
S€/$ = spot exchange rate

by Stock Specialist ~ Saturday, October 10, 2009 0 comments

The Foreign Exchange Market - Four theories

Theory #1: Purchasing power parity

Theory #2: Interest rate parity

Theory #3: The Fisher condition

Theory #4: Expectations theory of forward rates

by Stock Specialist ~ Thursday, October 8, 2009 0 comments

The Foreign Exchange Market - Definitions

r$ : dollar rate of interest (r¥, rHK$,…)
i$ : expected dollar inflation rate
f€/$ : forward rate of exchange
s€/$ : spot rate of exchange
“Indirect quote”:
s€/$ = 0.83215 Þ 1 $ buys 0.83215 €
“Direct quote”:
s$/€ = 1.2017 Þ 1 € buys $1.2017

by Stock Specialist ~ Wednesday, October 7, 2009 0 comments

The Foreign Exchange Market...

Some basic questions

Why aren’t FX rates all equal to one?

Why do FX rates change over time?

Why don’t all FX rates change in the same
direction?

What drives forward rates – the rates at
which you can trade currencies at some future
date?

by Stock Specialist ~ Monday, October 5, 2009 0 comments

The Foreign Exchange Market

Some currency rates as of May 21, 2004:

Per U.S. dollar:
Brazil (Real) 3.1939
Mexico (Peso) 11.5754
Japan (Yen) 112.2839
Indonesia (Rupiah) 89066
South Africa (Rand) 6.7295
United Kingdom (Pound) 0.5593

by Stock Specialist ~ Sunday, October 4, 2009 0 comments

Foreign Exchange Markets

The foreign exchange (FX) market

Basic questions and definitions

Four theories

- Purchasing Power Parity

- Interest Rate Parity

- Fisher condition for capital market equilibrium

- Expectations theory of forward rates

by Stock Specialist ~ Thursday, October 1, 2009 2 comments

FX Quant Advisors - Tactical Asset Allocation Fund

Managed Accounts Program

Tactical Asset Allocation Fund - Five-year proven track record (average over 50% per year)

True diversification – non-correlated to traditional asset classes (stocks, bonds,
real estate). Alternative asset class yields higher risk-adjusted rate of return (MPT)

Managed account funds held at JP MorganChase – only clients can access account funds

Trading execution on an institutional (Currenex) trading platform – no dealing desk intervention

Transparency – clients can monitor account online 24/7

Liquidity – no restrictions on client withdrawals

Fees – primarily performance-based – FXQA makes money when you make money*

*FXQA also charges a spread mark-up

by Stock Specialist ~ 0 comments

Trading Strategy and Money Management Principals

Trading Advisor utilizes technical analysis of the Forex markets as the primary determinant of its trading strategy. Technical analysis operates on the theory that market prices at any given point in time reflect all known factors affecting supply and demand for a particular market.

Technical analysis is of particular concern in the timing of entry and exit positions, in ascertaining the development of trends, and in evaluating the extent to which the market price reflects the underlying value.

The inherent structure of most investment (mutual) funds is reliant on a directional market (on the long side only) – whereas the Advisor is indifferent to market direction (long or short). The focus is on precision of market entry/timing signals and favorable risk/reward algorithms.

The overall trading program is not only diversified by its use of multiple systems, but also by markets and timeframes. These layers of diversification are intended to expand the range of opportunities, reduce overall program risk, and provide a high degree of non-correlation between the returns of the GMF Managed Account program and global stock and bond markets.

The focus is on risk reduction, capital preservation, anticipation of significant technical levels, efficient trade entry and exit points, and continual evaluation and adjustment of portfolio exposure.

Attempt to eliminate large losses and show profit day in and day out through ANY market condition.

by Stock Specialist ~ 0 comments

The Trading Advisor

The Trading Advisor for the Tactical Asset Allocation Fund is FX Quant Advisors (“FXQA”) – FXQA is a subsidiary of Protrade Capital Group, LLC., a California limited liability company. FXQA provides FX advisory and asset management services to institutional and high net-worth clients. The Managing Director and Trading Advisor of FXQA is Mr. Mark Shawzin.

Mr. Shawzin has over twenty-five years experience in the stock and futures and Forex markets in varying capacities as an analyst, broker, trader and portfolio manager. Since 1979, Mr. Shawzin has traded for his personal account and has managed discretionary accounts for individuals and institutional accounts , including Commodity Corp. (a division of Goldman Sachs), Itafin, GIC Management Co. and the Laurentian Bank of Canada, based on his proprietary trading methods and analysis.

During his trading and brokerage career, Mr. Shawzin was a senior broker and officer with Merrill Lynch, EF Hutton, Drexel, Burnham & Lambert, and Oppenheimer & Co. and a senior portfolio manager with Bridgewater U.S.A. and Global Futures Exchange & Trading Co.

Mr. Shawzin has spent thousands of hours developing his proprietary trading methodology and has worked extensively in the areas of portfolio optimization, risk management and trading strategy development.

In 1979 Mr. Shawzin graduated from USC Business School with a degree in Finance and Management.

by Stock Specialist ~ 0 comments

FX Quant Advisors - Managed Account Features & Benefits

Professional management
Leverage and low investment requirements
Optimal "per trade" risk management
Broad Diversification
Access to International markets
Non-correlated to traditional equity and fixed income markets
Potential profits in both rising and falling markets
Liquidity – month-to-month
Transparency – monitor/view account 24/7 in “real-time”
No commingling of accounts

by Stock Specialist ~ 0 comments

Why Managed Forex

Forex markets have many important advantages over other investment alternatives:

Forex markets are highly liquid and trade 24 hours a day around the world.

Forex markets offer leverage without interest expense. An equivalent amount of money can control significantly more value than futures or stocks.

Forex markets are traded globally, which makes it possible to spread risk and participate in potential profit opportunities around the world.

Forex can be traded in both rising and falling markets. Because there is no prohibition against short sales in Forex markets, it is just as easy to establish a short position with the objective of profiting from declining prices, as it is to establish a long position with the objective of profiting from rising prices.

Because managed Forex accounts have a low to negative correlation to stocks and bonds, adding them to the traditional portfolio mix enhances risk-adjusted returns.

SAFETY OF FUNDS: Your money remains deposited with a large and reputable FX dealing firm (FXDD) – client deposits are held at JPMorgan Chase bank.). FXQA cannot and will not accept custody of your funds or securities.

TRANSPARENCY – clients can view/monitor their account balances/positions in real-time 24/7

Managed Forex is suitable for your IRA, 401(k), Roth IRA, & SEP

by Stock Specialist ~ 0 comments

FOREX = Controlled Risk

Perception = Higher leverage capability implies Forex most “risky” investment vehicle
Reality = no other trading market (stocks, futures) offers the ability to CONTROL
RISK as well as FOREX market:

FOREX Trades 24hrs/day/6days/week – means no price gaps, stop-loss orders ALWAYS working
LIQUID - $1.5 – 4 trillion/day turnover – INSTANT EXECUTION on large $ orders
NO SLIPPAGE on stop orders (even in fast market) – HUGE advantage
No fixed unit size – FLEXI-LEVERAGE – select trade unit size ($10,000 mini or $100,000 standard lot) to meet individual/customized risk/reward parameters
Electronic platform “kicks-out” positions before go negative – NO DEBIT BALANCES, NO MARGIN CALLS
Limit your risk to an amount you choose: System software offers clients ability to automatically close out positions and cease trading at a specified risk tolerance level

by Stock Specialist ~ 0 comments

Forex vs. Stocks

Forex
- Open 24 Hours, 6 Days a Week
- Superior Market Liquidity
- Profit Potential in both
rising and falling markets
- No commission fees
- Increased leverage

Stocks
- Open Limited Hours
- Limited Liquidity
- Profit in rising markets
- Commission fees
- Limited leverage

by Stock Specialist ~ 0 comments

FX Market - Overview

FX market more than 40x US stock market
FX market has no physical location or central
Exchange
Operates through an electronic network
of banks, corporations, institutional
investors and individuals
Trades filled in seconds
Forex market operates on a 24-hour basis,
spanning from one zone to another across
the major global financial centers

by Stock Specialist ~ 1 comments

Features and Advantages of the FOREX market

LARGEST and most LIQUID investment market in the world ($1.5 - 4 trillion per day – 50x larger than US stock market)
LIQUIDITY – trades 24 hours/day and 5.5 days/week
LEVERAGE –100:1 on invested $ - $1,000 controls $100,000
FASTER LEARNING CURVE – 15-20 currency pairs vs. 40,000 stocks
CONTROLLED RISK – 24 hour market means no price gaps – no slippage on stops - clients set a $ stop-loss limit on their account
INSTANT EXECUTION – FX market is all electronic – no delays in order fills
NON-CORRELATED to traditional asset classes (stocks, bonds, real estate) – true DIVERSIFICATION
TRENDING MARKETS – Forex markets tend to trend for days, weeks, months and years
NO UPTICK RULE - ability to go long and short with equal ease
NO MARGIN CALLS – trading software will not let an account go deficit - can’t lose more than you invest!
NO FINANCIAL DISCLOSURE – clearing firm does not report financial gains

by Stock Specialist ~ 0 comments

FX Quant Advisors - The Current Investment Environment

U.S. stock market – high-volatility, non-trending market environment makes trading success difficult for S-T AND L-T investors/traders. Recession likelihood & mid-low single-digit returns makes L-T risk/reward unfavorable for this asset class.

Inflation soaring – unofficial estimates now over 10%/year!

Mutual Fund investor return - paltry 3.5% over twenty-year period.

Rising L-T interest rates constraining returns for “traditional assets” - stocks, bonds & real-estate.

Money-market yield at 2.0%; 10-year government treasury bond yield 3.8%.

Real estate investors prisoner of “credit crunch”.

Twin deficits (trade/budget) and “demographic bubble” - long-term overhang over economy and inhibiting investment returns.

FXQA believes we have positioned our portfolios to take advantage of these trends. What are you doing to protect and/or enhance your portfolio?

by Stock Specialist ~ 0 comments

FX Quant Advisors - Philosophy

IT IS ABSOLUTELY NECESSARY TO HAVE AN EDGE...
"You can't win without an edge, even with the world's
greatest discipline and money management skills.
If you could, then it would be possible to win at
roulette (over the long run) using perfect discipline
and risk control. Of course, that is an impossible
task because of the laws of probability. If you don't
have an edge, all the money management and discipline
will do for you is to guarantee that you will gradually
bleed to death.”

Incidentally, if you don't know what your edge is,
you don't have one.

by Stock Specialist ~ 0 comments

FX Quant Advisors

The Current Investment Environment

About the FOREX market – Features & Advantages

Trading Styles & Methodologies

Managed Account Program – Features & Benefits

About FX Quant Advisors

How to Open An Account

by Stock Specialist ~ 0 comments

Conclusions and Concerns (4)Main Concerns

Delay in bankruptcy proceedings and credit dispute resolution
Time taken for winding up proceedings is highest in the world
Improvement in effective enforcement of creditor rights required
Faster resolution of stressed assets of financial intermediaries
Regulation of financial conglomerates and holding companies
Role of SROs
Regulatory co-operation – particularly cross border
Management of capital account
Deficiency in retail payment systems

by Stock Specialist ~ Monday, September 28, 2009 0 comments

Conclusions and Concerns (3)Main Concerns

Financial Markets –
Risk of contagion
Development of an appropriate risk free yield curve
Corporate bond markets
Issues relating to derivatives – knowledge concentration and capacity building
Transparency –
Some issues in fiscal transparency; Need to strengthen data collection agencies

by Stock Specialist ~ 0 comments

Conclusions and Concerns (2)Main Concerns

Macro economy –
Fiscal Deficit
Agricultural Growth
Susceptibility to international commodity price movements
Institutions –
Emerging liquidity concerns
Corporate governance in co-operative sector
Health of rural co-operatives
Funding constraints for NBFCs
Lack of timely data to gauge household indebtedness
Stress Testing
Lack of database, techniques and capacity to conduct appropriate systemic stress tests taking into account sectoral interlinkages as also contagion risk

by Stock Specialist ~ 0 comments

Conclusions and Concerns (1)Summary of Assessment

Financial Sector – Has expanded; acquired greater depth and vibrancy
Macro economy – Short-term - Uncertainty; Medium-term - high growth sustainable
Banks – Healthy and Robust
Financial Markets – Resilient and fairly liquid
Financial Infrastructure – Robust
Transparency – Significant improvements

by Stock Specialist ~ 0 comments

CFSA and Advisory Panels – Some Differences

Regulatory Independence
Panel view : Issues regarding independence of SEBI and IRDA
CFSA view: Regulatory independence adequate
Review of Legislation
Panel view : Review of RBI Act needed
CFSA view : Requires to be viewed in a more comprehensive manner
Role of HLCCFM
Panel view : Further formalisation and institutionalisation
CFSA view: Not consistent with regulators’ autonomy
Prompt Corrective Action
Panel view : Appropriate time-frame required
CFSA view: Any rigidity in timeline unduly restrictive

by Stock Specialist ~ 0 comments

Accounting and Auditing

Ian Mackintosh
Exercise caution while developing country specific and sector specific accounting standards
Important to give functional independence to AASB
N.P. Sarda
Determining the role of the Quality Review Board to review and improve the quality of audit service is required

by Stock Specialist ~ 0 comments

Peer Reviewers’ Comments (3)

Bankruptcy Laws
Thomas Baxter
Indian insolvency regime remains an enigma
Special Insolvency regime for banks complement access to credit facilities of central bank and deposit insurance
Fiscal Transparency
Vito Tanzi
Better classification of expenditure central to fiscal policy
Relevant fiscal target should be GFD and not revenue deficit
Relatively few countries have made a transition to accrual based accounting

by Stock Specialist ~ 0 comments

Peer Reviewers’ Comments (2)

Assessment of BCP
Eric Rosengren
Urgent need to improve co-ordination between regulatory agencies
LoLR should have the ability to assess solvency and liquidity risks facing institutions
Report should elaborate on aspects relating to Central Government’s role in operation of PSBs – whether it interferes with the regulatory role of RBI
Corporate Governance and
Transparency in Monetary Policy
Sir Andrew Large
Higher corporate governance standards for the unlisted sector
Mechanism to enable central bank to be adequately informed to handle liquidity related events
Improvements in transparency would enhance central bank independence

by Stock Specialist ~ 0 comments

Financial Stability Assessment and Stress Testing

V. Sundararajan
Plausible shocks and vulnerabilities arising out of domestic macroeconomic and external sectors should be systemically linked to stress scenarios
Growing use of purchased funds need analysis of second round contagion effects
Andrew Sheng
Creation of secondary mortgage market
Setting up of Government sponsored secondary mortgage vehicles
On-site examination process should be supplemented by a forensic “follow the evolution of the product” approach.

by Stock Specialist ~ 0 comments

Transparency and Development Issues (4) Making Financial Inclusion Work

Rangarajan Committee on financial inclusion
Exploit synergies between local and national level financial institutions
Finance consumption and household expenditure
Scale-up IT initiatives
Biometric smart cards in rural areas
Development of mobile banking
Incentivise BCs
Urban poor
Dilute KYC norms

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Transparency and Development Issues (3) Assessment of Data Dissemination Standards

Major Gaps:
Need for proper legal and institutional support for CSO
IIP data - need to adjust basket of commodities and weights assigned
Multiple agencies in collection of labour data
WPI – outdated weights

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Transparency and Development Issues (2) Assessment of Fiscal Transparency

Significant improvement following FRBM Act and Fiscal Responsibility Legislations
Major Gaps/Issues:
Functional overlap by Central Government on issues relating to State Government like health and agriculture
Mode of calculating FD does not capture off-budget items separately –augmented FD required
Need for accrual-based accounting – guarded approach

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Transparency and Development Issues (1)Assessment of Transparency in Monetary and Financial Policies

Major Gaps/Issues:
Need for review of legislations- overhaul of legislations not required
Operational independence of RBI
Strengthening TACMP – requires ongoing review
Separation of debt management from monetary management – Chairman’s
dissent
Price index for measuring inflation – WPI/CPI debate

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Financial Infrastructure (7)Depositor Protection

Independence of Deposit Insurance and Credit Guarantee Corporation (DICGC) (recommended by Advisory Panel)
Increase flat-rate premium
Involvement of DICGC in resolution process- delink settlement of DICGC claims from liquidation process

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Financial Infrastructure (6)Assessment of Bankruptcy Law Principles

Major Gaps:
Implementation of bankruptcy laws – poor- average 10 years to complete liquidation proceedings – ‘Doing Business Report’- World Bank
Amendment to the Companies Act still pending – Setting up of NCLT
Issues relating to Competition Amendment Act, 2007
Lack of a Central Registry for recording security interests

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Financial Infrastructure (5)Business Continuity Management

Ease of operations during crises
Areas for strengthening
Human Resources management
Business continuity processes of vendors
Outsourcing risk
Succession planning

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Financial Infrastructure (4)Payment and Settlement

Payment & Settlement Act of 2007 fills a major gap

Sub-optimal utilisation of electronic payment infrastructure

Delays in collection of outstation cheques

Financial resources with CCIL need strengthening

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Financial Infrastructure (3)Accounting and Auditing

More autonomy for Accounting Standards Board

Need to develop sector-specific guidance

Issues in auditing about convergence with ISAs

Need to give functional independence to AASB

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Financial Infrastructure (2)Markets and Liquidity

Large capital movements
Volatility in overnight rates
Strengthen government cash management
Asset liability management of banks
Issues related to market integrity—participatory notes
Term liquidity facility not required at this stage

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Financial Infrastructure (1)Regulatory Infrastructure

Multiple roles of regulators
Consistent with financial development
Needs effective coordination
Principles vs. Rules-based: complementary
Develop supervision of financial conglomerates
Legislation, a new Act?
Develop Self -Regulatory Organisations?
Regulatory independence
Panels have raised some issues
But CFSA considered adequate

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Financial Markets (8) Compliance With IOSCO

Despite high compliance, some gaps remain
Equities Market: Responsibilities and operational independence of regulator; inspection and surveillance powers; capital and prudential requirements for market intermediaries
Foreign Exchange Market: Operational independence and accountability of regulator; co-operation and detection of manipulation and unfair trading practices
G-Sec markets: Operational independence and accountability of regulator; home-host co-operation; disclosure of financial results
Money markets: Operational independence; regulatory co-operation with foreign regulator

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Financial Markets (6)Other Market Segments

Need to develop corporate bond market

Develop credit risk transfer mechanism

But with appropriate checks and balances

Capacity building in financial institutions with

regard to securitisation and credit derivatives

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Financial Markets (5)Money Market

Liquid market
Increased share of repo and CBLO
Need for active interest rate futures market
Being re-introduced
Development of term money market
Development of short-end yield curve necessary
Under examination in TAC Group
Development of the repo market

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Financial Markets (4)Equity Market

Significant improvement in market and settlement infrastructure
Functions in robust regulatory environment
Very high compliance with IOSCO Principles
Risk management by market participants
Strengthening of inter-exchange surveillance
Need to improve IPO processes
Setting up of Central Integrated Platform

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Financial Markets (3)Sovereign Debt Market

Significant growth in volume and liquidity
Further diversification of investor base needed
Foreign investor participation: proceed with care
Increase in tradable assets desirable
Large proportion parked in HTM category

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Financial Markets (2)Foreign Exchange Market

Fastest growing market globally
Total annual turnover increased from USD 1.3 trillion
during 1997-98 to USD 12.3 trillion during 2007-08
Derivatives:
High growth in forward market
Forex futures introduced in 2008
Need for monitoring and regulation
Customer appropriateness and product suitability

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E. Financial Markets

Financial Markets (1)Regulation and Supervision

Systemic stability
Importance of markets other than equity market
IOSCO Principles extended to:
G-Sec markets; Forex Markets; Money Markets
Results: Generally satisfactory

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Financial Institutions (10)An Assessment of Insurance

Significant growth in size, penetration and diversified products
Comfortable solvency and capital adequacy
But gaps/issues remain
Increase supervisory powers of IRDA
Group-wide supervision – effective policy to be put in place
Risk Management
Further requirement of skilled professionals – actuaries, treasury managers

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Financial Institutions (9)An Assessment of Insurance

The level of compliance of the Insurance Sector to IAIS Core Principles

Assessment
Observed
Number of Principles - 5
Largely Observed
Number of Principles - 13
Partly Observed
Number of Principles - 10
Not Observed
Number of Principles - 10

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Financial Institutions (8)Non-Bank Financial Services

NBFCs are key players in financial markets
Corporate bond market development would ease funding constraints
Development of regulatory structure for financial conglomerates
Prudential regulations of NBFCs strengthened – some way to go
Housing finance: growing and important segment
National Housing Price Index, Housing Starts Index a priority
Regulation of HFCs should be entrusted to RBI – Government’s stance – status quo

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Financial Institutions (7) Risk Management and Governance

Conservative risk management matters
Counter-cyclical prudential measures by RBI
Off-balance sheet items: Better accounting, disclosure
Capital charge if reliance on purchased liquidity beyond a threshold

Consolidation
Encourage market-based consolidation

Co-operative and rural banks need better governance
Dual control: improve corporate governance
Regulation and supervision of rural financial sector: role for RBI and NABARD

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Financial Institutions (6) New Competition Act: Some Issues

Power of Competition Commission to regulate combination
Any combination required to be notified to Commission
Maximum period of wait 210 days
RBI may be able to give sanction only after getting order of Commission or wait for 210 days
Delays the process
Possibility of regulatory conflict as order of any statutory authority not binding on Commission
Could lead to regulatory overlap and conflict
Central Government could give necessary exemption under Section 54 of the Competition (Amendment) Act 2007

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Financial Institutions (5)Banking For The 21st Century

Capacity Building:
Training
Succession Planning
Lateral Recruitment
Improved remuneration – but discourage excessive risk taking
Corporate Governance:
Improve governance in PSBs
Roadmap for foreign banks –
A well-considered approach within the WTO norms

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Financial Institutions (4)Commercial Banks Oversight

Government ownership poses dilemmas
Possibility of conflicts of interest minimized through even-handed regulation
Newer instruments
Through selective dilution of government equity

Capital augmentation of PSBs is a challenge,
but could be managed through a variety of ways
Amalgamation where commercial synergies exist

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Financial Institutions (3)Basel Core Principles: A Compliance Summary

Major Gaps:
All Institutions: Risk management (for commercial banks the level of compliance is comparatively lower in respect of banking groups); home-host country regulation
Commercial Banks: Exposure to related parties; non-compliance in respect to interest rate risk in banking book for which guidelines have since been issued
Rural & Co-operative Banks: Dual Control; internal control; corporate governance
NBFCs: Major acquisitions, transfer of significant ownership, internal control
HFCs: Permissible activities; internal control

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Financial Institutions (1)Regulation and Supervision

Inherent linkages across institutions
Inter-bank
Bank and non-banks
Basel Core Principles not applicable to:
Co-operative Sector; Regional Rural Banks;
NBFCs; HFCs
But, Assessment done for health check
Results: Generally satisfactory

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Stability Assessment and Stress Testing (9)The Way Forward

In Sum:
Commercial Banking System – Broadly Sound
Can withstand significant shocks from large potential changes
Possible Next Steps:
Need to strengthen liquidity management
Stress Testing by individual banks
Periodic scenario testing by RBI
Setting up of a Financial Stability Unit

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Stability Assessment and Stress Testing (8)Liquidity Risk Management

Gradual, growing dependence on purchased liquidity

Increase in illiquid parts of banks’ balance sheets

Greater reliance on volatile liabilities for asset growth

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Stability Assessment and Stress Testing (6)Interest rate risk

Calculates the erosion in accounting capital due to unit
increase in interest rate

Higher the DoE (duration of equity), greater the sensitivity
of banks capital to interest rate shocks
The annualised yield volatility is estimated at 244 bps

Given a DoE of 8.1 years, a 244 bps shock implies
an erosion of 20 per cent of capital and reserves.

=> Better management of interest rate risk by
commercial banks over time

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Stability Assessment and Stress Testing (5)Credit Risk

Concerns about credit risk remain
muted at present

Need for close monitoring of such risks
in the current scenario

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Stability Assessment and Stress Testing (4) Stress Testing

What is Stress Testing
Techniques to assess vulnerability of the financial system in the face of shocks;
identifies how portfolios respond to changes in key economic variables: e.g., interest rates, credit quality
Coverage of stress tests
Credit risk
Market/interest rate risk
Liquidity risk
Open positions in foreign exchange much below regulatory limits – Exchange rate tests not undertaken

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C. Stability Assessment and Stress Testing

Stability Assessment and Stress Testing (1)
Main Findings

Financial Institutions
Commercial Banks: financially robust
NBFCs and HFCs: healthy financial indicators
Some financing concerns
UCBs and RRBs: improvements in financials
governance concerns
Rural Co-operative Sector
significant weaknesses

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Macroeconomic Outlook and Vulnerabilities (2)Pressing Challenges

Need for revival of growth in agriculture
Address restoration of the fiscal reform path
Continuation of financial sector consolidation and development
Address the infrastructure deficit
Complement bank financing with bond market development
Insurance and pension reforms
FCAC desirable, but with concomitant macroeconomic and market developments

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Macroeconomic Outlook and Vulnerabilities

Macroeconomic Outlook and Vulnerabilities (1)
The Growth Story

Growth in recent period contributed by several factors

High domestic demand

Productivity

Credit growth

High levels of savings and investment

Current global financial crisis: shift from
benign outlook to one of uncertainty
8 %+ growth sustainable in the medium-term due to
high demand; deceleration in the short-term

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Background and Timing (3)The Process

Benefits
Composition of CFSA: ownership and commitment
Regulatory cooperation: GoI, RBI, SEBI, IRDA, other agencies
Involvement of experts: advisory panels
Peer reviews: Impartiality
Learning and capacity-building: involvement of professionals
Execution
Complex issues – approach with humility
Broad directions instead of specifics in the current context
Focus on Transparent Reporting : Differing opinions of CFSA and
Panels covered in the report

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Background and Timing (2)Overview of Self-Assessment

Approach and Methodology

Pillar I Macro-prudential surveillance and financial stability analysis

Pillar II Legal and institutional frameworks review

Pillar III International financial standards and codes:
assessment and status of implementation

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The FSAP and Self-Assessment

A. Background and Timing

Background and Timing (1)
The Story So Far

IMF-WB FSAP in 2001, self-assessment of international
standards and codes in 2002, reviewed again in 2005

Set up CFSA in 2006

India among the first country to undertake
comprehensive and holistic self-assessment
of financial sector

Post-crisis, emphasis by the G-20

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FSAP

Part I: The FSAP and Self-Assessment

A. Background and Timing

B. Macroeconomic Outlook and Vulnerabilities

C. Stability Assessment & Stress Testing

Part II: Lessons and Issues from the Assessment

D-F. Financial Institutions, Markets and Infrastructure

G. Transparency and Developmental Issues

Part III: Transparent Reporting

H. Peer Reviewers’ Comments

I. CFSA and Advisory Panels – Some Differences

Part IV: Conclusions and Concerns

J. Summary of Assessment

K. Main Concerns

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Financial Sector Assessment

What is an FSAP?

The Financial Sector Assessment Program
is an IMF-World Bank initiative

A comprehensive health check of the
financial system

A review of strengths, vulnerabilities and
weaknesses

Measures compliance with international financial
standards and codes

Initiated after the1997 Asian financial crisis

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‘Structural sensitivity analysis’

Alter assumptions about market clearing

Alter assumptions about property rights

Alter assumptions about macroeconomic closure

e.g. Adjustment to equilibrium through domestic
tax system vs. adjustments through accommodating
international capital flows.

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Institutional issues

Trees may be cut (or planted) to establish
property rights over land.

In open access forests (non-commercial),
opportunity cost of forest is set by
ag. land values and clearing costs.

In commercial forestry, timber
harvesting/replanting also depends
on property rights.

Will an increase in timber prices promote
or retard tree-felling in aggregate?
Depends on property rights.

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Land degradation

Hard to measure, and problems of aggregation.

Can use information on erosion rates by crop,
together with land use data, to build ‘baseline’
data set.

Then erosion changes can be inferred from changes in land use

Production externalities: technical ‘regress’.

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Deforestation & land degradation

Commercial and non-comm’l deforestation:
does timber have market value?

Non-comm’l deforestation is driven by search
for land, and responds to changes in the marginal
valuation of land in agricultural production...

… although institutional setting also matters

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Environmental analysis in GE

Most AGE models constructed for more
general analytical purposes: environmental
structure is added later

Given uncertainty about env. variables
and valuations this may be appropriate!

Industrial emissions: ‘side calculations’

Natural resource degradation

Questions about institutions.

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Open access to natural capital

Addressing env. damages and natural resource depletion

Pigovian taxes (Bovenberg & Goulder, AER 1996)

Private purchase of abatement services

Public provision of abatement or clean-up services

Quotas or limits on resource use or
emissions (command & control)

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Schematic social accounts - Social accounting matrix

Schematic social accounts

Social accounting matrix

‘Standard’ national accounts ignore environment

Assumptions:

Property rights on resources

No externalities

No non-marketed amenity values

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Data

Social accounting matrix: base year data

Input-output accounts of industries

Factor markets, household incomes & expenditures

Trade and final demand

Taxes and G. expenditures

Micro and macro balance

Elasticities

Estimated (see www.aae.wisc.edu/coxhead/apex ),
or more commonly ‘guesstimated’.

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Features of Johansen models

Parameter values are shares and elasticities
Quick checks:
Homogeneity & ‘balance’ of underlying data base.
Solution is by matrix inversion
Entire model is a system of linear equations
Examples of Johansen-style models:
ORANI (Australian economy)
GTAP (international agricultural trade)
Models in OEE, Ch.6–8

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Solving the model: the ‘Johansen’ AGE structure

First-order approximations to changes in variable values

Models solved in proportional (percentage) changes of variables, or ‘hat calculus’.

Advantages:

Models are linear in variables

Parameter values are intuitive and accessible (shares from SAM,
elasticities from other sources)

Simulation results are additive in separate shocks

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Other features

Can add in:

Intermediate inputs

Products distinguished by source (domestic, imported)

Different kinds of labor

Many sources of final demand

Trade and transport ‘margins’

Tariffs, taxes, and other policies … etc.

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Closure rules and decisions

Other closures are possible

‘Neoclassical’ closure has all domestic prices flexible

Alternatives: e.g. fix wages, allow unemployment in labor market.

These choices reflect our beliefs or observations about the real world.

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Closure

No. of equations must match endog. vars.
In (5.1)-(5.8): 4N + F + FN + M + 1 eqns.
But we have 5N + 2F + FN + 2 variables.
Must choose N - M + F + 1 exog. vars
Declare V exog; (N - M) elements of P, and f.
Now (5.1)-(5.8) solves for Y, W, R, X, D, S and U as endogenous variables.
Endogenous: income, factor prices, quantities produced and demanded, trade, and utility.
Exogenous: factor endowments, traded goods’ prices and a numeraire price.

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An N-good, F-factor economy

General structure

Equilibrium conditions

Closure rules and decisions

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Overview of AGE models

Describe Walrasian equilibria in fairly
detailed manner--sufficient to support
policy claims

Too large to be solved analytically;
must use numerical solutions instead

But structure and results depend on
same theoretical foundations

Advantages and disadvantages of size.

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Pros and cons of AGE modeling

Importance of economy-wide mechanisms
and implications

Intractability of higher-dimension
analytical models

Opportunities for ‘structural sensitivity
analysis’

X Limitations

Time is usually not explicitly taken into
account

Micro details such as risk/uncertainty or
credit market imperfections usually
ignored

aggregations can mask important differences
(e.g. intra-industry variations)

AGE approach is highly time and energy-intensive:
benefits over PE approach obtained at high cost.

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8 Applied GE modeling of economy & environment

Rationales

Basics of applied GE models

Incorporating environmental issues

Main source: OEE Ch. 5.
Additional: Shoven & Whalley, JEL 1984;
Ginsburgh & Keyzer, Structure of applied
general eq. models (MIT Press, 1997);
Coxhead, World Development 28(1), 2000.

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Research & Development

Establish Labs to

perform ground

breaking research.

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Services

Forex

Options

Commodities

Overseas Markets

Capital Management

Macroeconomic Outlook

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Advantages of premium membership

Access to all robots

Email alerts on currency trends and major
economic news

Support and comprehensive training

Automatic updates for the subscribed robots

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Neural Traders Robots

BreakEA – to capture break outs for
GBPUSD on M15.

MacPro – Based on macd and a few other
indicators to trade EURUSD, GBPUSD and
NZDUSD hourly.

AIRobot – Artifical intelligence enabled
EURUSD short term trader.

XPIPS – Maritangle Strategy on EURUSD
H4.

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Technical Indicators

Moving Averages

Stochastic

William's Percentage Range

ADX

ATR

Macd

RSI

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Risk Management

Golden rule: Risk no more than 3% per trade.

Keep greed and fear in control

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Mathematical Foundation

Probability

Expectation

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Trading Strategies

Scalping

Momentum

Breakout

Swing

Carry Trading

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Technical and Fundamental Analysis

Technical analysis: based on indicators such as moving averages, volume
oversold and undersold conditions etc

Fundamental analysis: based on news and economic events, speeches by
Key personalities such as fed chairman, ECB chairman etc.

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Automated vs Manual Trading

Manual trading can be effective
for people who want to be in control
and have the right trading discipline.

Automated trading consists of translating
a trading strategy into an
Automated agent or Expert Advisor for MT4

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The Forex Market - Brokers and Tools

MT4 (fxdd / alpari)

FXCM's trading station

Avafx

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Time Zones

Asian

European

Newyork

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Understanding the trading lingo

Pips

Spread

StopLoss

TrailingStop

TakeProfit

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The Forex Market - Leverage – the power to profit even from small volatility

Daily currency fluctuations are usually very small.
Most currency pairs move less than one cent per day, representing a less than
1% change in the value of the currency.
This makes foreign exchange one of the least volatile financial markets around.
Therefore, many currency traders rely on the availability of enormous
leverage to increase the value of potential movements.

A 200:1 leverage means your 100$ will control 20,000 $.

e.g If Yen goes from 95.0 to 95.10 without leverage you will only be making 1.1%
without leverage – whereas with with 100:1 leverage you will make 100%.

by Stock Specialist ~ Wednesday, September 16, 2009 0 comments

The Forex Market

The foreign exchange market (forex or FX for short) is one of the most exciting,
fast-paced markets around.
Until recently, forex trading in the currency market had been the domain of
large financial institutions, corporations, central banks, hedge funds and extremely
wealthy individuals. The emergence of the internet has changed all of this,
and now it is possible for average investors to buy and sell currencies easily with
the click of a mouse through online brokerage accounts with brokers such as

FXDD
FXCM
Alpari

by Stock Specialist ~ Tuesday, September 15, 2009 0 comments

Foreign Exchange Definitions

Value Rate – is the date of settlement for the
foreign exchange transactions

Bid price – the price the dealer is willing to buy
a currency at

Offer price/ ask price – is the price the dealer
sells currency for

Spread – is the difference between the buy and
sell price from the dealer’s point of view.

by Stock Specialist ~ Monday, September 14, 2009 0 comments

Foreign Exchange - Balance of Payments

B of P – is a record of the value of all economic
transactions between residents of a country

Consists of the following accounts:

Merchandise Trade Bal.
Services
Unilateral Transfers +
Current Accounts

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Foreign Exchange Definitions

Convertibility – the degree that one currency can
be exchanged for another one without difficulty

Hard Currency – is a currency that is convertible
and is supported by a strong economy

Spot Rate – an exchange rate quoted for
immediate delivery or within 2 business days

Forward Rate – an exchange rate quoted for
today that is intended for use in the future. It is a
verbal agreement or a binding contract

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Demand for the Dollar ($)

Investment Currency

Reserve Currency

Transaction Currency

Invoice Currency

Intervention Currency

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Foreign Exchange

What is the foreign exchange rate?

What is the foreign exchange market?

What is the foreign exchange organization?

Who are the participants?

- importers/exporters, investors, tourists,
banks, dealers, brokers, speculators

Why use the foreign exchange markets?

- to hedge currency risk, to diversify
portfolios, to make money

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The Foreign Exchange Market - Interest Rates and Exchange Rates

Interest rates reflect expectations of inflation rates;

- high interest rates reflect high inflation expectation

- Fisher Effect: i = r + I

i: “nominal” interest rate in a country

r: “real” interest rate

I: inflation over the period the funds are to be lent

- International Fisher Effect: (S1-S2)/S2 X 100 = i$ - i¥

For any two countries the spot exchange rate should change
in an equal amount but in the opposite direction to the
difference in nominal interest rates between the two
countries

S1: spot rate at time 1, S2 : spot rate at time 1; i$, i¥: nominal
interest rates in the US and Japan

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Exchange Rate Forecasting

The efficient market school

- Prices reflect all available public information

The inefficient market school

- Prices do not reflect all available public information

Approaches to forecasting

- Fundamental analysis

Econometric models draw on economic theory to
forecast future movements

- Technical analysis

Extrapolation/interpretation of past trends
assuming they predict future movements

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Convertibility

Currency convertibility and government policy

- Freely convertible: residents/non-residents allowed to
purchase unlimited amounts of a foreign currency with
the local currency

- Not freely convertible: residents/non-residents not
allowed to purchase unlimited amounts of a foreign
currency with the local currency

Countertrade

- Barter agreements by which goods and services can
be traded for other goods and services
- Used to get around the non-convertibility of currencies

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Money Supply and Currency Value

Inflation occurs when the quantity of money in
circulation rises faster than the stock of goods
and services

Money supply growth related to currency value

Relative inflation rates and trends can predict
relative exchange rate movements

When changes in relative prices in two
countries change their currencies’ exchange
rate, then the currency of the country with the
highest inflation should decline in value

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Prices and Exchange Rates

The law of one price:

- Identical products sold in different countries must sell
for one price if their price is expressed in one currency

- Assumptions:

Competitive markets
No transportation costs; no trade barriers

Purchasing Power Parity (PPP):

- If the law of one price holds for all goods / services, the
PPP exchange rate is found by comparing prices of
identical products in different countries

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The Foreign Exchange Market

Minimizes foreign exchange risk (unpredictable rate
swings)

To do so there are different ways to trade currencies

- Spot exchange rates: the day’s rate offered by a
dealer/bank
- Forward exchange rates:
Agreed in advance rates to buy/sell a currency on a future
date
Usually quoted 30, 90, 120 days in advance
The market is “open” 24 hours…
Arbitrage is the process of buying low and selling high
… given slightly different exchange rate quotes in one
location vs another (e.g., London vs Tokyo)

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Currency Conversion In The Foreign Exchange Market

Currency conversion in the foreign exchange
market

- Is necessary to complete private and commercial
transactions across borders
- A tourist needs to pay expenses on the road in local
currency
- A firm
Buys/sells goods and services in the other country’s local
currency
Uses the foreign exchange market to invest excess funds

Is used to speculate on currency movements

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Foreign Exchange

The foreign exchange market

- Is the market where one buys or sells
the currency of country A with
the currency of country B

A currency exchange rate

- Is simply the ratio of
a unit of currency of country A to
a unit of the currency of country B
at the time of the buy or sell transaction

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The Foreign Exchange Market

Form and function of the foreign exchange
market

Difference between spot and forward rates

Determinants of currency exchange rates

Foreign exchange risk and the exchange
market

Exchange rate forecasting

Convertibility of currencies

Countertrade as convertibility mitigation factor

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Economic Risk

- How can we capture empirically economic risk?

- Empirical literature has tried to estimate the rate of
return of a firm as a function of the market rate of
return (CAPM) and exchange rate variability

- Mixed results

- Younger firms more exposed than older firms to the
effects of exchange rate variability

- Older firms may be more capable of hedging economic
risk

by Stock Specialist ~ Saturday, September 12, 2009 0 comments

Economic Risk

- Now, change assumptions. US exports are
invoiced in $ and Italian exports in euros.

With demand partially elastic, $ export revenues rise

With euro pricing unchanged, dollar imports
(inputs) now cost more in dollars. US exporter will
be looking for cheaper alternatives. If demand is
inelastic, dollar imports rise.

- Case when exports and imports are € invoiced

- Case when exports are invoiced in euros and imports in dollars

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Economic Risk

- Assume a $1 = € 1, products priced at $ 1, 10%

depreciation of the dollar, and $ invoicing

With $ pricing unchanged, $ depreciation → € 0.91

With demand completely inelastic, $ revenues
remain unchanged

With demand partially elastic, $ revenues rise

$-based inputs do not change in value

FCF rises

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Economic Risk

- Value of the firm or value of the project. Us firm sells
partly in the US and partly exports to Italy. Cash
outflows partly in dollars and partly in euros

- Concept of cash flow. Start from net income and adding
non-cash items like depreciation and subtracting cash
items like expenditures on fixed assets

- Free cash flows are projected or forecasted forward,
into infinity. Euro-based cash flows need to be
converted into dollars

- Stream of cash flows discounted by a dollar-based rate
of return expected by US shareholders

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Kelley Instruments

- Pound is functional currency; dollar is reporting currency

- $2=£1 at year beginning; $2.2=£1 at year end; $2.1= £1 mid-point

- I shall assume that you know accounting sufficiently well to arrive
at the solution indicated on page 45 of my text

- Let’s concentrate on current method

- Income statement: all items are recorded at mid-point exchange
rate. Net income is equal to retained earnings. No translation gains

- Balance sheet: all assets and liabilities at year-end exchange rate,
except common stock at year beginning and retained earnings at
mid-point exchange rate

- Net worth: common stock at year beginning plus retained

- CTA: (common stock and retained earnings)*(2.2) – (common
stock)*(2.0) – (retained earnings)*(2.1)

- CTA goes into dollar net worth

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Translation risk

- US accounting principles allow conversion

gains or losses to be shielded from taxation in

the current period; these gains or losses are

accumulated in a separate account, which are

taxed when the investment is sold or liquidated.

The idea is that yearly gains or losses may be

temporary but long-term ones are not.

- Best way to understand how this works is to

consider the case study in Box 2.3 of the text.

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Types of Forex risk

- Translation risk: multinational co. (MNC) with branches or
subsidiaries in different currency areas of the world must report its
consolidated financial accounts in a single currency. The
conversion creates gains or losses and may have tax
consequences. The US has the most elaborate system of
accounting to handle the conversion risk. Light coverage in the
course

- Transaction risk: arising from transactions in different currencies.
Heavy coverage in the course.

- Economic risk: typical in a foreign direct investment (FDI).
Investment is valued in terms of discounted cash flows in foreign
currencies and then converted in local currency, with the local
discount rate. Light coverage in the course

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Quotes and practices

- Forward one month for the dollar/euro (same date)

$1.2887/ €1

- Forward premium at an annual rate

(1.2887-1.2862)*1200/1.2862 = 2.3324%

- Euro is at a premium, or the dollar is at a discount

- Cross rates: these appear in the FT every day and can be computed
simply by taking the ratio of two exchange rates

E.g., C$/US$ = 1.117 and US$/€ = 1.2862 → without
transaction costs (C$/US$)*(US$/€) = C$/€ = (1.117)*1.2862)
= € 1.4367

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Quotes and practices

- Direct quote: domestic money/foreign money

€ 0.7775/$1 (17/8/2006)

- Indirect quote: foreign money/domestic money

$1.2862/ €1 (same date)

- Indirect quote prevails for the euro and the pound

- Bid rate: rate at which dealer buys

$1.2860/€1

- Ask rate: rate at which dealer sells

$1.2864/€1

- Spread: (ask rate – bid rate)/bid rate

[(1.2864-1.2860)/1.2860]*100 = 0.03%

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Organized exchanges

- Chicago Mercantile Exchange, an offshoot of
the Chicago Board of Trade: oldest exchange

- Euronext: from the merger of Amsterdam,
Brussels and Paris plus acquisition of the
London International Financial Futures and
Options Exchange

- Moscow Interbank Currency Exchange

- Tokyo Commodity Exchange

- Sydney Futures Exchange

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Organized exchanges

- Smaller segment than the OTC market

- Have a physical place, rules, and face
regulation

- Three features

Product standardization

Clearinghouse

collateral

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Types of transactions

- Foreign currency options

Gives the right but not the obligation to buy or sell a
specified quantity of one currency in exchange for
another at a specified price within a specified period
of time.

Differs from the forward in that the owner of the
option does not have to execute the transaction

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Types of transactions

- Forex swap (two legs)

In the first leg there is a swap of one currency for another

In the second leg, which occurs in the future, there is a re-
exchange, that is the opposite swap

The swap can occur with the first leg, say, in one month, and
the second in three months

- Currency swap (three legs)

First: a spot exchange of two currencies with underlying assets

Second: an exchange of flows of fixed or floating interest rate payments

Third: a re-exchange of the currencies at the initial spot rate

It thus combines an interest rate swap with a forex swap

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Types of transactions

- Spot

Outright exchange of one currency for another at the current spot price
with a two-day settlement.

Currency covers both actual currency and bank deposits.

Large transactions are in deposits. Currency for retail

- Outright forward

Outright exchange of one currency for another at the current
market price but with future delivery

Transaction used to be done typically in agriculture. An Italian
exporter of Parmigiano cheese to the US, with an invoice due in 60 days,
would sell forward the dollars against liras.

Now forwards are used for a variety of reasons.

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Two components to Forex

- Forex has two components

Over-the-counter (OTC)

Organized exchanges

- OTC is a network of dealers, brokers, and final customers. Low
regulation

Dealers are mostly commercial and investment banks that buy a
currency at a bid price and sell it at an ask price

Dealers take a position and thus face a risk of a price change between
purchase and sale

Biggest dealers are Deutsche Bank, UBS, Citigroup, HSBC, Barclays
Bank, Merril Lynch, J.P. Morgan Chase, Goldman Sachs, ABN
AMRO, and Morgan Stanley

Brokers help in carrying out a deal, connecting a dealer with a final
buyer or seller. They receive a fee and take no exchange rate risk

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Size of the Forex Market

- Largest and most liquid in the world

- BIS issues a Triennial Central Bank Survey; latest in 2004

Daily turnover of $1,800 billion

$ 621 bn spot transactions

$ 208 bn forwards

$ 944 currency swaps

Dollar 88.7/200

Euro 37.2/200

Yen 20.3/200

- Market never sleeps and has its own circadian rhythm

Starts in Sydney and ends in S. Franciscoand ends in S. Francisco

Max. intensity at 8:00 and 14:00 (GMT)

Min. intensity at 4 (Tokyo lunchtime) and 23 (end of NY)

- Important centers: London, NY, Frankfurt, Tokyo

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