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Forex concepts


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Forex concepts

  1. 1. FOREX market defination • Foreign exchange markets are markets on which individuals, firms and banks buy and sell foreign currencies: – foreign exchange trading occurs with the help of the telecommunication net between buyers and sellers of foreign exchange that are located all over the world – can actually talk about a single international foreign exchange market for every single currency – foreign exchange trading takes place at least in some of the world financial centers in every moment
  2. 2. • Clearing of currencies: – service of exchanging one currency for another • Provision of Credit: – trader that bought a certain good from the manufacturer, needs time to sell this good to the final customer and to pay the manufacturer with the money he received from the customer 2. Foreign Exchange Market Functions Clearing of Currencies and Provision of Credit
  3. 3. Forward Contracts • Agreement to buy or sell an asset at a certain time in the future for a predetermined price • Over-the-counter product that do not trade on any organized exchange • Delivery date can be any date that is mutually convenient to both the parties to the contract • Size can be customized • Not marked-to-market daily
  4. 4. The Forward Market • A forward contract is an agreement to buy or sell an asset in the future at prices agreed upon today. • If you have ever had to order an out-of-stock textbook, then you have entered into a forward contract.
  5. 5. Forward Rate Quotations • The forward market for FOREX involves agreements to buy and sell foreign currencies in the future at prices agreed upon today. • Bank quotes for 1, 3, 6, 9, and 12 month maturities are readily available for forward contracts. • Longer-term swaps are available.
  6. 6. Futures Contracts • A futures contract is an agreement to buy or sell a specified quantity of a specified asset at a certain point in the future at a price agreed upon today • In the case of currencies, it is an agreement to buy/sell a specified quantity of a specific currency at a pre agreed upon exchange rate at a certain time in the future
  7. 7. • cross exchange rate: – can be calculated with the help of the relationship of two currencies with a third currency • hedging: – activities with which the foreign exchange market participants avoid exchange rate risk or activities with which they are closing their open foreign exchange position
  8. 8. • arbitragers: – they want to earn a profit without taking any kind of risk (usually commercial banks): • try to profit from simultaneous exchange rate differences in different markets • making use of the interest rate differences that exist in national financial markets of two countries along with transactions on spot and forward foreign exchange market at the same time (covered interest parity)
  9. 9. hedgers and speculators:  hedgers do not want to take risk while participating in the market, they want to insure themselves against the exchange rate changes  speculators think they know what the future exchange rate of a particular currency will be, and they are willing to accept exchange rate risk with the goal of making profit  every foreign exchange market participant can behave either as a hedger or as a speculator in the context of a particular transaction
  10. 10. 5. Types of Foreign Exchange Market Transactions  almost immediate delivery of foreign exchange  buyer and seller establish the exchange rate at the time of the agreement, payment and delivery are not required until maturity  forward exchange rates:  1, 3, 6, 9 months, one year 2. Outright Forward Transactions 1. SPOT Transactions
  11. 11. Options • basic characteristics of options: – financial instrument that gives the buyer the right, but not the obligation, to buy or sell a standardized amount of a foreign currency, that is traded, at a fixed price at a particular time, or until a particular time in the future – call option and put option – American and European options – three different prices: • exercise/strike price • cost, price or value of the option • underlying or actual spot exchange rate “at-the-money” “in-the-money” “out-of-money”
  12. 12. Options • types of options trading: – in organized markets: • standardized contracts with given strike prices, standardized durations (1, 3, 6, 9, 12 months) and expirations • only certain currencies, contract amounts are standardized – over-the-counter trading: • expiration date, strike price and contract amount depend on the individual needs of the client • counterparty risk! • retail and interbank market • information about options trading
  13. 13. • Usage of options: – when the economic agent expects that the exchange rate trend of a particular currency could change drastically – when the economic agent does not know for sure that a certain foreign exchange flow will occur in the future – advantages: • fixed option costs • options do not need to be executed Options
  14. 14. Bid & Ask Quotes  Foreign currency dealers provide two quotes: Bid Price: Price at which the dealer is willing to buy foreign currency from you. Ask Price: Price at which the dealer is willing to sell foreign currency to you.  It is always the case that the Ask Price > Bid Price. The difference is the Bid-Ask spread.  The less traded and more volatile a currency, the greater is the spread.
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