Ask (Offer) - price of the offer, the price you buy for.
Bank Rate - the percentage rate at which central bank of a country lends money to the country's commercial banks.
Bid - price of the demand, the price you sell for.
Broker - the market participating body which serves as the middleman between retail traders and larger commercial institutions.
Cable - a Forex traders slang word GBP/USD currency pair.
CFD - a Contract for Difference - special trading instrument that allows financial speculation on stocks, commodities and other instruments without actually buying.
Commission - broker commissions for operation handling.
CPI - consumer price index the statistical measure of inflation based upon changes of prices of a specified set of goods.
Fibonacci Retracements - the levels with a high probability of trend break or bounce, calculated as the 23.6%, 32.8%, 50% and 61.8% of the trend range.
Flat (Square) - neutral state when all your positions are closed.
Fundamental Analysis - the analysis based only on news, economic indicators and global events.
GTC (Good Till Cancelled) - order to buy or sell of a currency with a fixed price or worse. The order is alive (good) until execution or cancellation.
Hedging - maintaining a market position which secures the existing open positions in the opposite direction.
Jobber - a slang word for a trader which is aimed toward fast but small and short-term profit from an intra-day trading. Jobber rarely leaves open positions overnight.
Limit Order - order for a broker to buy the lot for fixed or lesser price or sell the lot for fixed or better price. Such price is called limit price.
Liquidity - the measure of markets which describes relationship between the trading volume and the price change.
Long - the position which is in a Buy direction. In Forex, the primary currency when bought is long and another is short.
Loss - the loss from closing long position at lower rate than opening or short position with higher rate than opening, or if the profit from a position closing was lower than broker commission on it.
Lot - definite amount of units or amount of money accepted for operations handling (usually it is a multiple of 100).
Margin - money, the investor needs to keep at broker account to execute trades. It supplies the possible losses which may occur in margin trading.
Margin Call - demand of a broker to deposit more margin money to the margin account when the amount in it falls below certain minimum.
Market Order - order to buy or sell a lot for a current market price.
Market Price - the current price for which the currency is traded for on the market.
Offer (Ask) - price of the offer, the price you buy for.
Open Position (Trade) - position on buying (long) or selling (short) for a currency pair.
Order - order for a broker to buy or sell the currency with a certain rate.
Pivot Point - the primary support/resistance point calculated basing on the previous trend's High, Low and Close prices.
Pip (Point) - the last digit in the rate (e.g. for EUR/USD 1 point = 0.0001).
Profit (Gain) - positive amount of money gained for closing the position.
Principal Value - the initial amount of money of the invested.
Resistance - price level for which the intensive selling can lead to price increasing (up-trend)
Settled (Closed) Position - closed positions for which all needed transactions has been made.
Slippage - execution of order for a price different than expected (ordered), main reasons for slippage are - "fast" market, low liquidity and low broker's ability to execute orders.
Spread - difference between ask and bid prices for a currency pair.
Stop-Limit Order - order to sell or buy a lot when the market reaches certain price. Usually is a combination of stop-order and limit-order.
Stop-Loss Order - order to sell or buy a lot for a certain price or worse. It is used to avoid extra losses when market moves in the opposite direction.
Support - price level for which intensive buying can lead to the price decreasing (down-trend).
Technical Analysis - the analysis based only on the technical market data (quotes) with the help of various technical indicators.
Trend - direction of market which has been established with influence of different factors.
Volatility - a statistical measure of the number of price changes for a given currency pair in a given period of time.
Tuesday, August 14, 2007
Forward Contract - A Hedging Instrument
A forward contract is normally entered into to hedge oneself against exchange risk ie the uncertainity regarding the future movements of the exchange rate. By entering into a forward contract the customer locks-in the exchange rate at which he will buy or sell the currency
Discount and Premium
A currency is said to be at premium against another currency if it is more expensive in the forward market than in the spot market. In this case, its forward rate will be higher than its spot rate. This happens when the future spot rate is expected to be higher than the current spot rate. Conversely, a currency is said to be at a discount if it is cheaper in the forward market than in the spot market. In this case, its forward rate will be lower than its spot rate. This happens when the future spot rate is expected to be lower than the current spot rate. Let us assume the following USD/INR quotes
USD/INR Spot :: 40.50/51
USD/INR 3 Months :: 40.76/78
Here the bank is ready to give only 40.50 currently in exchange for a dollar, while it is ready to give 40.76 after 3 months. So the dollar is expected to be more expensive in the future and hence is at a premium against the rupee.
Swap Points
The difference between the spot rates and the forward rates can be expressed in terms of swap points. In the above example the swap point will be 26/27 ie (40.76-40.50/40.78-40.51). When the swap points are low/high (as in the Dollar-Rupee example given above).
Calculation of Forward Rates
The method of calculation of forward rates is tabulated below. We will consider USD/INR forward calculation for the time.
Forward Buying Rate
Dollar/ Rupee Market Spot Buying Rate :: 40.50
Add : Forward Premium (For forward period, transit period and usance period, round off to lower months)
OR
Less : Forward Discount (For forward period, transit period, transit period and usance period, rounded off to higher months)
Thus give the Forward Buying Rate for USD/INR
Forward Selling Rate
Dollar/ Rupee Market Spot Selling Rate :: Rs. 40.52
Add Forward premium for forward period
OR
Less Forward discount for forward period
Thus arrives the Forward Selling Rate for USD/INR
Example : One of the export customer requests you on 15th July to book a Forward Contract delivery September for USD 1000000. Assuming the dollars are quoted in the local interbank market as under
Spot USD/INR :: 40.5100/5200
Spot/July :: 0300/0400
Spot/August :: 0800/0900
Spot/September :: 1300/1400
Spot/October :: 1800/1900
Spot/Novemebr :: 2300/2400
What rate will the customer get from the bank.
Solution : Dollar is at premium. The rule is to take the earliest delivery. The option to the cutomer is over September. Taking earliest delivery, the date of delivery will be taken as 1st September. As the bank will consider the earliest delivery of the commodity ie USD the customer rate will be based on Spot/September.
Calculation : Dollar/Rupee Spot :: 40.5100
Add forward premia for Sep Deliv :: 0.1300
Total :: 40.6400
(Here the customer should consider the margins charged by banks. That will differ from bank to bank as there is no strict rule on exchange margins as of now)
Less exchange margin(charged by bank) :: 0.0500
Rate quoted to the Customer would be :: 40.5900
Problem for Practice :: One of export cutomer requests you on 4th April to book a forward contract for USD 100000 for delivery June. Assuming the dollars are quoted in the local interbank market as under
Spot USD/INR :: 43.5100/5200
Spot/April :: 0300/0400
Spot/May :: 0800/0900
Spot/June :: 1300/1400
Spot/July :: 1800/1900
Discount and Premium
A currency is said to be at premium against another currency if it is more expensive in the forward market than in the spot market. In this case, its forward rate will be higher than its spot rate. This happens when the future spot rate is expected to be higher than the current spot rate. Conversely, a currency is said to be at a discount if it is cheaper in the forward market than in the spot market. In this case, its forward rate will be lower than its spot rate. This happens when the future spot rate is expected to be lower than the current spot rate. Let us assume the following USD/INR quotes
USD/INR Spot :: 40.50/51
USD/INR 3 Months :: 40.76/78
Here the bank is ready to give only 40.50 currently in exchange for a dollar, while it is ready to give 40.76 after 3 months. So the dollar is expected to be more expensive in the future and hence is at a premium against the rupee.
Swap Points
The difference between the spot rates and the forward rates can be expressed in terms of swap points. In the above example the swap point will be 26/27 ie (40.76-40.50/40.78-40.51). When the swap points are low/high (as in the Dollar-Rupee example given above).
Calculation of Forward Rates
The method of calculation of forward rates is tabulated below. We will consider USD/INR forward calculation for the time.
Forward Buying Rate
Dollar/ Rupee Market Spot Buying Rate :: 40.50
Add : Forward Premium (For forward period, transit period and usance period, round off to lower months)
OR
Less : Forward Discount (For forward period, transit period, transit period and usance period, rounded off to higher months)
Thus give the Forward Buying Rate for USD/INR
Forward Selling Rate
Dollar/ Rupee Market Spot Selling Rate :: Rs. 40.52
Add Forward premium for forward period
OR
Less Forward discount for forward period
Thus arrives the Forward Selling Rate for USD/INR
Example : One of the export customer requests you on 15th July to book a Forward Contract delivery September for USD 1000000. Assuming the dollars are quoted in the local interbank market as under
Spot USD/INR :: 40.5100/5200
Spot/July :: 0300/0400
Spot/August :: 0800/0900
Spot/September :: 1300/1400
Spot/October :: 1800/1900
Spot/Novemebr :: 2300/2400
What rate will the customer get from the bank.
Solution : Dollar is at premium. The rule is to take the earliest delivery. The option to the cutomer is over September. Taking earliest delivery, the date of delivery will be taken as 1st September. As the bank will consider the earliest delivery of the commodity ie USD the customer rate will be based on Spot/September.
Calculation : Dollar/Rupee Spot :: 40.5100
Add forward premia for Sep Deliv :: 0.1300
Total :: 40.6400
(Here the customer should consider the margins charged by banks. That will differ from bank to bank as there is no strict rule on exchange margins as of now)
Less exchange margin(charged by bank) :: 0.0500
Rate quoted to the Customer would be :: 40.5900
Problem for Practice :: One of export cutomer requests you on 4th April to book a forward contract for USD 100000 for delivery June. Assuming the dollars are quoted in the local interbank market as under
Spot USD/INR :: 43.5100/5200
Spot/April :: 0300/0400
Spot/May :: 0800/0900
Spot/June :: 1300/1400
Spot/July :: 1800/1900
Forex Market Participants
The participants in the forex market can be classified under four broad categories
1. Non bank entities who wish to exchange currencies to meet or hedge there commitments
2. Banks which exchange currencies to meet client requirements
3. Speculators buying or selling currencies in the hope of profiting from price movements.
4. Arbitragers who take advantage of price disparities on a fully hedged basis.
Exchange Rate Quotes
Direct and Indirect Rates
1. Under direct rate system, the exchange rate for a foreign currency is expressed in terms of units of local currency equal to one unit of foreign currency. For example USD 1.00 = INR 43.20
2. Under Indirect Systems, the exchange rate is quoted in terms of the number of units of foreign currency equal to a unit of local currency. For example USD 2.3148 = INR 100
Bid and Offered Rates
Normally in inter bank market the rate will be quoted in two way pricing. For example USD/INR will be quoted as 43.20/21. It indicates the buying and selling of USD against INR. The buying and selling rates are also referred to as the bid and offered rates
1.BID : Consider the above example of USD/INR 43.20/21. In this quotation, the
bid rate for dollar is 43.21. Now consider the quote of GBP/USD 1.7090/98. In this quotation, the bid rate(buying) for dollars is 1.7098. The meaning of this quote is that if u want to buy 1 GBP from market you have pay 1.7098 Dollars.
2. Offer : Consider the example of USD/INR 43.20/21. In this quotation, the offered rate for dollar is 43.20. Now consider the quote of GBP/USD 1.7090/98. In this quotation, the offered rate (selling) for dollars is 1.7090. The meaning of offer is that if u want to sell 1 GBP to the market u will get 1.7090 dollars
The term bid and offered rates is also prevalent in the money market. For example if a bank quotes an interest rate of 3.65/75 for six-month dollar deposits, it conveys that the bank is willing to accept a six-month dollar deposit at 3.65 per cent while it is willing to place deposit of the same duration at 3.75 per cent per annum. In the market jargon, it is bidding for deposits at 3.65 while offering deposits at 3.75
Spot and Forward Rates : Value Dates
Every forex transaction involves exchange of two currencies by the counter parties to the transactions. One party, for example, receives dollars in New York and pays out rupees in Mumbai. The counter party pays out dollars and receives rupees in respective centers. The date on which the exchange of currencies is to take place is the value date of the transaction. In practice this is not possible because of time differences in the two countries. Hence the use of value dates ie currencies must be paid and received on the same day.
There are standard nomenclatures and practices prevalent to determine the value date of exchange contracts, namely the dates on which the two currencies involved in an exchange transaction change hands.
For example Rupee being Paid in Bombay and dollar being received in New York. If either of the two centers has a holiday on a particular day, its date cannot be a proper value date for dollar.
The Standard nomenclatures for value dates are
1. Ready or Cash – Value Today – Here currency will change hands on the same day where transaction done
2. Tom (Tomorrow) – Value Tomorrow or next working day – Here currency will change hands tomorrow or the next working day
3. Spot- Value two business days after the trading date – For spot transaction done Monday, currency will change hands the following Wednesday assuming this is a working day in both centers. Similarly for spot transaction done on Thursday, currencies will change hands following Monday, there being no forex transaction on Saturdays and Sundays.
4. Forward – Any value date beyond spot – The rules for determining value dates of standard maturities of forward transactions are as follows. In general the value date of a one-month forward contract will be the date in the next month corresponding to the spot value date. For example Let us consider a transaction done on 22nd July 2005. The value date for a spot transaction will be 26th July 2005 and the value date of a one-month forward transaction undertaken on 22nd July 2005 will be 26th August 2005. Forward transaction can also be structured to give one of the parties to the transaction an option to determine any value date within a prescribed period. On example of this would be an exporter desiring to sell forward foreign currency to his bank, but not knowing in advance the exact date of receipt or shipment. In this case he can book forward with an option of delivering the dollar say September 15th to September 30th.
Interbank Market, LIBID and LIBOR
Apart from customer transactions there is an extremely active inter-bank market in offshore currencies. The two rates are referred to as bid and offer rates – hence the terms, London Inter- Bank Rate (LIBID) and London Inter- Bank Offer Rate (LIBOR). Since LIBID and LIBOR are the rates at which a bank is bidding for and offering deposits in the market, the actual quotations on a given day, and indeed time, can differ from bank to bank. As LIBOR is the most common floating rate benchmark used in interest rate swap agreement, the bank specific LIBORs could lead to dispute about the amounts to be exchanged under the swap agreements. To avoid such disputes, the LIBOR used in many case is that published by the British Bankers Association.
1. Non bank entities who wish to exchange currencies to meet or hedge there commitments
2. Banks which exchange currencies to meet client requirements
3. Speculators buying or selling currencies in the hope of profiting from price movements.
4. Arbitragers who take advantage of price disparities on a fully hedged basis.
Exchange Rate Quotes
Direct and Indirect Rates
1. Under direct rate system, the exchange rate for a foreign currency is expressed in terms of units of local currency equal to one unit of foreign currency. For example USD 1.00 = INR 43.20
2. Under Indirect Systems, the exchange rate is quoted in terms of the number of units of foreign currency equal to a unit of local currency. For example USD 2.3148 = INR 100
Bid and Offered Rates
Normally in inter bank market the rate will be quoted in two way pricing. For example USD/INR will be quoted as 43.20/21. It indicates the buying and selling of USD against INR. The buying and selling rates are also referred to as the bid and offered rates
1.BID : Consider the above example of USD/INR 43.20/21. In this quotation, the
bid rate for dollar is 43.21. Now consider the quote of GBP/USD 1.7090/98. In this quotation, the bid rate(buying) for dollars is 1.7098. The meaning of this quote is that if u want to buy 1 GBP from market you have pay 1.7098 Dollars.
2. Offer : Consider the example of USD/INR 43.20/21. In this quotation, the offered rate for dollar is 43.20. Now consider the quote of GBP/USD 1.7090/98. In this quotation, the offered rate (selling) for dollars is 1.7090. The meaning of offer is that if u want to sell 1 GBP to the market u will get 1.7090 dollars
The term bid and offered rates is also prevalent in the money market. For example if a bank quotes an interest rate of 3.65/75 for six-month dollar deposits, it conveys that the bank is willing to accept a six-month dollar deposit at 3.65 per cent while it is willing to place deposit of the same duration at 3.75 per cent per annum. In the market jargon, it is bidding for deposits at 3.65 while offering deposits at 3.75
Spot and Forward Rates : Value Dates
Every forex transaction involves exchange of two currencies by the counter parties to the transactions. One party, for example, receives dollars in New York and pays out rupees in Mumbai. The counter party pays out dollars and receives rupees in respective centers. The date on which the exchange of currencies is to take place is the value date of the transaction. In practice this is not possible because of time differences in the two countries. Hence the use of value dates ie currencies must be paid and received on the same day.
There are standard nomenclatures and practices prevalent to determine the value date of exchange contracts, namely the dates on which the two currencies involved in an exchange transaction change hands.
For example Rupee being Paid in Bombay and dollar being received in New York. If either of the two centers has a holiday on a particular day, its date cannot be a proper value date for dollar.
The Standard nomenclatures for value dates are
1. Ready or Cash – Value Today – Here currency will change hands on the same day where transaction done
2. Tom (Tomorrow) – Value Tomorrow or next working day – Here currency will change hands tomorrow or the next working day
3. Spot- Value two business days after the trading date – For spot transaction done Monday, currency will change hands the following Wednesday assuming this is a working day in both centers. Similarly for spot transaction done on Thursday, currencies will change hands following Monday, there being no forex transaction on Saturdays and Sundays.
4. Forward – Any value date beyond spot – The rules for determining value dates of standard maturities of forward transactions are as follows. In general the value date of a one-month forward contract will be the date in the next month corresponding to the spot value date. For example Let us consider a transaction done on 22nd July 2005. The value date for a spot transaction will be 26th July 2005 and the value date of a one-month forward transaction undertaken on 22nd July 2005 will be 26th August 2005. Forward transaction can also be structured to give one of the parties to the transaction an option to determine any value date within a prescribed period. On example of this would be an exporter desiring to sell forward foreign currency to his bank, but not knowing in advance the exact date of receipt or shipment. In this case he can book forward with an option of delivering the dollar say September 15th to September 30th.
Interbank Market, LIBID and LIBOR
Apart from customer transactions there is an extremely active inter-bank market in offshore currencies. The two rates are referred to as bid and offer rates – hence the terms, London Inter- Bank Rate (LIBID) and London Inter- Bank Offer Rate (LIBOR). Since LIBID and LIBOR are the rates at which a bank is bidding for and offering deposits in the market, the actual quotations on a given day, and indeed time, can differ from bank to bank. As LIBOR is the most common floating rate benchmark used in interest rate swap agreement, the bank specific LIBORs could lead to dispute about the amounts to be exchanged under the swap agreements. To avoid such disputes, the LIBOR used in many case is that published by the British Bankers Association.
The meaning of Foreign Exchange
Foreign Exchange is the system or process of converting one national currency into another and of transferring the ownership of money from one country to another country
What is the meaning of Exchange Rate?
The rates applied by the Bank for converting foreign currency into Indian rupees and vice versa are known as exchange rates. In other words, exchange rate is the rate at which one currency can be exchanged for another.
What are the systems of quoting Exchange Rates?
There are two systems of quoting exchange rates:
i.Direct Quotation: Where the price of foreign currency is quoted in terms of home or local currency. In this system variable units of home currency equivalent to a fixed unit of foreign currency is quoted
For Example US Dollar 1 = Rs 43.50
ii. Indirect Quotation: Where exchange rates are quoted in terms of variable units of foreign currency as equivalent to a fixed number of units of home currency.
For Example US Dollar 2.30 = Rs. 100
Till 01.08.1993 banks in India were required to quote all the rates on indirect basis. From 02.08.1993 banks are quoting rates on direct basis only
Purchase and Sale Transaction – How it Arise?
Its important to have a very clear idea about purchase and sale transaction and how they arise. From the Banks point of view conversion of foreign currency on behalf of an exporter into Indian Rupees would involve a Purchase and conversion of domestic currency into foreign currency on behalf of an importer would be a Sale.
What is the meaning of Exchange Rate?
The rates applied by the Bank for converting foreign currency into Indian rupees and vice versa are known as exchange rates. In other words, exchange rate is the rate at which one currency can be exchanged for another.
What are the systems of quoting Exchange Rates?
There are two systems of quoting exchange rates:
i.Direct Quotation: Where the price of foreign currency is quoted in terms of home or local currency. In this system variable units of home currency equivalent to a fixed unit of foreign currency is quoted
For Example US Dollar 1 = Rs 43.50
ii. Indirect Quotation: Where exchange rates are quoted in terms of variable units of foreign currency as equivalent to a fixed number of units of home currency.
For Example US Dollar 2.30 = Rs. 100
Till 01.08.1993 banks in India were required to quote all the rates on indirect basis. From 02.08.1993 banks are quoting rates on direct basis only
Purchase and Sale Transaction – How it Arise?
Its important to have a very clear idea about purchase and sale transaction and how they arise. From the Banks point of view conversion of foreign currency on behalf of an exporter into Indian Rupees would involve a Purchase and conversion of domestic currency into foreign currency on behalf of an importer would be a Sale.
Subscribe to:
Comments (Atom)
