Forex Market (FIN435 Topic 3) PDF

Chapter 3 (Part 2) Foreign Exchange ◤ Market  ◤ Chapter Outline ▪ Characteristics of FOREX Market ▪ Developments of FOREX Market ▪ Participants of FOREX Market ▪ Factors affecting FOREX market ▪ Foreign exchange risk (Transaction, Transla...

Chapter 3 (Part 2) Foreign Exchange ◤ Market  ◤ Chapter Outline ▪ Characteristics of FOREX Market ▪ Developments of FOREX Market ▪ Participants of FOREX Market ▪ Factors affecting FOREX market ▪ Foreign exchange risk (Transaction, Translation, Settlement) ▪ FOREX quotations ▪ Basic trading strategies ▪ Stop loss Strategies ▪ Take profit order  ◤ ◤ An essential market for Foreign corporations to complete their Exchange international transactions (FOREX) Market It is a market that provides corporation with an avenue for The required currencies for them to effect payment for the imported products To convert the currencies received from the proceeds of the sales to local currency ◤ ◤ Foreign Exchange Market ▪ Is where participants can buy and sell various currencies of the world ▪ It is an exchange of a specific amount of one currency for another between two counterparties at an agreed rate for delivery at a certain agreed date ◤ Characteristics of FOREX Market A willing An exchange Facilities are A Commercial buyer and rate is available for mechanism documents seller of the available for the to effect to support currencies the two institutions payment of the FOREX currencies to operate large transactions required amount of funds  ◤ 1988 – 95 ◤ Development of Volume of the Malaysian FOREX is not in line with FOREX Market economic growth Regional Financial Crisis Heavy speculative activities on the RM 1997 – 98 Limit on the offer side of the SWAP transactions Fixing the RM exchange rate against USD 2005 The abandonment by BNM of the fixed exchange regime to a managed float exchange rate system ◤ Participants of FOREX Market Commercial Corporations banks NBFIs Money Brokers BNM  ◤ Participants of ▪ The purpose or needs of commercial FOREX Market banks in the FOREX Market can be (Commercial divided into Banks) ▪ Meeting the requirements of banks customers (corporations) between banks and customers ▪ For their own trading positions by speculating in the market (interbank)  ◤ Participants of ▪ Their requirements are for commercial FOREX Market needs such as to pay foreign exporters for (Corporations) the purchase of goods like raw materials or for investment ▪ These corporations are normally the buyers of the FC or ▪ Are exporters, need to sell the currencies that they received as proceeds of their export ◤ Participants of FOREX Market (NBFIs) Need FC for trade or investment purposes For example : Insurance Companies, Pension Funds and Pilgrim Funds Board Their requirements can be large due to investment policies or can also be due to seasonal activities  ◤ ◤ Participants of They do not trade for themselves or take position FOREX Market (Money Brokers) They function as the middlemen in identifying the buyers and sellers having the same amount to trade in FC They interact mostly with banks by giving market “indication rates” and the “dealing rates” of the various currencies Their income comes from the commission for any transactions done  ◤ BNM monitors the currencies to ensure ◤ Participants of They monitor, that exchange rates intervene and are stable and do not FOREX Market manage the fluctuate excessively (BNM) exchange rates in the FOREX Market  ◤ To support the RM, to make BNM will decide to impose Intervention – buying or sure that exchange rates are certain policies or selling of large amount of at reasonable level that restrictions such as fixed currencies so as to reduce satisfies both importers and rate or managed float market volatilities exporters exchange rate policy regime ◤ Participants of FOREX Market (BNM)  ◤ Domestic economic condition & ◤ economic policies Factors affecting FOREX Market Geopolitical Factors Global Economic Condition Market Sentiments Speculation Differential Factors  ◤ The risks in FOREX are mainly as a result of the unexpected volatility in the ◤ exchange rates of the Foreign Exchange currencies and Risks The non settlement of the currencies leading to losses incurred by the participants ◤ Types of Foreign Exchange Risk Transaction risk Settlement risk Translation risk  ◤ The risk happens when the exchange rates change The value of the FC in relation to the HC will ◤ also change Transaction risk If the changes cause the corporation (importers) to pay more for any purchases, than it is a situation which is not favour to the corporation This risk occurs whenever a corporation has entered into an agreement to make payment of to receive a specific amount of FC  ◤ Occur due to fluctuations in exchange rates causing the value of assets and liabilities to move adversely ◤ Translation risk This situation happens when a corporation has assets and liabilities denominated in FC Can also occur when a corporation, having its offices outside the country, consolidates its accounts and because of the negative currency movement result in revaluation losses  ◤ Occur due to fluctuations in exchange rates causing the value of assets and liabilities to move adversely ◤ Translation risk This situation happens when a corporation has assets and liabilities denominated in FC Can also occur when a corporation, having its offices outside the country, consolidates its accounts and because of the negative currency movement result in revaluation losses  ◤ Happens when the counter party is not able to fulfil the agreement on the amount of currency to exchange on a specific date ◤ In other words there is a default payment on the Settlement risk delivery dates by one party causing the other party to incur losses This risk occur when one party fail to make the delivery of the agreed currency on the agreed date ◤ Foreign Exchange Quotation USD/MYR 4.3510/4.3520 The bank will buy USD/MYR at 4.3510 and sells at 4.3520 If customers, want to buy USD from the bank, the rate will be at 4.3520 Likewise, if a customer wants to sell USD, he can sell at 4.3510  ◤ ◤ Spot Types of foreign A market for spot rate and spot date currency trading market Forward A foreign exchange market for value any time after two good business market days (forward rate)  ◤ Speculative trading ◤ Basic Trading Strategies Squaring Commercial position trading  ◤ Riskier because it involves taking position Long position (buy) ◤ Speculative Trading Short position (sell) Normally done by inter bank dealers of a commercial bank who trades on behalf of the bank Short term trading Structural trading  ◤ ◤ Provide currency rate level to Commercial Known as corporate dealers, the customers Trading will deal with corporate customers such as MNCs,SMEs and sole proprietorship Provide foreign exchange advisory services They will perform the following task Provide quotation rates for the various currencies Squaring the position created by the customers in the market ◤ Squaring position To net off the position by buying in the market the It other words the traders are same amount of currency doing the opposite direction you have earlier on sold, or to the earlier transaction to sell the same amount if you have bought it earlier  ◤ One of the tools to manage risk in FOREX ◤ Market Stop loss strategy A trader has to know when to reduce losses Firstly a trader has to determine a stop loss level (maximum amount of losses can be absorbed) The calculate the stop loss rate With a stop loss rate, a dealer will be able to limits its losses, thus minimizing the overall losses/risk to be incurred by the bank ◤ ◤ Take profit order ▪ The opposite of the stop loss where the dealer would like to lock in profit once it has meet its targeted profit ▪ It is a situation when market is volatile that can move in either direction ▪ Therefore a trader can buy and sell accordingly once it reaches a price where you make profit ▪ It is form of protection to ensure profit is made when market is in the dealer’s favor