Forex Investment and Currency Trading

Which clients are involved in spot markets?

• Corporate clients looking to execute cross-border transactions, either strategic or operational hedging
• Hedge funds looking to profit from fluctuations in market
• Asset managers hedging or financing currency exposure
• Individuals buying products from overseas

Why is the spot market risky?

• FX rates change almost every second
• FX positions are continually generating gains / losses
• If you hold a position you take risk

FX Spot Rate

• The exchange rate at which one currency is exchanged for another
  • In two business days – i.e. T+2 – for most currencies
  • In one business day – i.e. T+1 – for the Canadian dollar, Russian Ruble, Turkish Lira, Philippine Peso
  • The date on which a transaction is settled is referred to as the “value date”

FX Spot Market – Quoting Conventions

• Spot Rate = Term Currency / Base Currency
  • X Units of Term Currency – The changing variable
  • 1 Unit of Base Currency – Always stays the same
• Example: USD/JPY = 98.25
  • JPY – is the Term Currency
  • USD – is the Base Currency
• EUR / USD = 1.2678
  • USD – is the Term Currency
  • EUR – is the Base Currency

It takes 98.25 JPY to buy 1 USD or 1.2678 USD to buy 1 EUR

• Typically the USD is the base currency except against: EUR, GBP, AUD, NZD and a few others
• Currencies are quoted usually at the 4th decimal; 2nd decimal for JPY
  • EUR-USD is 1.2678 – a pip here is 0.0001
  • USD-JPY is 98.25 – a pip here is 0.01

Spot Rate

• Major Currencies
  • Usually assumed that everyone knows the big figure
  • Electronic screens will be updated with current market rate
  • The quote – on the phone – will be the last two digits, bid-offer

Other currencies

•  
  • Big figure should be quoted
  • No assumption of knowledge
  • Electronic screens may not be up-to-date

Trade Dates

• Cash – same day transactions are possible in the Canadian dollar, the Mexican peso and the majors if completed by 7:00 am PST
• Holidays – where there is a holiday in one of the two coutries in question, it is normal to value the trade to the next business day when both countries are open
  • Forward points can be difficult to calculate around Christmas, New Year and Easter because of the large number of holidays around the world
  • U.S. Holidays vs Foreign Holiday

FX Spot Market – How to Ask for a Price

• Where you are from
• Both currencies involved
• Size of the trade
• Value date
• Done! (a clear indication of dealing)

FX Spot Market – Asking fort a Price (Example)

• Customer: Hi it’s Emma from ABC Corp. I would like to buy 5 million EUR for spot value
• Salesperson: Hi Emma. We can sell 5 million EUR for USD at 1.2671
• Customer: That’s Done
• Salesperson: OK, ABC Corp bought 5 million EUR at 1.2671 value 12 March 2009 for USD of 6,335,500
• Customer: All agreed
• Salesperson: Thanks for the deal!

FX Spot Market – Pricing

• How did the trader know what price to make?
• Pricing is based on current market quotes from brokers and other information sources
• Also depends importantly on:
  • Size of trade
  • Currency pair
  • General market liquidity (time of day, market depth, etc.)

Flow of a FX Spot Transaction

• Customer Calls sales person
• Salesperson Calls trader to get a price and he does not hold a position
• Trader Can hold onto the position or lays off the risk in the Interbank Market

FX Spot Market – The Interbank Market

• Banks all tied together via interbank brokers
• Dealing also occurs directly between banks

FX Spot Market – Order Management

• An alternative to executing spot trades at current levels is to leave an order
• Many banks have a robust order book, where orders are watched 24 hours a day
• There are four main types of orders:
  • Take Profit – An order to be executed at better rates than the current market
  • Stop Loss – An order to be executed at worse rates than the market
  • OCO (One Cancels the Other) – Both a Take Profit and Stop Loss, if one is triggered the other one is canceled
  • At Best – Work to execute trade in the current market
• Orders are passed from London to New York to Asia, 24 hour coverage
• Clients leave take profit orders
  • Enters trade when spot reaches a certain level
  • Client needs to buy EUR but thinks the EUR will trader lower first
  •  
    • the order is left to buy EUR below the current market
  • Client needs to sell GBP but thinks the GBP will trade higher first
    • the order is left to sell GBP 50 pips above the current market

Clients leave stop loss orders

• Limits losses of an underlying position if market moves against client
• Client needs to buy GBP and the market is currently 1.4525
  • the order is left to buy GBP if price breaks 1.4830
• Client needs to sell AUD and the market is currently 0.6525
  • the order is left to sell AUD if price breaks 0.6320

• Stop Loss orders vs. Take Profit orders
  • Benefits of Stop Loss orders
  • Limits possibility of loss
  • If spot moves in your favor, then move the stop loss level in the same direction, thus improving your worst-case rate
  • Eventually, you will have a retracement that triggers your stop loss order