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    Foreign Currency Transactions

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    Forex - Foreign Currency Transactions

    Individual investors who are considering participating in the foreign currency exchange (or “forex”) market need to understand fully the market and its unique characteristics. Forex trading can be very risky and is not appropriate for all investors.

    It is common in most forex trading strategies to employ leverage. Leverage entails using a relatively small amount of capital to buy currency worth many times the value of that capital. Leverage magnifies minor fluctuations in currency markets in order to increase potential gains and losses. By using leverage to trade forex, you risk losing all of your initial capital and may lose even more money than the amount of your initial capital. You should carefully consider your own financial situation, consult a financial adviser knowledgeable in forex trading, and investigate any firms offering to trade forex for you before making any investment decisions.

    Background: Foreign Currency Exchange Rates, Quotes, and Pricing

    A foreign currency exchange rate is a price that represents how much it costs to buy the currency of one country using the currency of another country. Currency traders buy and sell currencies through forex transactions based on how they expect currency exchange rates will fluctuate. When the value of one currency rises relative to another, traders will earn profits if they purchased the appreciating currency, or suffer losses if they sold the appreciating currency. As discussed below, there are also other factors that can reduce a trader’s profits even if that trader “picked” the right currency.

    Currencies are identified by three-letter abbreviations. For example, USD is the designation for the U.S. dollar, EUR is the designation for the Euro, GBP is the designation for the British pound, and JPY is the designation for the Japanese yen.

    Forex transactions are quoted in pairs of currencies (e.g., GBP/USD) because you are purchasing one currency with another currency. Sometimes purchases and sales are done relative to the U.S. dollar, similar to the way that many stocks and bonds are priced in U.S. dollars. For example, you might buy Euros using U.S. dollars. In other types of forex transactions, one foreign currency might be purchased using another foreign currency. An example of this would be to buy Euros using British pounds - that is, trading both the Euro and the pound in a single transaction. For investors whose local currency is the U.S. dollar (i.e., investors who mostly hold assets denominated in U.S. dollars), the first example generally represents a single, positive bet on the Euro (an expectation that the Euro will rise in value), whereas the second example represents a positive bet on the Euro and a negative bet on the British pound (an expectation that the Euro will rise in value relative to the British pound).

    There are different quoting conventions for exchange rates depending on the currency, the market, and sometimes even the system that is displaying the quote. For some investors, these differences can be a source of confusion and might even lead to placing unintended trades.

    For example, it is often the case that the Euro exchange rates are quoted in terms of U.S. dollars. A quote for EUR of 1.4123 then means that 1,000 Euros can be bought for approximately 1,412 U.S. dollars. In contrast, Japanese yen are often quoted in terms of the number of yen that can be purchased with a single U.S. dollar. A quote for JPY of 79.1515 then means that 1,000 U.S. dollars can be bought for approximately 79,152 yen. In these examples, if you bought the Euro and the EUR quote increases from 1.4123 to 1.5123, you would be making money. But if you bought the yen and the JPY quote increases from 79.1515 to 89.1515, you would actually be losing money because, in this example, the yen would be depreciating relative to the U.S. dollar (i.e., it would take more yen to buy a single U.S. dollar).

    Before you attempt to trade currencies, you should have a firm understanding of currency quoting conventions, how forex transactions are priced, and the mathematical formulae required to convert one currency into another.

    Currency exchange rates are usually quoted using a pair of prices representing a “bid” and an “ask.” Similar to the manner in which stocks might be quoted, the “ask” is a price that represents how much you will need to spend in order to purchase a currency, and the “bid” is a price that represents the (lower) amount that you will receive if you sell the currency. The difference between the bid and ask prices is known as the “bid-ask spread,” and it represents an inherent cost of trading - the wider the bid-ask spread, the more it costs to buy and sell a given currency, apart from any other commissions or transaction charges.

    Generally speaking, there are three ways to trade foreign currency exchange rates:

    On an exchange that is regulated by the Commodity Futures Trading Commission (CFTC). An example of such an exchange is the Chicago Mercantile Exchange, which offers currency futures and options on currency futures products. Exchange-traded currency futures and options provide traders with contracts of a set unit size, a fixed expiration date, and centralized clearing. In centralized clearing, a clearing corporation acts as single counterparty to every transaction and guarantees the completion and credit worthiness of all transactions.

    स्रोत : www.sec.gov

    Foreign Exchange Market

    Foreign Exchange Market

    Marketmakers in the foreign exchange market who quote prices at which they are willing to buy or sell foreign currency from/to others, and initiate currency trades with other dealers.

    From: Handbook of Safeguarding Global Financial Stability, 2013

    Related terms:

    Interest RateMonetary PolicyForeign ExchangeVolatilityExchange RateCurrency DerivativeExchange Rate RegimeEuroCentral Bank

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    Stock Markets, Derivatives Markets, and Foreign Exchange Markets

    Rajesh Kumar, in Strategies of Banks and Other Financial Institutions, 2014

    5.3.5 Foreign Exchange Market and Instruments

    The foreign exchange market or forex market is the market where currencies are traded. The forex market is the world’s largest financial market where trillions are traded daily. It is the most liquid among all the markets in the financial world. Moreover, there is no central marketplace for the exchange of currency in the forex market. It is an OTC market. The currency market is open 24 hours a day, five days a week, with all major currencies traded in all major financial centers. Trading of currency in the forex market involves the simultaneous purchase and sale of two currencies. In this process the value of one currency (base currency) is determined by its comparison to another currency (counter currency). The price at which one currency can be exchanged for another currency is called the foreign exchange rate. The major currency pairs that are traded include the EUR/USD, USD/JPY, GBP/USD, and USD/CHF.6 The most popular forex market is the euro to US dollar exchange rate (EUR to USD), which trades the value of euros in US dollars.

    Foreign exchange markets can be considered as a linkage of banks, nonbank dealers, and forex dealers and brokers who all are connected via a network of telephones, computer terminals, and automated dealing systems. Electronic Broking Services and Reuters are the largest vendors of quote screen monitors used in trading currencies.

    The forex market consists of three major segments: Australasia, Europe, and North America. Australasia includes the major trading centers of Bahrain, Sydney, Tokyo, Hong Kong, and Singapore. Europe includes Zürich, Frankfurt, Paris, Brussels, London, and Amsterdam. The North America region includes New York, Montreal, Toronto, Chicago, San Francisco, and Los Angeles.

    5.3.5.1 Exchange rate quotation

    The two basic quotations are direct and indirect quotes. In direct quotation, the cost of one unit of foreign currency is given in units of local or home currency. In indirect quotations the cost of one unit of local or home currency is given in units of foreign currency.

    For example, consider EUR as the local currency. Then

    Direct Quote: 1 USD = 0.773407 EUR

    Indirect Quote: 1 EUR = 1.29303 USD

    View chapter Purchase book

    The Foreign Exchange Market

    Michael Melvin, Stefan Norrbin, in International Money and Finance (Ninth Edition), 2017

    Abstract

    Foreign exchange trading refers to trading one country’s money for that of another country. The kind of money specifically traded takes the form of bank deposits or bank transfers of deposits denominated in foreign currency. The foreign exchange market typically refers to large commercial banks in financial centers, such as New York or London, that trade foreign-currency-denominated deposits with each other. This chapter provides a big picture of foreign exchange trading and particularly covers the details of the “spot market,” which is the buying and selling of foreign exchange to be delivered on the spot as opposed to paying at some future date. Major issues discussed are trading volume, geographic trading patterns, spot exchange rates, currency arbitrage, and short- and long-term foreign exchange rate movements. Specific examples illustrate the discussions of broad concepts. Two appendices further elaborate on exchange rate indexes and the top foreign exchange dealers.

    View chapter Purchase book

    The Foreign Exchange Market

    Michael Melvin, Stefan C. Norrbin, in International Money and Finance (Eighth Edition), 2013

    Appendix 1B The Top Foreign Exchange Dealers

    Foreign exchange trading is dominated by large commercial banks with worldwide operations. The market is very competitive, since each bank tries to maintain its share of the corporate business. Euromoney magazine provides some interesting insights into this market by publishing periodic surveys of information supplied by the treasurers of the major multinational firms.

    When asked to rank the factors that determined who got their foreign exchange business, the treasurers responded that the following factors were the most important: The speed with which a bank makes foreign exchange quotes was ranked third. A second-place ranking was given to competitiveness of quotes. The most important factor was the firm’s relationship with the bank. A bank that handles the other banking needs of a firm is also likely to receive its foreign exchange business.

    The significance of competitive quotes is indicated by the fact that treasurers often contact more than one bank to get several quotes before placing a deal. Another implication is that the market will be dominated by the big banks, because only the giants have the global activity to allow competitive quotes on a large number of currencies. Table 1B.1 gives the rankings of the Euromoney survey. According to the rankings, Deutsche Bank receives more business than any other bank. Note also that the big three—Deutsche Bank, UBS and Barclays Capital—dominate the foreign exchange market

    स्रोत : www.sciencedirect.com

    29.1 How the Foreign Exchange Market Works – Principles of Economics

    29.1 HOW THE FOREIGN EXCHANGE MARKET WORKS

    Learning Objectives

    By the end of this section, you will be able to:

    Define “foreign exchange market”

    Describe different types of investments like foreign direct investments (FDI), portfolio investments, and hedging

    Explain how the appreciating or depreciating of currency affects exchange rates

    Identify who benefits from a stronger currency and benefits from a weaker currency

    Most countries have different currencies, but not all. Sometimes small economies use the currency of an economically larger neighbor. For example, Ecuador, El Salvador, and Panama have decided to dollarize—that is, to use the U.S. dollar as their currency. Sometimes nations share a common currency. A large-scale example of a common currency is the decision by 17 European nations—including some very large economies such as France, Germany, and Italy—to replace their former currencies with the euro. With these exceptions duly noted, most of the international economy takes place in a situation of multiple national currencies in which both people and firms need to convert from one currency to another when selling, buying, hiring, borrowing, traveling, or investing across national borders. The market in which people or firms use one currency to purchase another currency is called the foreign exchange market.

    You have encountered the basic concept of exchange rates in earlier chapters. In The International Trade and Capital Flows, for example, we discussed how exchange rates are used to compare GDP statistics from countries where GDP is measured in different currencies. These earlier examples, however, took the actual exchange rate as given, as if it were a fact of nature. In reality, the exchange rate is a price—the price of one currency expressed in terms of units of another currency. The key framework for analyzing prices, whether in this course, any other economics course, in public policy, or business examples, is the operation of supply and demand in markets.

    Visit this website for an exchange rate calculator.

    THE EXTRAORDINARY SIZE OF THE FOREIGN EXCHANGE MARKETS

    The quantities traded in foreign exchange markets are breathtaking. A survey done in April, 2013 by the Bank of International Settlements, an international organization for banks and the financial industry, found that $5.3 trillion per day was traded on foreign exchange markets, which makes the foreign exchange market the largest market in the world economy. In contrast, 2013 U.S. real GDP was $15.8 trillion per year.

    Table 1 shows the currencies most commonly traded on foreign exchange markets. The foreign exchange market is dominated by the U.S. dollar, the currencies used by nations in Western Europe (the euro, the British pound, and the Australian dollar), and the Japanese yen.

    Currency % Daily Share

    U.S. dollar 87.0% Euro 33.4% Japanese yen 23.0% British pound 11.8%

    Australian dollar   8.6%

    Swiss franc   5.2%

    Canadian dollar   4.6%

    Mexican peso   2.5% Chinese yuan   2.2%

    Table 1. Currencies Traded Most on Foreign Exchange Markets as of April, 2013 (Source: http://www.bis.org/publ/rpfx13fx.pdf)

    DEMANDERS AND SUPPLIERS OF CURRENCY IN FOREIGN EXCHANGE MARKETS

    In foreign exchange markets, demand and supply become closely interrelated, because a person or firm who demands one currency must at the same time supply another currency—and vice versa. To get a sense of this, it is useful to consider four groups of people or firms who participate in the market: (1) firms that are involved in international trade of goods and services; (2) tourists visiting other countries; (3) international investors buying ownership (or part-ownership) of a foreign firm; (4) international investors making financial investments that do not involve ownership. Let’s consider these categories in turn.

    Firms that buy and sell on international markets find that their costs for workers, suppliers, and investors are measured in the currency of the nation where their production occurs, but their revenues from sales are measured in the currency of the different nation where their sales happened. So, a Chinese firm exporting abroad will earn some other currency—say, U.S. dollars—but will need Chinese yuan to pay the workers, suppliers, and investors who are based in China. In the foreign exchange markets, this firm will be a supplier of U.S. dollars and a demander of Chinese yuan.

    International tourists will supply their home currency to receive the currency of the country they are visiting. For example, an American tourist who is visiting China will supply U.S. dollars into the foreign exchange market and demand Chinese yuan.

    Financial investments that cross international boundaries, and require exchanging currency, are often divided into two categories. Foreign direct investment (FDI) refers to purchasing a firm (at least ten percent) in another country or starting up a new enterprise in a foreign country For example, in 2008 the Belgian beer-brewing company InBev bought the U.S. beer-maker Anheuser-Busch for $52 billion. To make this purchase of a U.S. firm, InBev would have to supply euros (the currency of Belgium) to the foreign exchange market and demand U.S. dollars.

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