Forex Rates: Factors Affecting Forward Rates

There are many factors that one way or the other affect the forward rates, or rather forward or swap margins. Generally, forward rate of a currency in relation to another is a function of interest rate differential between the two currencies. In other words, the forward margin, be it premium or discount, tends to be equal to the differential between interest rates of the two currencies concerned. If 2 month sterling deposit in London yields 12% per anum and dollar deposit for the same period yields 9% p.a. , the swap or forward, margin will tend to be equal to 3% on an annualized basis. With interest differential being 3% p.a. the sterling will be dealt in the forward market at a discount of 3 % p.a. or near about in relation to US dollar. Conversely, the premium for US dollar will tend to be around 3% in relation to sterling. It is however , naive to suggest that interest rate differential always dictates the forward margin. In fact, interest rates and forward margins influence each other. For instance, if sterling deposit earns interest at 12% and dollar deposit at 8% p.a. the investors, with invest able dollars will try to switch from dollar to sterling by spot purchase and forward sale of sterling. Oversupply of sterling in the forward market coupled with increased demand for forward dollar will naturally widen the discount. At the same time influx of sterling in pursuit of higher interest rate would tend to reduce its interest rate while outflow of dollar will create shortage and increase interest rates. The two way adjustment process will thus restore the equation between interest differential or what we call ‘interest parity’ and forward margin at an equilibrium level.

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Forex Rate: Forward Contract, Currency Swap and Spot Rate

Forex Rate: Forward Contract, Currency Swap and Spot Rate

Understanding rate and other concept s are not difficult to new investors in this arena rather then very interesting . Theories, models, ideas, concepts, terms in forex market for new investors are seems to be sort of problem to understand. But if we think it’s a game to acquire knowledge about forex for making money online that will help us understand forex easily. Here we discuss some forex rate and concepts so that we can realize the market easily.

Forward Contract

A forward contract is a transaction between a bank and another party – a customer or another bank – involving of a foreign currency against local currency at an agreed exchange rate on a specified future date or within an agreed time frame. This definition brings into focus some important features of forward contract transactions. First, the amount , the rate of exchange and the value date are agreed upon in advance at the time the deal is concluded. Second, no money is paid or received until the settlement date; sometimes, though, the bank may ask for a margin deposit from customer. The only thing that distinguishes a forward contract transaction from the spot rate transaction is that a spot deal is settled immediately while a forward contract deal is settle on a future date or within a definite time frame at an agreed rate. In the narrow sense, spot rate too have an element of forward contract deal in that spot sale normally involves delivery after two days.
Foreword contract transactions are either ‘outright’ or ‘Currency Swap’. An outright involves foreword purchase or sale of a currency at a foreword rate which expresses the actual price of one currency against another for delivery on a specified value date. However , as the volume of transactions picks up and exchange rate s become more responsive to the changes in the international markets, it will be convenient to use margin in forward quotations. Besides, it is the margin which is more relevant in the Currency Swap market.

Currency Swap

A Currency Swap, which is common in forex market, involves purchase or sale of a currency spot with a reverse deal in the forward contract market or simultaneous purchase and sale of forward currency with different maturities. The difference between the two is called Currency Swap margin or Currency Swap rate. the Currency Swap transactions are normally done by banks to cover their own exchange risks. In short we can say that under a Currency Swap
deal the bank buys and sells specified foreign currency simultaneously for different maturities. Thus a Currency Swap deal may involve:
1. Simultaneous purchase of spot and sale of forward or vice versa; or
2. Simultaneous purchase and sale, both forward but for different maturities.
A Currency Swap deal is done in the market at a difference from the ordinary deals. In the ordinary deal the following factors enter into the rates:
i. The difference between the buying and selling rates;
ii. The forward margin i.e. the premium or discount.
In most Currency Swap deals, the two exchanges are made the same time with the same counter party but from or sale spot to one counter party and sale to or buy out right forward from another party. This is called engineered Currency Swap compared to ‘pure’ Currency Swap. In Currency Swap market spot rate is not very important. What is important is Currency Swap rate: the premium or discount received for the forward sale of the currency which is being bought spot.

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Foreign Exchange Rates: Some Basics

Foreign Exchange Rate (Forex) : Some Basics

Foreign Exchange (Forex) Market is the trading of currencies. The foreign exchange market –Forex Market- is not a single place like NY Stock Exchange (NYSE). It is a widely decentralized 24 hour-a-day market, made up of banks and traders communicating electronically. The retail market is between individuals, non financial companies, non bank financial institutions and other customers of banks. The wholesale market is the trading between banks. This accounts for 60% or more of the total trading.
Scope of the Market:
About half the daily forex trading is done between banks in London and New York. Most of the trading involves U.S currency. Sometimes the intent is to trade one foreign currency for another and the U.S. currency is only involved as an intermediate step. When this is done the dollar is called a vehicle currency.
Foreign Exchange Rate: Some Basics
The exchange rate is the price of one country’s money in terms of another country’s money. The ‘Spot’ exchange rate is the price for immediate exchange. Immediate usually means within two working days. This amount is to about 33% of all trading. The ‘forward’ exchange rate is the price for exchange to take place at some specific time in future, often 30, 90, 140 days. This amount is to about 11% of all trading. A ‘Swap’ is a ‘package trade’ that includes both spot exchange of two currencies and a contract to the reverse forward exchange a short time later. This is useful when the parties to the swap have only a short term need for the currency. This amount is to about 56% of all trading.
Exchange rate quotation:
Quoted currency means the currency that is variable in an exchange rate quotation, base currency means that is fixed. Thus if ₤1= CAD 117.00, here sterling Pound is base currency and the CAD is the quoted currency.
Types of quotation:
In direct quotation base currency is the Foreign currency and quoted currency is the Domestic Currency and quoted Currency is the Foreign Currency (CAD1=US$0.0144).
In American terms Base currency is any currency other then USD and quoted Currency is USD( CAD1=$0.01444). In European Terms Base currency is the USD and quoted Currency is any Currency other than USD ($1=CAD75.00)
Reciprocal Quotations:
Currency can be quoted in terms of number of units of A per unit of B or, alternatively, the number of unit B per Unit of A. The two rates represents equal value and are reciprocals of each other. To convent from one method to the other, one simply divides the number 1by the rate.
Example: USD1/CAD69.50 = 1/69.50 CAD/USD
= 0.0143 CAD/USD
Cross Rate: A cross rate may be defined as an exchange rate that is calculated from two other rates. In practice, cross-rate is the exchange rate between 2 non US$ currencies.
Forward Rates: It is an exchange Rate for the transaction to be happened at some future date, but agreement for the transaction is to be done today. Forward rate is quoted either at premium (+) or at discount rate (-) over spot rate. In case of direct quotation, premium will be added to and discount will be subtracted from spot rate. The reverse is for indirect quotation.
Quotation of Forward Rates:
Forward at Premium (pm)
Forward at Discount (dis)
Forward at ‘par’ meaning the Forward Rate at Parity with Spot Rate.
Premium and Discount
The quoted currency is said to stand at a premium in the forward market if it is more expensive in the future than it is now in term of the base currency. Conversely the base currency may be said to stand at a discount relative to the quoted currency.

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Currency Trading: Pips, Lots & Stop-Loss Orders

What are Pips?

In the currency trading it is vital things to understand what is a pip because you must be apply pips in estimate your profits or losses. Elaboration of ‘pip’ is ‘Percentage in Point, sometimes referred as ‘point’. A pip is the smallest price movement of a traded currency. For most currencies a pip is 0.0001 or 1/100 of a cent. The value of a pip changes based upon the size of your account, because the size of your account affects how much currency you can leverage. A standard full size trading account is 100,000 units of the base currency. If you are trading in USD, a standard account has a value of $100,000 USD. Though it seems that value of a pip is very low but it take consideration that most currencies are traded in lots of $100 000. For that amount a pip is $10. When a currency moves from a value of 1.4511 to 1.4514, it moved 3 pips. When a pip has a value of $10, you have gained $30.There is an exception for quotations for Japanese Yen against other currencies. For currencies in relation to Japanese Yen a pip is 0.01 or 1 cent. Then if you are trading USD/JPY in $100 000 lots, one pip will be equivalent to $1000.

What is Lot?

Lot means the minimal traded amount for each currency transaction. For the Regular Accounts one lot equals 100 000 units of the base currency. You can also open a Mini Account and trade in mini lot sizes that are 10 000 units of the base currency.

What is Pip Spread ?

Spread is related to pips. It is very importance for forex traders. There is always difference between the selling and buying price of a given currency pair. There are two types of price of currency, i.e. ask price and bid price. The ask price of a currency at which you want to buy on other hand bid price is that price at which you want to sell. For example, the EUR/USD is quoted at 1.4505 bid and 1.4508 ask. In this case the spread is 3 pips. The pip spread is your cost of doing business here. In the case above it means you sustain a paper loss equal to 3 pips at the moment you enter the trade. Your contract has to appreciate by 3 pips before you break even. The lower the pip spread the easier is it for you to profit. Generally the more active and bigger the market, the lower the pip spread. The smaller and exotic markets tend to have a higher spread. Most brokers will be offering different spreads for different currencies. The account which are operated small amount of money usually they have higher spreads. On other hand of which account operated good amount of money, they have lower spread. You may find a broker offering a pip that is lower because it is sound for your profit though low pip spread is not everything for currency trading. Everybody want to make profit trading as well as protect his fund. In this connection you may understand currency trading strategy and basics of them.

Your currency Trading strategies:

You may invest in currency trading both your own sources of fund and loan from other sources. Though currency trading allows you to pull more funds than you actually have, this can be a double edged sword. While you can make profits on funds that you pull (rather than own), you can also have losses amplified as well. There are some ways, however, to manage your risk when trading Forex. If you are interested in trading Forex, you should have a definite trading strategy. You must educate yourself to know when to enter and exit the market and what kind of movements to anticipate. You can also place something known as a stop loss order. You can minimize your risk by placing stop-loss orders. When currency price reaches a certain point a stop-loss order ensure your position to exit. If you are taking a long position, you would place the stop loss order below current market price. For a short position, you would place a stop loss order above current market price. This technique allows you to manage your risk and, just as the name suggests, stop your losses at a certain point. In fact it is a safeguard for your investment in currency trading. You must have a mechanism in your trading strategy to protect your fund effectively and efficiently.

Currency trading seems to be sort of complex but when you educate enough yourself for fundamental principles, basics and trading strategies you will find currency trading is one of the exciting ways to make money.

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