Forward Transactions

FOREX: One Way to Deal with the FX risk

In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future and the transaction occurs on that date, regardless of what the market rates are then. The date can be a few days, months or years in the future.

Futures
Foreign currency futures are forward transactions with standard contract sizes and maturity dates — for example, 500,000 British pounds for next November at an agreed rate. These contracts are traded on a separate exchange set up for that purpose.

Swap
The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date.

Exchange Risk

FOREX: Spot Transaction

Suppose a U.S. company orders machine tools from a company in Japan.

* Tools will be ready in six months and will cost 120 million yen.
* At the time of the order, the yen is trading at 120 to a dollar.
* U.S. company budgets $1 million in Japanese yen to be paid when it receives the tools (120,000,00 yen ¸ 120 yen per dollar = $1,000,000)

There is no guarantee that the rate will remain the same six months later.

Suppose the rate drops to 100 yen per dollar:
* Cost in U.S. dollars would increase (120,000,000 ¸ 100 = $1,200,000) by $200,000.

Conversely, if the rate goes up to 140 yen to a dollar:
* Cost in U.S. dollars would decrease (120,000,000 ¸ 140 = $857,142.86) by over $142,000

One alternative for a company is to pay for the foreign good right away to avoid the exchange rate risk. But no one wants to part with money any sooner than necessary—if the company does pay the money in advance, it loses six months’ interest and risks losing out on a favorable change in exchange rates.

Foreign Exchange Rates

Most common contact with foreign exchange occurs;

When we travel or buy things in other countries.

It would seem logical that if the dollar weakens, the trade balance will improve, as exports would rise. However, this does not always happen. U.S. trade balance usually worsens for a few months.

The J–curve explains why the trade position does not improve soon after the weakening of a currency. Most import/export orders are taken months in advance. Immediately after a currency’s value drops, the volume of imports remains about the same, but the prices in terms of the home currency rise. On the other hand, the value of the domestic exports remains the same, and the difference in values worsens the trade balance until the imports and exports adjust to the new exchange rates.

Exchange rates are an important consideration when making international investment decisions. The money invested overseas incurs an exchange rate risk.

When an investor decides to "cash out," or bring his money home, any gains could be magnified or wiped out depending on the change in the exchange rates in the interim. Thus, changes in exchange rates can have many repercussions on an economy:

* Affects the prices of imported goods
* Affects the overall level of price and wage inflation
* Influences tourism patterns
* May influence consumers’ buying decisions and investors’ long-term commitments.


Suppose a U.S. tourist travelling in London wants to buy a sweater.

Price tag is 100 pounds.

Current exchange Price of sweater in
rate dollars
$1.45 to £1 100 x 1.45 = $145.00
$1.30 to £1 Pound falls 100 x 1.30 = $130.00
$1.60 to £1 Pound rises 100 x 1.60 = $160.00

Thus, small changes in exchange rates may not seem significant. But when billions of dollars are traded, even a hundredth of a percentage point change in exchange rates becomes important.

Stronger US dollar implies;

1. U.S. can buy foreign goods more cheaply ------Cost of purchasing foreign goods falls

2. Foreigners find U.S. goods more expensive and demand falls -----Does not help firms that produce for exports

Weaker U.S. dollar implies;

1. Foreigners buy more U.S. goods -------Helps firms that rely on exports

2. Foreign goods become more expensive ------Demand for imports falls

Potential Profits

What is the contract size of each trade and how do you calculate profits ?

The minimum size of a contract of the major currencies is the value of $100,000 USD (1% margin=$1000). But the value of each currency relative to the USD is different each minute, so the actual US dollar value fluctuates, and that's where you make your profit. The usual contract size is about 100,000 Euros, 62,500 pounds, 187,500 Swiss Francs, 12.5 million Yen, all with an initial margin of $1000 on deposit, making it the cheapest way to own large quantities of assets.

For example, today Mr. and Mrs. Joe Public buy a FOREX contract of £62,500 at the exchange rate of $1.4225 (USD) per pound, while using for that purchase only US dollars of $1,000. Five hours later poor US economic indicators are released, the Fed lowers interest rates again, NYSE and NASDAQ both tumble, and the dollar falls 1.5 cent against the pound sterling.

The price of the pound is now worth $1.4375. After discussion with their broker, Mr. and Mrs. Joe Public quickly decide to close their contract, taking $937 profit and almost 100% return of their initial investment of only $1000 in buying one contract of £62,500 five hours ago. $1000 will enable you to buy (or sell) one contract of any major currency, making FOREX the quickest way to make a profit.

Forex Trading

How to Begin Forex Trading

For the average newbie, the Forex market can be a very scary place. Taking the time to carefully learn about the different currencies can allow you to really maximize your efforts while you are investing. The best course of action that you can take is going to the effort to actually determine how the Forex market can be beneficial to you.

The benefits that the market has for some consumers and investors may not be the best benefits though for you, it is important to determine which you are most concerned with before you start investing in the market though so that you can keep a clear perspective on your investments.

What is the minimum deposit I need to begin trading?

You can start trading with regular Individual Account with a minimum deposit of $2,000, and with a Mini-account with as little as $500. Regular accounts trade in $100,000 lots, and Mini-accounts trade in $10,000 lots.