Currencies (Foreign Exchange / FX / Forex)

  Bloomberg Benchmark Currency Rates

  European Central Bank Euro Exchange Reference Rates

  Bank of Japan Yen Foreign Exchange Rates (Daily)

  CME Group American Style FX Options on Globex

  CME Group European Style FX Options on Globex

  Hong Kong Association of Banks Exchange Rates

  Swiss National Bank Exchange Rates

  Trade Weighted Exchange Index, Federal Reserve Bank of St. Louis

  Federal Reserve Release H.10 USD Foreign Exchange Rates (Historical)

Currency Valuation

The values of national currencies were once established and stabilized based on the convertibility of the currency into a specific amount (wieght) of gold at an official price. This was known as the gold standard or gold exchange standard and was adhered to by many nations between the years of 1870 to 1914, and then again between the years of 1925 to 1931. The United Kingdom linked its paper currency to gold in 1816 (further legislation in 1821), while the United States did not officially institute a gold standard until 1900. The gold standard was only abandoned prior to World Wars I and II. Nations that were able to maintain substantial gold reserves had their currencies become international reserve currencies, used to satisfy official and trade payments. With regard to U.S. currency, the U.S. government set the initial price of convertibility at $19.75 per troy ounce with the Coinage Act (1792), revised to $20.67 per troy ounce in 1834, revised to $35 per troy ounce with the Gold Reserve Act of 1934, and was at $42.2222 per troy ounce at 1973 (after convertibility was ended in 1971).

After World War II, the Bretton Woods Agreement established a fixed-rate of exchange between the major currencies. However, the rise of inflation and the cessation of the convertibility of the U.S. dollar to gold bullion in 1972 resulted in a situation where the fixed rate mechanism did not accurately reflect the economic and political realities of respective currency values. The IMM (International Monetary Market) was organized in 1972 as a division of the Chicago Mercantile Exchange (CME), in order to allow the futures trading of currencies. This was the beginning of the return to adjustable, free-floating exchange rates.

Currency Market

There is a spot currency market, a forward currency market, a swaps currecny market, a futures currency market and options market on currencies. As of April 2004, the Bank for International Settlement (BIS) indicated that the daily trading volume in traditional currency markets, world-wide, was $1.95 trillion (adjusted). By April 2007, average daily turnover had increased to $3.21 trillion. The greatest volume of any single currency was the U.S. dollar against other major currencies (followed by the Euro and then the Japanese Yen). The greatest volume by currency pair was the USD / EUR followed by the USD / JPY and the USD / GBP. The greatest volume of actual trading (by geographical / legal domicile) is within the United Kingdom, followed by the United States, Japan, Singapore and Hong Kong.

Spot transaction: single outright transaction involving the exchange of two currencies at a rate agreed on the date of the contract for value or delivery (cash settlement) within two business days. (BIS)

Outright forward: transaction involving the exchange of two currencies at a rate agreed on the date of the contract for value or delivery (cash settlement) at some time in the future (more than two business days later). This category also includes forward foreign exchange agreement transactions (FXA), non-deliverable forwards and other forward contracts for differences. (BIS)

Foreign exchange swap: transaction which involves the actual exchange of two currencies (principal amount only) on a specific date at a rate agreed at the time of the conclusion of the contract (the short leg), and a reverse exchange of the same two currencies at a date further in the future at a rate (generally different from the rate applied to the short leg) agreed at the time of the contract (the long leg). (BIS)

Currency option: Option contract that gives the right to buy or sell a currency with another currency at a specified exchange rate during a specified period. This category also includes exotic foreign exchange options such as average rate options and barrier options. (BIS)

There is no single regulated exchange on which spot currencies are traded. Rather, currencies are traded over-the-counter by various types of financial institutions, corporate treasury departments, investment funds with their own trading capability and central banks of governments in what is known as the interbank market. This market is global and operates 24 hours a day, and has 2 major on-line, screen-based order book / dealing systems (interbank market).

A foreign exchange trade is actually 2 simultaneous transactions: one must sell a currency in order to purchase another currency. Thus, a particular currency is always priced in terms of another currency. The first currency is known as the base currency and any other currecy (the quote currency) is given in the exchange rate equivalent amount of the base currency. In addition, there are always 2 prices for the quoted currency: there is a Bid (the price at which the market maker will purchase / buy the currency), and an Ask price (the price at which the market maker will sell the currency). The Bid price for the quoted currency will always be lower than the Ask price for the quoted currency, as the market maker wants to purchase the currency at a lower price than they will sell it (and earn a profit on the spread). The difference between the Bid and Ask prices is known as the spread, and if the currency is actively being traded and there is quite a bit of liquidity than the spread will be narrow. Again, as per the April 2004 BIS report indicated above, the U.S. dollar accounted for 89% of one side of all transactions, followed by the Euro, then the Yen and the Pound.

In a newspaper or on-line one will always see a currency (base or quoted currency) presented with a minimum of four decimal places (example: 1.8572). These price quotes are in what is known as interbank European terms, which indicates the amount of the currency required to purchase one USD (with the exception of the Euro and the British Pound). Thus, an example of a quote would be: Late NY for Japanese Yen 110.12. The Euro and the British Pound are quoted in interbank U.S. terms. Thus, a quote for British Pounds would be: Late NY 1.8324 (1 GBP = $1.8324).

Speculative trading in the foreign exchange market is an attempt to buy a currency that will appreciate in value in relation to another (or several) currency. Thus, perhaps in 30 days I sell back the currency I had purchased and I receive more of the original currency back than I had needed to originally make the purchase. For instance, the spot price for USD angainst the Japanese Yen (JPY) is USD 1.00 = JPY 108. I sell USD 100 and purchase JPY 10,800. Perhaps, 30 days later the Japanese Yen appreciates (increases) in value relative to the U.S. Dollar to JPY 106 = USD 1.00 (this means that it now takes fewer Yen to purchase an equivalent amount of Dollars compared to 30 days ago). Thus, I am holding JPY 10,800 and I want to now sell it back to purchase dollars. JPY 10,800 divide by JPY106 = USD 101.87. Thus, I have earned $1.87 on my original $100.00.

Currency prices are effected by interest rates in a particular country, the strength of that particular nation's economy and trade patterns. The main concern is that if there is an interest by investors to invest in assets in a particular country, or if a country has products that are exported to other countries then there will be a demand for a nations's currency in order to pay for those investments or products in the local currency. Related to trade activity is the fact that a nation may have a trade balance deficit or credit during any given month. In the event of a deficit situation, this means that the nation has imported hard goods and has essentially exported its currency. The surplus of a nation's currency outside its border results in a weakened curency value as the surplus of the currency is offered in the market. In addition, national governments regularly intervene to purchase or sell its currency (sometimes in concerted effort with other nations) and this action will also effect the price by sending a message to currency traders as to what that respective government will allow to be either a high or low price for its currency (and to what lengths a nation is willing to go to achieve that goal). Sometimes, overseas divisions of corporations will repatriate profits to the home company, usually at the end of a quarter. This large movement of cash can temporarily drive up the value of a nation's currency as the profits must be converted into the currency of where the corporation's headquarters are domiciled.

Traders who pay attention to these trade issues, national interest rates and daily / monthly economic news releases and then plan their long-term trading strategy based on this information are known as technical traders.

The value of a currency is also effected by statements made by government officials with regard as to whether they want a "strong" currency or a "weak" currency. These statements are made in quarterly or monthly meetings, for instance when the Governor of the Fedral Reserve Bank testifies before Congress. As an example, when the Governor makes a statement abount wanting a strong dollar it is referred to as "talking up the dollar" and indicates to traders that the Fed will intervene (buy dollars) in the market to support at certain exchange rate level. The ECB and Asian central banks also engage in the same activity, however it is more difficult for the ECB as it may be responsible for monetary policy but fiscal policy is still formulated by each respective national government whose position may be in contrast to the ECB. It is important that there be an articulate, concise and cohesive position presented to the markets by a government or the announcements will not be taken seriously.

When a currency rises in value or declines in value relative to other currencies there can be a related effect upon an existing financial situation and/or upon asset values. For instance,

A decline in the U.S. dollar can result in foreign currency denominated instruments now valued higher in dollar terms (because if it is cashed in and coverted to dollars it will result in more dollars than would have been paid prior to the decline in the USD).

When the U.S. dollar declines, U.S. manufactured merchandise is now cheaper in terms of another currency, thus U.S. import activity improves with a new demand for cheaper U.S. goods.

When the U.S. dollar declines, foreign subsidiary operations owned by a U.S. corporation now have improved results in terms of consolidated U.S. dollar denominated earnings.

A decline in the U.S. dollar can make dollar denominated assets (financial, corporate and real estate) already owned in the United States less attractive to foreigners as when they sell the investment it requires more dollars than it did in the past to purchase their home currency, thus the investment has not performed as well as it would have in an appreciating dollar environment. However, a decline in the dollar can also make direct investment in U.S. assets less expensive to invest in if that is the starting point of the investment.

A decline in the U.S. dollar makes international commodities, which are denominated in U.S. dollars, less expensive to purchasers in terms of their home currency (as they can now obtain more dollars per their own currency). Conversely, it means less money to producers of commodities as they are paid in dollars but require more dollars to purchase their home currency.

How to convert between 2 currencies:

If:   1 U.S. Dollar equals 108.7 Japanese Yen

USD = JPY108.7

 

Then:   $1,000.00 equals 108,700.00 Japanese Yen

USD1,000 X JPY108.7 = JPY108,700

 

And:   108,700.00 Japanese Yen equals 1,000 U.S. dollars

JPY108,700 ÷ 108.70 = USD1,000

Similar to our explanation above about quotes in the newspaper, converting between currencies is actually finding the reciprocal of a currency.

The credit issue in the interbank market is that it is unregulated. Thus, each party must do its own due dilligence on a potential counterparty (trade confirmation messages and derivative contracts are standardized). According to Eurompney's Annual FX Poll, Deustche Bank AG was the institution with the greatest foreign exchange volume marketshare (19.3%), followed by UBS AG (14.85 %), Citigroup (9.0%), Royal Bank of Scotland (8.9%) and Barclays Capital (8.8%).
www.euromoneyfix.com/Article.aspx?ArticleID=1331250

The second credit issue is Settlement Risk. This is the risk that one party to a currency transaction will default after the other side has met its obligation, usually due to bankruptcy, inability or time zone differential. The settlement of different currencies in different markets and time zones from the moment the sold currency becomes irrevocable until the purchased currency receipt is confirmed (duration and amount of risk faced by market participants affects ability to accurately determine actual exposure). If the two parties are paid separately in local payment systems and may be in different time zones, resulting in a lag time of three days and mounting exposure that may exceed a party's capital. The risk is reduced by improved reconciliation (such as including unreconciled trades) and netting agreements. exposure to settlement risk is related to forward trades but spot trades (which are suppose to settle in 2 days) also create settlement risk exposure due to the sheer volume of transactions.

In a foreign exchange forward, swap or option contract, the Notional Prinicipal is the amount on which interest and other payments in the transaction are based. Typically, the notional principal does not trade hands once the contract has expired. Rather, it is simply the quantity that is used to calculate payments. Notional principal is a volume measure in the foreign exchange derivatives market, it is not a measure of credit exposure.

Mark-to-market is the measure, at a point in time, of the foreign exchange contract (replacement cost) based on the valuation of the underlying notional principal since the start date of the contract. There is an asymmetric relationship between the trading parties: a positive mark-to-market for one side of the transaction results in a corresponding (equal amount) negative mark-to-market for the counterparty to the transaction. The Net Mark-to-Market is the net exposure to a single counterparty, which is detrmined by netting all positive against all negative mark-to-market positions with the counterparty. There are 2 types of netting: netting by novation (nets contractual obligations) and the netting of all settlement payments.

Netting agreements are usually entered into bilaterally between parties and the definitions and terms for use in confirmations of individual transactions governed by the 1992 ISDA Master Agreements, the International Foreign Exchange and Options Master Agreement (FEOMA), the International Foreign Exchange Master Agreement (IFEMA) and the International Currency Options Market Master Agreement (ICOM), as published by ISDA (International Swaps and Derivatives Association), EMTA (Emerging Markets Trade Association) and the Foreign Exchange Committee (FXC / includes representatives of the major financial institutions engaged in foreign currency trading in the United States and is sponsored by the Federal Reserve Bank of New York) in association with the British Bankers Association, the Canadian Foreign Exchange Committee and the Tokyo Foreign Exchange Market Practices Committee. (The International Swaps and Derivatives Association ISDA Master Agreement was updated in 2002; The British Bankers Association International Foreign Exchange & Currency Options Market Terms Master Agreement was updated in 2002; The Multilateral Master Confirmation Agreement for Non-Deliverable Forward FX Transactions was published in 2007; The Foreign Exchange Committee has issued a revision to the International Foreign Exchange and Currency Option Master Agreement (“IFXCO”) published on June 1, 2005. This revision was effective December 4, 2006).

The value of entering into the netting agreement with a counterparty is the confidence that in the event of insolvency the netting agreement will be enforceable, either on a close-out basis or on a novation basis depending on the specific jurisdiction.

The primary settlement system is CLS Bank International (Continuous Linked Settlement; headquartered in London, U.K., incorporated in New York), that has several hundred "third parties" (banks, insurance companies, financial institutions, corporate desks) using its cross-currency settlement system. In CLS, both companies must transfer the correct payment to CLS Bank before the bank will relaese funds. By maintaining an account with the central banks of the major currency nations, CLS Bank can settle cross-currency transactions in real time. CLS is capable of a payment-versus-payment settlement for members on the following currencies: Australian dollar, Canadian dollar, Danish krone, euro, Hong Kong dollar, Japanese yen, New Zealand dollar, Norwegian krone, Singapore dollar, South Africa rand, South Korean won, Swedish krona, Swiss franc, UK Sterling, and US dollar. CLS does not guarantee delivery of a currency. However, in the event that a settlement fails due to a default by a FX counterparty, CLS will return paid in funds of the non-defaulting counterparty thereby eliminating the gross portion of currency settlement risk.

In 2007, Reuters and the Chicago Mercantile Exchange combined to commence operations of FXMarketSpace, which in addition to being a front-end trading platform also aspires to provice a global, centralized clearing system for the foreign currency exchange market (All trades placed through the platform are cleared through the CME Clearing system).

Currency Abbreviations (As per ISO 4217 guidelines)

Note: The nation of France sponsors several overseas currencies used by former colonies:

The Euro (EUR) is the legal tender for the nations of Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia and Spain. The Euro is used also in Andorra, Kosovo, Monaco, Montenegro, San Marino and Vatican City, as well as in the Canaries, Madeira, the Azores, Guyana, Martinique, Guadeloupe, Réunion, Mayotte and St Pierre and Miquelon, which are all part of EU countries using the euro.

There are a number of currencies that are pegged to the Euro (the market exchange rate may deviate from the parity within the +/-15 percent fluctuation band):
Bosnia and Herzegovina konvertibilna marka (1 euro = 1.95583 konvertibilna marka)
Bulgarian lev (1 euro = 1.95583 leva)
Cape Verde escudo (1 euro = 110.265 escudos)
Danish krone (1 euro = kr 7.46038)
Estonian kroon (1 euro = 15.6466 krooni)
Hungarian forint (1 euro = 282.36 forint)
Latvian lats (1 euro = Ls 0.702804)
Lithuanian litas (1 euro = 3.45280 litai)
Slovak koruna (1 euro = 35.4424 Sk)

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