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A true 24-hour market, Forex trading begins each day in Sydney, and moves around the globe as the business day begins in each financial center, first to Tokyo, London, and New York. Unlike any other financial market, investors can respond to currency fluctuations caused by economic, social and political events at the time they occur - day or night.

The FX market is considered an Over-The-Counter (OTC) or 'inter-bank' market, due to the fact that transactions are conducted between two counterparts over the telephone or via an electronic network. Trading is not centralized on an exchange, as with the stock and futures markets.

The Foreign Exchange market, also referred to as the "Forex" or "FX" market, has a daily average turnover of US $1.9 trillion - 30 times larger than the combined volume of all U.S. equity markets. In percentage terms, it is the same in India.

Reading a foreign exchange quote may seem a bit confusing at first. However, it's really quite simple if you remember two things: (a) The first currency listed is the base currency and (b) the value of the base currency is always 1.

The US dollar is the centerpiece of the Forex market and is normally considered the 'base' currency for quotes. In the "Majors", this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the second currency quoted in the pair. Therefore, the second listed currency is called the ‘terms currency’, because it represents the value against the base. For example, a quote of USD/JPY 110.01 means that one U.S. dollar is equal to 110.01 Japanese yen.

When the U.S. dollar is the base unit and a currency quote goes up, it means the dollar has appreciated in value and the other currency has weakened. If the USD/JPY quote we previously mentioned increases to 113.01, the dollar is stronger because it will now buy more yen than before.

The three exceptions to this rule are the British pound (GBP), the Australian dollar (AUD) and the Euro (EUR). In these cases, you might see a quote such as GBP/USD 1.7366, meaning that one British pound equals 1.7366 U.S. dollars. In these three currency pairs, where the U.S. dollar is not the base currency, a rising quote means a weakening dollar, as it now takes more U.S. dollars to equal one pound, euro or Australian dollar. In other words, if a currency quote goes higher, that increases the value of the base currency. A lower quote means the base currency is weakening.

Currency pairs that do not involve the U.S. dollar are called cross currencies, but the premise is the same. For example, a quote of EUR/JPY 127.95 signifies that one Euro is equal to 127.95 Japanese yen.

When trading forex you will often see a two-sided quote, consisting of a 'bid' and 'ask': The 'bid' is the price at which you can sell the base currency (at the same time buying the counter currency). The 'ask' or 'offer' is the price at which you can buy the base currency (at the same time selling the counter currency).

Cross	Bid	Ask
USD JPY	95.00	95.05
	To sell	To Buy

In the Forex market, prices are quoted in pips. Pip stands for "percentage in point" and is the fourth decimal point, which is 1/100th of 1%. In EUR/USD, a 3 pip spread is quoted as 1.2500/1.2503, spread defining the difference between the bid and ask prices.

Among the major currencies, the only exception to that rule is the Japanese yen. In USD/JPY, the quotation is only taken out to two decimal points (i.e. to 1/100 th of yen, as opposed to 1/1000th with other major currencies). In USD/JPY, a 3 pip spread is quoted as 114.05/114.08

Inter Bank Rates are essentially Spot Rates (48 hours maturity) which are quoted by one bank to another in order to buy or sell a currency against another. For all direct quotes, the first quote represent the Bid and the second one the offer and as such the bid will always be lower than the offer.

Thus a bank can buy or sell a currency to another bank at a particular rate, which it does on behalf of its client and charges a margin above the transaction rate which essentially is the transaction cost of the bank. However, the transactions are usually done by quoting the IB rate and then the margin is added or subtracted as the case may be. It is thus imperative for the client to know the current IB rate to get the best possible rate from its bank for conversion.

Inter Bank Rates (as explained separately) are the rates quoted by banks themselves to buy / sell among the banks. These rates carry very thin spreads and are used as a benchmark to convert higher value transactions with a pre-fixed margin for all remittances in the form of bills of exporters and importers.

However, the Currency and Travelers’ Cheque values are much lower than these bill amounts and these being primarily retail products are priced with a much wider margin from the Inter Bank Rates. So even though the inter bank rates remain the reference point for these, the margins ensure that the final rate of Travellers’ cheques etc are much different from that of a bill conversion. Currency rates tend to be even wider as these are mostly driven by demand and supply.

In India, most forward swap markets are dealt on Month End basis as opposed to overseas markets which are on a Monthly Basis. By month end we mean the last working day of the month (like 31st July, 31st Aug, 30th September etc). In a monthly format however the forward premiums are quoted in multiples of 30 days from the spot date from which it is calculated (e.g if the spot date is 15th September, the first month forward is automatically for 15th of October, second month for 15th of November and so on).

In overseas markets, the forward premiums are quoted in their respective currencies (Overseas premium) and these have to be converted to the INR which are pre-calculated for the user in both Month End and Monthly format. Additionally, one can use the forward calculator which can calculate the finished forward rate for any date in the future, depending on inward or outward. Please visit our User’s Guide for more details.

A support is the price level which, historically, a currency has had difficulty falling below. It is thought of as the level at which a lot of buyers tend to enter the stock.

A resistance is the price level at which a currency or market can trade, but not exceed, for a certain period of time.

Supports and resistances serve as effective points for entry and exit of a currency and to apply stop loss and take profit levels. In practice, a breakout is most commonly used to refer to a situation where the price breaks above a level of resistance and heads higher, rather than breaking below a level of support and heading lower. Once a resistance level is broken, it is regarded as the next level of support when the asset experiences a pullback. Most traders use chart patterns and other technical tools such as trendlines to identify possible candidates that are likely to break through a support/ resistance level. A breakout is the bullish counterpart to a breakdown.

A sideways trend is a horizontal price movement that occurs when the forces of supply and demand are nearly equal. A sideways trend is often regarded as a period of consolidation before the price continues in the direction of the previous move.

One would come across these terms when visiting the technical analysis section in EforexIndia where two levels of supports and resistances are mentioned for day trading and is an extremely useful tool for traders.

After determining the exposure, the company needs to know which way the currency is headed. The focus should primarily be on:-

• The Direction or the Big Trend in Rates.
• The underlying assumption behind the forecasts.
• The probability/weightage that can be assigned to the forecasts.
• The Range of movement possible, i.e. noting the Supports and Resistances.

Forecasting a currency is a complex process as they are (a) universal and cannot be influenced by isolated factors (b) moves as per interest rates (c) 24 hours market (d) immense volume. This forecast can be done by Fundamental and Technical Analysis which our traders are trained in and requires considerable amount of technical and market knowledge. Fundamental Analysis refers to Policy related changes including interest rate decisions while technical analysis done from charting and statistical methods.

One of the first things to learn is that the market is supreme and thus at no point should one try to over-rule the underlying trend of a market. The Trend is the Biggest Friend and it is always wise to catch that signal. One should only enter the market after identifying the long term and them the intermediate and short-term trend of the market. As regards patterns of currency movements remember that ‘a currency always goes UP by the LADDER BUT comes DOWN by a LIFT’.

Support and Resistance are points where a chart experiences recurring upward or downward pressure. A Support level is the low point of a chart whereas the Resistance is the high point of the pattern. It is advisable to BUY when the price is close to a Support and SELL when it is close to a Resistance. Remember, once these support / resistance points are broken, they become quite the opposites; in a rising market when the resistance level is broken, it becomes a support for the next set of movements and the vice versa. The various tools of analysis used by us in this section and for forecasting various trends and cycles are briefly explained for our readers.

Moving Averages tell the price in a given point of time over a defined period of time. They are so called because they reflect the latest average, while adhering to the same time measure.

The problem with using moving averages is that they are lagging indicators, which means they change only after a trend has changed. This can be overcome by using a shorter period or by combining two averages of distinct time frame. So if one use a combination of 40and 200-day moving average, buy signals are detected when the shorter-term average crosses above the longer-term average and a sell signal in the reverse combination. Assigning of weights to moving averages also alleviates the problem of a single or a few days’ volatile data giving wrong signals.

Momentum Analysis measures the underlying strength of a price movement or the rate of change of price rather than plotting the actual price itself. It is plotted around a zero line and results may be either negative or positive. It should be remembered that a Top in the momentum line does not mean that the price has reversed, only a move through a zero line signals a price reversal. Thus a momentum indicator signals acceleration or deceleration of a price and can be classified as a leading indicator.

RSI reflects the overbought or oversold position of a market. For this calculation, to compute support the RSI figure should be taken at 70 and for the purpose of Resistance, RSI should be taken at 30. However, this method should ideally be used in a consolidating market and would best be avoided in a trending market.

This tool carries the advantages of other tools and tried to nullify their disadvantages and is calculated at 1.95/2.00 Standard Deviation of the Moving Average (usually 20 day period) which results in an envelope within which majority of the prices move. The bands of this envelope act as support and resistance so it is easy to buy at the lower end of the band and sell at the upper end. Entry and exit should best be done when a price has closed outside the band and is definitely a leading indicator.

This is a very popular retracement series based on mathematical ratios arising from mostly natural phenomenon and is used to determine how far a price has rebounded or backtracked from its underlying trend. Since the series is like 1, 1, 2, 3, 5, 8, 13, 21, 34…, the ratios we get are 23.6%, 38.2%, 50%, 61.8%, 76.4% and so on.

This is done by classifying prices into patterned waves that can indicate future targets and reversals. Waves moving with the trend are called impulse waves and waves moving against the trend are called corrective waves. These Impulse and Corrective waves are broken down into five primary and three secondary movements respectively which forms a complete wave cycle and these can be further subdivided. These wave patterns needs to be identified so as to predict accurately and is best used in conjunction with the Fibonacci theory.

A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.

It is an over-the-counter contract between parties which determines the rate of interest, or the currency exchange rate, to be paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used along with the termination date and notional value. On this type of agreement, it is only the differential that is paid on the notional amount of the contract. It is also known as a "future rate agreement".

• 3 months rate starting in 3 months time is 3/6
• 3 months rate starting in 6 months time is 6/9
• 6 months rate starting in 3 months time is 3/9

Two-way quotes are available in the market and levels can be found on the Reuters (MIBORO2). The lower rate is the bid at which the bank is ready to pay fixed and the higher rate will be the offer rate at which the bank will be ready to receive fixed.

We take the case of a borrower who has obtained a one-year credit amounting to Rs.10 lakhs on September 5, 2009. The interest rate is based on 6 months MIBOR. For the first six months MIBOR has already been fixed. Now he is not confident about the second six months, as he is not confident about what he has to pay and apprehends rates to rise. To protect himself he can buy an FRA for the next 6 months with a matching notional principal. Suppose a bank quotes him for 6X12 FRA 9.10 / 90 on September 3rd itself. He can lock in at 9.90% by buying 6X12 FRA on Sept 3rd itself for the period Sept 5, 2009 to Sept 4, 2010. On March 3, 2010 the 6 months MIBOR will be known (we assume 10%) and on that date the 6m MIBOR rate is compared with the FRA rate and the settlement amount is computed by discounting back to the beginning of the contract period using the formula below:

SA = ((SR – FRA ) X NP X CP) / 360 + ( SR X CP )

Where SA is Settlement Amount, SR is Settlement Rate, NP is Notional Principal and CP is Contract period. Using the data in our example we get:

(0.10 - 0.099) X 10,00,000 X 182 / 360 + (0.10 X 182) = Rs. 481.23

Thus the borrower would receive Rs.481.23 and this amount will be used to pay the extra 10bp (10% -9.9%). It is clear from the calculation that the net cost to the borrower will be the same as agreed under the FRA contract in both the cases. It should be remembered that the counter-party of a customer is always a bank as there is no secondary market and an FRA price should be analysed/ calculated by always keeping the corporate's point of view and not that of the market maker or the bank.

There is no restriction on the Notional Principal of FRA/IRS and any domestic money market or debt market can be used as benchmark to enter into FRA/IRS once the basis is computing is acceptable to both the parties. There are various Exposure and Capital Adequacy Norms that are laid down by the apex bank to whom all such deals have to be reported on a fortnightly basis.

However, the derivative markets are highly leverages and thus care should be taken in the initial stages by engaging professional consultants to avoid untoward losses by either not using the instrument available or using it in an erroneous manner.

Currency Convertibility is the ability to exchange money for gold or other currencies. Currency is considered to be convertible when the concerned country formally accepts the obligations of Article VIII, Sections 2, 3 and 4 of the Articles of Agreement of the IMF.

While currencies like the US Dollar, Euro, Pound and Yen are fully convertible, the Rupee in India is a partially convertible currency.

The word "margin" means something very different in forex than it does in stocks. With stocks, trading on margin means that a trader can borrow up to 50% of a stock's value to buy that stock. This can be a costly move because the investor must pay interest to the brokerage firm on the amount borrowed. This is not the case in forex trading.

The leverage available in forex trading is one of main attractions of this market for many traders. Leveraged trading, or trading on margin, simply means that you are not required to put up the full value of the position.

Forex provides more leverage than stocks or futures. In forex trading, the amount of leverage available can be up to 200 times the value of your account.

On a daily basis, the volatility of the major currencies is less than 1%. This is much lower than an active stock, which can easily have a 5-10% move in a single day. With leverage, you can capture higher returns on a smaller market movement. More importantly, leverage allows traders to increase their buying power and utilize less capital to trade. Please note: Increasing leverage increases risk.

Call Money Market is a short-term money market, which allows large financial institutions, such as banks, mutual funds and corporations to borrow and lend money at inter-bank rates. The loans in the call money market are very short, usually lasting no longer than a week and are often used to help banks meet reserve requirements.

It is the interest rate at which a depository institution lends immediately available funds (balances within the central bank) to another depository institution overnight. In countries where central banks exist, this provides for an efficient method whereby banks can access short-term financing from central bank depositories. As the overnight rate is influenced by the central bank, it is a good predictor for the movement of short-term interest rates.

In the U.S., this is referred to as the Federal Funds Rate.

CRR (Cash reserve ratio) or the portion of deposits the banks have to keep with the Reserve Bank of India (RBI). Indian banks are required to hold a certain proportion of their deposits as cash. In reality they don’t hold these as cash with themselves, but with Reserve Bank of India (RBI), which is as good as holding cash. This ratio (what part of the total deposits is to be held as cash) is stipulated by the RBI and is known as the CRR, the cash reserve ratio.

It is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight.

It is an interest rate at which banks can borrow funds, in marketable size, from other banks in the London inter-bank market. The LIBOR is fixed on a daily basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' inter-bank deposit rates for larger loans with maturities between overnight and one full year.

Traditionally, it meant the exchange of one currency for another or to change the date of maturity of a particular currency because investment objectives have changed. Recently, swaps have grown to include currency swaps and interest rate swaps. One would require knowing the forwards rate to execute a Swap transaction in case of currencies and interest rates (like Libor, Mifor etc) for an interest rate swap.

An Interest Rate Swap (IRS) can be defined as a contract between two parties (called Counter Parties) to exchange, on a particular date in the future, one series of Cash Flows (fixed interest) for another series of Cash Flows (variable or Floating Interest) in the same currency on the same principal amount (called Notional Principal) for an agreed period of time. The two payment streams are called the legs or sides of a swap. The exchange of Cash Flows need not occur on the same date. This means payment may be different for each side of the swap. So the variable rate may be paid monthly and the fixed quaterly, in which case the pricing of the swap can allow for discounted timing cost.

Swaps, unlike FRA’s, generally do not net-settle the difference between the agreed fixed interest rate and the Variable interest rate. Netting of payments is however allowable. The Floating rate of interest is referenced to a short-term interest rate like the LIBOR in the international market or the MIBOR in the Rupee market. The Floating Rate used as benchmark or index is RMIBOR (Reuters Mumbai Inter Bank Offered Rate) or N-MIBOR (NSE Mumbai Inter Bank Offered Rate).

The reset frequency for the floating rate index is the term for the interest rate index itself. However, the reset frequency for the floating rate does not necessarily match the timetable of the floating rate index. Therefore the floating rate may be set daily, weekly, month, quarterly while settlement dates may fall monthly, quarterly, semi-annually etc. If the reset date and the settlement date do not coincide, the swap is said to be “paid in arrears set in advance”.

Quoting of SWAP points

The pricing of swaps is against the fixed interest rate. At the start of a swap, the expected NPV is zero for both couterparties. Theoretically, the floating leg’s worth is the same as those of a fixed rate leg and thus swaps are a zero sum game at the inception. In case at the inception the NPV’s are not exactly equal, one party pays higher to compensate the price.
Generally, swaps have been quoted in a number of ways, but the most commonly used is setting the floating rate equal to a short term index (such as a given maturity of MIBOR) with no margin or plus/minus a given margin, which are payable in the money market by the couterparties. When no margin is added to a floating rate, such rate is said to be quoted 'Flat'. The price of a Fixed /Floating swap is quoted in two parts: a fixed interest rate and a short term index upon which the floating rate is based. The convention is to quote All-In-Cost (AIC) which means the fixed interest rate is quoted relative to the floating rate index without any margin. After having set the floating rate, the fixed rate is set appropriate to it. Each bank quotes its own swap rate to exchange fixed cash flows interest for floating in each maturity. Further one should take care of different day count conventions to calculate interest that is 30 days month means 360 days a year or actual number of days elapsed since the previous settlement is due based on a 360 days year.

EFFECT OF RATE CHANGES ON AN IRS

Floating Rate payers will gain if interest rate falls, as they will have to pay lesser interest whereas fixed rate payer will loose as they are locked in fixed rate. In case the Interest rate rises, The Floating payer will loose and the Fixed rate will gain.

UNWINDING SWAPS

The party who wishes to unwind a swap has the following three alternatives:

• Swap Buy-Back / Closeout/ Termination/ Cancellation.
• Swap Reversal with new swap equaling the remaining period of original swap with Same Reference Rate and Same Notional Principal.
• Swap Sale or Assignment

THE MECHANISM OF IRS

It is a known fact that investors willing to invest in fixed rate instruments are more sensitive to credit rating of the issuer than credit rate lenders. To compensate for this a higher premium is demanded from the issuer of lower credit quality in the fixed rate debt market than floating rate market. The counterparties obtain an arbitrage by drawing down funds where they have greater relative cost advantage, subsequently by entering into an IRS to cover the cost of funds so raised from a fixed rate to a floating rate ad vice-versa. Here it is a win-win situation. Therefore two companies can come together to an agreement such that both can reduce their cost of borrowings. The fact that such opportunities exist is due to imperfection in the money market that is the difference in risk-premium in fixed and floating market. An example will illustrate the point:

Suppose that there are two parties to the swap viz. X and Y and a dealer arranges a swap taking a margin (spread). The deal is for Rs. 100 Million in One Year. The other related data are hereunder:

It is clear from the above that each of the parties have a comparative advantage in either the floating or fixed rate market. The company X can borrow more cheaply than Y both fixed and floating loans, but its comparative advantage is in fixed rate market whereas Y has an advantage in the floating market. But X wants to be a floating rate payer and Y a fixed rate payer. One way which will divide the gain equally is for X to actually borrow at fixed rate and service floating rate in the swap and Y to borrow in floating and service fixed. But there are other methods of reaching the same goal and is generally done through an intermediary who takes credit risk on each counterparty. Suppose the swap dealer quotes 7.50/100 for the swap:

In the swap, X, the floating payer

• Pays floating to the swap bank at the prevailing rate.
• Receives fixed rate 7.5%
• Pays fixed rate 8%

Receives floating rate from the swap bank at the prevailing rate.

The net cost of funds and savings to X and Y using the swap arrangement can be worked out clearly. With swap X makes a payment of Floating rate to bank at 8% and receives 7.5% from swap bank. Thus his cost is floating rate + 50 bp. Without swap on the other hand his cost would be Floating rate +100bp. For Y with swap will involve a payment of Floating rate +150bp to swap bank and receive 8% from swap bank. His borrowing cost would be Floating Rate + 150bp + 8% - Floating Rate. Thus we can observe that X and Y are not only better by 50bp but also the swap bank has made a margin of 50bp (8%-7.5%). Thus the gain has been shared out between the swap parties and the bank is 150bp that are equal to the Quality Spread Differential in two markets.

USAGE OF SWAPS

Interest Rate Swaps are used to achieve one of the following:

• To lower the cost of borrowings as compared to those otherwise available in the market or from bank.
• To hedge against, or speculate upon Interest Rate Movements.
• To obtain fixed rate financing when it is impossible to access the market directly.

A latent option contract, that begins to function as a normal option ("knocks in") only once a certain price level is reached before expiration, is called a knock in option. Technically, this type of contract is not an option until a certain price is met, so if the price is never reached it is as if the contract never existed. Knock-ins are a type of barrier option that may be either down-and-in option or an up-and-in option.

A Knock Out option on the other hand has a built in mechanism to expire worthless should a specified price level be exceeded.

An American option can be exercised anytime during its life. The majority of exchange-traded options are American as they are cheaper, even though they have higher risk profile.

A type of option that differs from common American or European options in terms of the underlying asset or the calculation of how or when the investor receives a certain payoff. These options are more complex than options that trade on an exchange, and generally trade over the counter.

Central bank is the entity responsible for overseeing the monetary system for a nation (or group of nations). Central banks have a wide range of responsibilities, from overseeing monetary policy to implementing specific goals such as currency stability, low inflation and full employment. Central banks also generally issue currency, function as the bank of the government, regulate the credit system, oversee commercial banks, manage exchange reserves and act as a lender of last resort.

A Central Bank is the custodian of its own currency and resorts to intervention (either by way of selling or buying) in heavy amounts in case it finds that its home currency is under threat, of over appreciation or depreciation and sometimes to curb excess volatility. Owing the vast volume in which they intervene, any central bank play in the market is bound to move the currency to the direction it wants it to go and is treated with respect by all players.

The value of the U.S. Dollar has recently declined to all time lows against the EURO, and multi year lows against the Great Britain Pound and Canadian Dollar amongst others. For a long list of reasons, including massive increases in U.S. government deficits, the cost of prolonged war against terrorism and a massive trade imbalance, this trend may be just the beginning.

Today's financial markets are increasingly at risk from terrorism, political instability and war. As incidents continue to increase around the world, it is not unreasonable to expect further disruptions in financial markets, banking and commerce in the future.

Whenever and wherever tension or hostilities break out, people everywhere gravitate toward the assets they trust most.

Even in our high-tech driven 21st century, the asset class millions rely on in times of trouble is gold and silver. Precious metals have normally been, and will continue to be, a valued form of "wealth insurance" in good times.