## User blog: Karim Mansour

Anyone in the world

Relevant to the following CISI qualifications: ICWIM, ICAWM, Securities, Risk in Financial Services

### DEFINITION

The time value of money is based on the premise that most people would choose to receive, say, $10,000 now, rather than the same sum in five years’ time. Why? Firstly, because any rational person knows that the$10,000 will almost certainly buy you less in five years’ time than it will today. Secondly, there is no certainty that you will actually receive the money five years from now. As the proverb says, a bird in the hand is worth two in the bush.

Businesses use time-value-of-money formulae to make rational decisions on future expectations.

Discounting allows us to understand what we would need to invest today if we wanted to receive a certain amount in the future. Compounding helps us to calculate the sum that we will receive in the future if we invest a certain amount today.

Several other equations can be used to calculate loans, mortgages, the future values of annuities, etc. These equations are frequently combined for particular uses. For example, bonds can be readily priced using these equations. A typical coupon bond is composed of two types of payment: a stream of coupon payments similar to an annuity, and a lump-sum return of capital when the bond matures—that is, a future payment. The two  formulae can be combined to determine the present value of the bond.

For an annuity that makes one payment per year, there is an annual interest rate. However, the time frame in years must be converted into the number of periods consistent with the compounding frequency of the rate. For an income or payment stream with a different payment schedule, the interest rate must be converted into the relevant periodic interest rate. For example, if a mortgage requires monthly payments, the interest rate has to be divided by twelve.

The rate of return in these calculations can be either the variable solved or a predefined variable that measures a discount rate, interest, inflation, rate of return, cost of equity, cost of debt, or any number of similar concepts. The choice of the suitable rate is vital to the exercise, and the use of an incorrect discount rate will make the results worthless.

For calculations involving annuities, you must decide whether the payments are made at the end of each period (i.e. ordinary annuity) or at the beginning of each period (i.e. annuity due).

Most formulae are available on financial calculators or can be set up on a spreadsheet.

Time-value-of-money formulae are generally easy to understand and are widely used.

• The data used by the formulae are readily available.

• Discounting tells us what we would need to invest today if we wanted to receive a certain amount in the future.

• Compounding helps us to calculate the sum that we will receive in the future if we invest a certain amount today.

• It can often be difficult to identify the appropriate formula without expert help.

• The data on which the initial investment was made often change over the lifetime of the investment.

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Tadawul owns and operates the first bilingual learning portal for CISI in the world: www.TadawulExams.com

Tadawul delivers CISI training in Dubai, Abu Dhabi, Oman Qatar, Kuwait, Bahrain and Saudi Arabia.

Tadawul’s portfolio includes: CISI IISI, CISI ICWIM, CISI ICAWM, CISI IFQ, CISI Securities, CISI Risk, CISI Derivatives, and many more.

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[ Modified: Monday, 7 January 2019, 3:50 PM ]

Anyone in the world

Relevant to the following CISI qualifications: Risk in Financial Services, Derivatives

## DEFINITION

The successful management of a portfolio includes maximizing returns from shifts in exchange and interest rates, which in turn requires an appreciation of the associated exposures. Not knowing the exposure can leave the portfolio open to significant risk.

Exchange rate risk is the risk arising from a change in the price of one currency against another. Companies or institutions that trade internationally are exposed to exchange rate risk if they do not hedge their positions. There are two main risks associated with exposure to exchange rates.

• Transaction risk arises because exchange rates may change unfavorably over time. The best protection is to use forward currency contracts to hedge against such changes.
• Translation risk concerns the accounts, and the level of risk is proportional to the amount of assets held in foreign currencies. Over a period of time, changes in exchange rates will cause the accounts to become inaccurate. To avoid this, assets need to be offset by borrowings in the affected currency.

The significance of the exposure will depend on the portfolio’s weightings and operations. Identifying the level of risk in the above exposures should help with selecting a suitable defense strategy.

Interest rate risk relates to changes in the floating rate. Failure to understand exposure to interest rates can lead to substantial risk. The two main areas of concern here should be borrowings and cash investments. The best way of appreciating exposure to changing interest rates is to stress-test various scenarios. How, for example, would a change in rate from 4% to 6% affect your ability to borrow?

## MITIGATING THE RISK

### EXCHANGE RATE EXPOSURE

Other than the two strategies mentioned above, good strategies for minimizing exchange rate exposure involve employing one or more of the following products.

• Spot foreign exchange: An obligation to buy/sell a specified quantity of currency at the current market rate to be settled in two business days.
• Structured forwards: Exchange forwards embedded with, generally, more than one currency option. This adaptation allows a more effective hedge and should improve the exchange rate within the client’s perception of the market.
• Currency options: An option to the right to buy/sell a certain amount of currency at a specific exchange rate on or before a specific future date.

### INTEREST RATE EXPOSURE

Once identified, the risks can be minimized using the following methods:

• Interest rate swap: A method for changing the interest rate you earn/pay on an agreed amount for a specified time period.
• Cross-currency swap: An exchange of principal and interest payments in separate currencies.
• Forward rate agreement: Two parties fix the interest rate that will apply to a loan or deposit.
• Interest rate caps: The seller and borrower agree to limit the borrower’s floating interest rate to a specified level for a period of time.
• Structured swap: An interest rate/cross-currency swap embedded with one or more derivatives. This allows the client to minimize his exposure on his perception of the market.

The one key advantage to identifying exposure to interest and exchange rate fluctuations is the ability to minimize possible losses in the event that your view of the market is wrong. This approach will also minimize the chance of unexpected events disrupting the investment strategy.

As with any hedge strategy, minimizing possible losses also reduces potential gains. Only those who are supremely confident in their forecasts and with a cushion to absorb losses should consider taking any extra risk to maximize returns.

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Tadawul owns and operates the first bilingual learning portal for CISI in the world: www.TadawulExams.com

Tadawul delivers CISI training in Dubai, Abu Dhabi, Oman Qatar, Kuwait, Bahrain and Saudi Arabia.

Tadawul’s portfolio includes: CISI IISI, CISI ICWIM, CISI ICAWM, CISI IFQ, CISI Securities, CISI Risk, CISI Derivatives, and many more.

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Anyone in the world

Relevant to the following CISI qualifications: Risk in Financial Services

## DEFINITION

The concept of “liquidity risk” tends to be very loosely defined. It is used most commonly with reference to the banking and finance industry, but it is an important issue for all companies. Broadly, liquidity risk is the danger that it will be difficult or impossible for an organization to sell an asset in order to provide capital to meet short-term financial demands.

A company needs to remain solvent; the liquidity risk is in the secondary market for its assets, which may not be sellable in time to meet short-term financial commitments, or will be sold at a price considerably below the perceived current market value. The problem may arise as the result of a liquidity gap or mismatch. This means that the dates for inflow and outflow of funds do not match up, creating a shortage.

Systemic liquidity risks arise from external factors. National or international recessions and credit crunches have the largest general impact on liquidity. Capital market disruptions, however, are more common. The collapse of the Russian ruble in 1998, for instance, created a global liquidity crisis, with a capital flight to quality away from the highly speculative Russian stock market.

Generally, liquidity is abundant during times when the economy is booming. During a downturn the impact on companies may increase if they continue with strategies based on the assumption that the high liquidity will continue indefinitely.

## CASE STUDIES

A company has outgoings of $8,000,000 a month against income from sales of$10,000,000. It faces a number of threats to its liquidity: for example, the price of the commodity it sells has fallen by 25%, leaving its income at $7,500,000 against$8,000,000 outgoings, and it has to find a way to raise the additional $500,000. Some major customers have axed or cut their orders, leaving the company with a surplus of products to sell on the market. It has lost$4,000,000 in “normal” monthly sales and now has to offload products it is forced to sell, below cost, at 50% of the expected price simply to pay its bills ($6,000,000 in expected sales plus$2,000,000 to meet monthly obligations of $8,000,000). The company chose to secure its position and iron out liquidity problems in the following ways: • It held cash to cover some of the shortfall, but it lost the potential income from this capital. • It set up a line of credit with its bank to help cover the shortfall. • It sold off some assets in order to meet its financial obligations. This is risky as assets that have to be sold in a hurry may not realize their book price. All this assumes that the company assessed its liquidity risks accurately and market conditions did not change. ## STRATEGIES Threats to a company’s liquidity seldom happen in isolation but are intertwined with other financial risks. If, for example, a company fails to receive a payment, it may be forced to raise cash elsewhere or default on its payments. In this scenario, credit risk and liquidity risk are linked. The aim of a liquidity management strategy is to minimize the cost of capital, allowing efficient access to capital and money markets at competitive prices during times of “normal” activity. Concurrently, the strategy should provide high levels of liquidity during periods when the financial markets are impaired. The latter part of the strategy is often described as “life insurance.” At a simple level this can mean organizing lines of credit well in advance of market turmoil, which is the cheapest option. However, the activities of a company and the market it operates in are dynamic. There will be periods when it is cash-rich and others when it is cash-poor. As cash is the ultimate liquid asset, there will be periods when it can “self-insure” and times when it will need to approach an external source for insurance. ——————————————- Tadawul Academy is a CISI-Accredited Training Partner delivers training in English and Arabic. You can learn more at www.tadawul.academy Tadawul owns and operates the first bilingual learning portal for CISI in the world: www.TadawulExams.com Tadawul delivers CISI training in Dubai, Abu Dhabi, Oman Qatar, Kuwait, Bahrain and Saudi Arabia. Tadawul’s portfolio includes: CISI IISI, CISI ICWIM, CISI ICAWM, CISI IFQ, CISI Securities, CISI Risk, CISI Derivatives, and many more. Tags: ### Comments Anyone in the world Relevant to the following CISI qualifications: Risk in Financial Services, Derivatives, ICAWM ## DEFINITION Risks arise from the way the value of an investment changes with the level of interest rates. This is most clearly seen in the value of fixed-rate investments such as bonds. If interest rates rise, the opportunity cost from holding the bond falls as it becomes more advantageous to switch to other investments. Alternatively, a company with a loan at a variable rate of interest may want to adapt its payments to avoid the risk arising from a rise in interest rates. It may also want to aid its financial planning by creating a more even pattern of repayment. A number of instruments exist to hedge against the risks posed by changing interest rates. For a company that decides to reduce its exposure to rising interest rates associated with variable rate funding there are two main types of derivative. A cap will ensure that the company does not have to find more than a maximum agreed level of interest. The company will benefit if interest rate levels stay below that level. A cap is paid for up-front. A variation on this instrument is the cap and collar, whereby the company will pay the seller of the product if interest rates fall below an agreed level. Swaps allow the company to exchange variable-rate payments for a guaranteed fixed rate. Swaps do not generally require any advance payment to the seller. There are a huge variety of swap instruments, reflecting the international nature of the debt market. For instance, although there would be no advantage in swapping a fixed rate for another fixed rate within the same currency, as the outcome would be known, it may be desirable to swap fixed rates between two currencies. Every variable of currency, floating and fixed exchange rate can be swapped. ## CASE STUDIES ### Vanilla Interest Rate Swap A company enters into a vanilla interest rate swap with a bank to reduce the risk from fluctuations on a$10 million loan it has taken out on a floating rate. The bank agrees to a fixed rate of, for example, 6% over five years, while the floating rates are based on the six-monthly Libor (London Interbank Borrowing Rate) plus 2%. If the Libor is 4% at the start of the agreement, the amount payable is 6% in both cases, although any percentage could be agreed.

If the Libor rises to 6%, the amount payable every six months would be 8% of $10 million divided by two, or$400,000. The company’s agreement with the bank is for a rate of 6%, or a payment of $300,000 in this case. The company will receive the difference of$100,000 from the bank.

The amount of the loan does not change hands and the company may continue to make the variable payments. It will receive cash if interest rates rise, and pay the bank if they fall. The net effect on the company is the same as if it had taken out a fixed-rate loan. Although the obvious route would be for a company to take out a fixed-rate loan, initially this may not be available or it may be too expensive.

Moreover, because the amount of the swap is notional, it is not necessary for the company to match the whole amount of the loan or to ensure that its entire life is covered. There may well be occasions when risk managers expect interest rate rises over the short to medium term. Continuing with a swap arrangement after the rises have peaked could wipe out initial gains.

• A swap is flexible, allowing a company to adjust its maturity, payment frequency, and principal to suit its ongoing financial arrangements.
• Interest rates can be managed independently of financing arrangements.
• There is no requirement for a payment up-front.

• The arrangement locks the company into a fixed rate that may not be advantageous.
• Early termination may incur a cost.
• There is a slight additional risk of failure from involving an additional financial institution in the swap arrangement.

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Anyone in the world

Relevant to the following CISI qualifications: Risk in Financial Services, Derivatives, ICAWM

## DEFINITION

A company that imports raw materials, exports finished goods, or has overseas assets or subsidiaries is exposed to fluctuations in exchange rates. Adverse movements can wipe out export profits, while positive changes can increase the price of its products in the foreign market. Equally, the company could benefit from windfall profits as a result of exchange rate fluctuations.

A company trading across national borders therefore has a number of choices. It can take a chance with spot rates, buying currency when required. This leaves it totally at the mercy of exchange rates. The risk can be removed if it books a forward exchange contract that fixes the rate for the date on which it will be needed for a transaction. If the rate improves, however, the company will not be able to take advantage of the improvement.

Using a combination of flexible products allows the company to protect itself against adverse movements while still giving it the ability to profit from improvements. A wide variety of instruments are available that allow companies to pursue this strategy.

Which is chosen depends partly on the level of risk and also on the ease of converting the currencies.

## CASE STUDIES

### The Participating Forward

This product is similar to a forward exchange contract in that it limits risk by offering a worst-case exchange rate for a transaction. If, however, there is a favorable move in exchange rates, the company can take advantage—generally with half its currency. There is usually no premium payable for this product.

Example

A company imports Cava wine from Spain to the United Kingdom. It is April, and a supplier has to be paid €4 million in October in time to catch the Christmas market.

The forward rate is 1.2100, and the company wants the certainty of a worst-case rate but doesn’t want to lose out if the rate goes up. The foreign exchange broker offers a rate of 1.1800, with the option to buy half the currency on the spot market two days before completion of the transaction.

Possible Outcomes

Sterling strengthens against the euro and the rate rises to 1.2500. The customer pays £1,694,915 for the first €2,000,000 at the low rate agreed in advance and £1,600,000 for the second €2,000,000 at the spot rate.

The average rate is therefore 1.215, slightly better than the forward rate, but not as good as the spot rate.

Alternatively, the euro strengthens against sterling and the spot rate is 1.1600. The company then pays the rate of 1.1800 for the whole transaction. The advantages of a participating forward are: a guaranteed worst-case rate; total protection against currency falls; a partial benefit from currency gains; and no premium.

The disadvantages are: if the currency weakens the rate will not be as good as a forward exchange contract; and the spot rate will be better if there is a positive move in currency.

### The Protection Option

With this service a company pays a premium for an option to exchange currency on a fixed forward date at a predetermined rate. If the spot rate on that date is better than the predetermined rate, the company can decide not to exercise its option to sell at the predetermined rate.

Example

The fund decides to buy a credit default swap in a notional amount of $8,000,000 to cover the potential default value. The CDS in this case trades at 150 basis points, so the fund will pay 1.5% of$8,000,000, or $120,000 annually. If Mega Car Company does not default, the fund will simply receive the full$8,000,000. In this case, its return will not be as good as it would have been without the CDS. On the other hand, if the corporation does default after, say, two years, the fund will receive its $8,000,000 from the seller of the CDS. It could be that the seller will take the bond or pay the difference between the recovery value and the par value of the bond. Alternatively, Mega Car Company could make a breakthrough in low-emission technology and dramatically improve its credit profile. In that case the fund might decide to reduce its outgoings by selling the remaining period of the CDS. ADVANTAGES • Derivatives such as a CDS will reduce or entirely remove the risk of default. DISADVANTAGES • The cost of hedging will reduce the return on investment. This article was originally published on Tadawul Academy’s website: https://www.tadawul.academy/2018/11/18/cisi-exam-prep-hedging-credit-risk-case/ Tags: [ Modified: Sunday, 18 November 2018, 10:45 AM ] ### Comments Anyone in the world ## Share Capitalisation Issues: Ex-scrip price and effects on the Balance Sheet ## A case study on Emirates NBD Capitalisation issues, otherwise known as bonus issues or scrip issues, are shares issued by the company to existing shareholders free of charge. Although mostly intended to reward shareholders, bonus issues are an effective way for a company to lower its share price in the market without the need for a stock split. Lower share prices mean more liquidity, as high prices can turn small investors away. Bonus issues are covered in most CISI qualifications in varying depth. Level 2 qualifications introduce to students the concept of bonus issues, while Level 3 & 4 qualifications require further analysis, such as the calculation of ex-bonus price (price after bonus issue) and the effect on a company’s balance sheet (sometimes referred to as the Statement of Financial Position). In this quick lecture, we shall use Emirates NBD as a case study. In April 2009, Emirates NBD announced the distribution of 10% (1:10) bonus shares to existing shareholders. It was decided that April 2nd will be the ex-bonus date. The two most popular questions you’ll get asked in a CISI exam are: 1. What is the effect of the bonus issue on the market price? 2. What is the effect of the bonus issue on the balance sheet? ## The effect on the market price Market prices drop after the bonus issue. The drop happens on the ex-bonus date, in the same way the price drops on ex-dividend date when there is a dividend distribution. Before the bonus issue (cum-bonus), the share was trading at AED 3.2. Where do we expect the price to be after the bonus issue (ex-bonus)? Before the bonus issue: 10 shares @ AED 3.2 = AED 32 During the bonus issue: 1 share @ AED 0 (free) = AED 0 After the bonus issue: 11 shares = AED 32 The price of the share after the bonus issue is expected to be AED 32/11 = 2.9. This is referred to as Theoretical Ex-Bonus Price. Indeed, if you see the price of the share on April 3rd, you’ll notice it dropped to AED 2.9. Sometimes, CISI might give you the ex-bonus price, and ask you to calculate the cum-bonus (price before the bonus). Example: Ex-bonus price = AED 5 Bonus issue = 1:10 Find cum-bonus price Before the bonus issue: 10 shares @ AED x = AED x During the bonus issue: 1 share @ AED 0 (free) = AED 0 After the bonus issue: 11 shares @ AED 5 = AED 55 The total price for 11 shares was AED 55. The price for 10 shares will also be AED 55 because the additional share was free of charge. This means this price of the share before the bonus was AED 55/10 = AED 5.5 The cum-bonus price is AED 5.5 ## The effect on the Balance Sheet A bonus issue will bring no cash to the company. This means the “Assets” side of the Balance Sheet will not change. Consequently, in order to keep the Balance Sheet balanced, the “Equity” side shouldn’t change either. A bonus issue increases the number of shares in the market. This means an increase in capital. This additional capital is taken from the Equity Reserves. In CISI qualifications, the reserves used are called “Share Premium Reserves”. In the Emirates NBD Balance Sheet, the reserves used were “Other Reserves”. Before the bonus issue, Emirates NBD had 5,052,523 shares in the market. The 10% bonus issue (505,252 new shares) brought the number of shares up to 5,557,775. The nominal value of the shares was AED 1. Here’s how the Balance Sheet looked like before and after the bonus issue: Before Bonus Issue After Bonus Issue Capital 5,052,523 5,557,775 Reserves 3,324,385 2,819,133 TOTAL 8,376,908 8,376,908 The Capital account went up by AED 505,252, and the Reserves account went down by AED 505,252. In the end, the total of both remained the same (8,376,908). In a bonus issue, the capital increases while reserves decrease. Equity in total remains unchanged. Since assets also remain unchanged, this means the balance sheet remains balanced. ### References: Emirates NBD Corporate Actions: https://www.dfm.ae/en/issuers/listed-securities/securities/company-profile-page?id=EMIRATESNBD Emirates NBD Balance Sheet and financial statements: 2009 – Q1 (before the bonus issue): https://www.emiratesnbd.com/plugins/FinanceManagement/QuaterlyReports/FinancialEng/Q2_FinancialStatements_2009_English.pdf 2009 – Q2 (after the bonus issue): https://www.emiratesnbd.com/plugins/FinanceManagement/QuaterlyReports/FinancialEng/Q1_FinancialStatements_2009_English.pdf This article was originally published on Tadawul Academy’s website https://www.tadawul.academy/2018/08/07/solving-cisi-exam-questions-share-bonus-issues/ Tags: [ Modified: Tuesday, 13 November 2018, 3:05 PM ] ### Comments Anyone in the world # Inflation, Interest Rates & Forex Relevant to the following CISI qualifications: IISI, Securities, Global Securities, ICWIM, ICAWM. The inter-relationship between inflation, interest rates and foreign exchange rates has always been a popular area in CISI exams – with varying difficulty across different levels. The recent turmoil in the Turkish Lira provides an excellent case study that would help students understand how the three pillars of monetary policy influence each other. Before we begin, it is important to seperate the factors that caused the crisis between economical factors (inflation, interest, fx) and non-economical factors (psychological and religious). ## Economical Factors ### Exports and GDP Since July last year, the Turkish Lira has lost 35% of its value against the US dollar. This was mainly attributed to Trump’s tariffs on aluminium and steel which were imposed as a political retaliation for the imprisonment of an American pastor. Tariffs on Turkish products will cause American importers to import less from Turkey and source their aluminium and steel from somewhere else. This means lesser exports from Turkey to the USA. If you’ve taken any CISI securities qualification, you’ll know that any adverse changes in exports have a direct effect on a country’s economy (remember: GDP = consumer spending + government spending + investments + exports – imports). CISI exam point: negative movements in exports = negative effects on GDP = negative effects on currency ### Interest rates and Inflation Turkey’s inflation rates currently stand at an astonishing 15%. For comparison, in the USA, UK and the UAE inflation rates hover around 2%. Turkey has continuously used credit and its budget to stimulate its economy. This meant deficits in its current account and public-sector budget. These deficits were covered through foreign direct investments (FDI) and external borrowing (bond issuance). The yields on Turkish 1-year to 10-year government bonds range between 20% and 25%. Recent growth in income and GDP however was not adequate enough to cover the debt burden. CISI exam points: Deficit in current account means imports are higher than exports. Governments cover deficits by borrowing – usually through the issuance of bonds. With inflation at such high levels, investors and creditors expected the Turkish central bank to increase interest rates which are already high at 17.75%. Contrary to expectations, the central bank held interest rates at that level. This raised concern among investors who started to believe that the central bank is not serious about controlling inflation and stabilising the currency. These concerns grew when Erdogan appointed his son-in-law to run the Treasury and Finance Ministry. CISI exam points: When inflation is high, central banks are expected to interfere and raise interest rates. This will cause borrowing to drop. Consequently, inflation will drop too. ### Non-Economical Factors As a conservative Muslim, Erdogan has continuously expressed his loathing for interest rates. On multiple occasions, he’s been quoted saying: “If my people say continue on this path in the elections, I say I will emerge with victory in the fight against this curse of interest rates.” “Because my belief is: interest rates are the mother and father of all evil.” Islam considers charging interest on debts as usury, or “riba”, which is therefore prohibited. Therefore, Erdogan’s description of interest rates is literal and not figurative. Investors believe that Erdogan’s lack of understanding of how interest rates influence currency levels stems from his deep hatred for interest – which is not expected to change any time soon. This article was originally published on Tadawul Academy’s website https://www.tadawul.academy/2018/08/16/cisi-exam-articles-inflation-interest-rates-forex/ Tags: [ Modified: Tuesday, 13 November 2018, 3:05 PM ] ### Comments Anyone in the world # The Structure and Function of the Foreign Exchange Market Relevant to the following CISI qualifications: IISI, Securities, Global Securities, ICWIM and ICAWM ## DEFINITION The foreign exchange market, also known as the forex, FX, or currency market, involves the trading of one currency for another. Prior to 1996 the market was confined to large corporate banks and international corporations. However it has since opened up to include all traders and speculators. Today, the average daily turnover in forex markets is US$1.9 trillion, according to the Bank of International Settlement’s Triennial Survey. The market is growing rapidly as investors gain more information and develop more interest.

In trading foreign exchange, investors bet that one currency will appreciate over another; they profit when they bet correctly and collect the profit in the form of an interest rate spread when they return to the original currency. The profit margins are low compared with other fixed-income markets. Large trading volumes can, however result, in very high profits. Most forex trading takes place in London, New York, and Tokyo, with most trading activity in London, which dominates the market at 30% of all transactions. New York’s market share is 16%, and Tokyo’s has fallen to 10% due to the growing prominence of Singapore and Hong Kong. Singapore has become the fourth largest exchange market globally, and Hong Kong is the fifth, having overtaken Switzerland. The various players in the foreign exchange market include bank dealers, 16% of which are international investors and speculators. Banks account for almost two-thirds of forex transactions; of the rest, about 20% is mainly attributable to securities firms that operate in the international debt and equity markets.

One type of very short-term transaction is the spot transaction between two currencies, delivering over two days and using cash as opposed to a contract.

In a forward transaction, the money is not exchanged until an arranged date and an exchange rate is agreed in advance. The time period ranges from days to years. Currency swaps are a popular type of forward transaction; these involve the exchange of currency by two parties for an agreed length of time and an arrangement to swap currencies at an agreed later date. Another type is a foreign currency future, which is inclusive of interest. A standard contract is drawn up and a maturity date arranged. The time schedule is about three months.

In a foreign exchange option (FX option), the most liquid and biggest options market in the world, the owner may elect to exchange money in a designated currency for another currency at an agreed date in the future. This type of transaction depends on the availability of option contracts on an organized exchange. Otherwise, such forex deals may be carried out using an over-the-counter (OTC) contract.

• The forex market is extremely liquid, hence its rapidly growing popularity. Currencies may be converted when bought or sold without causing too much movement in the price and keeping losses to a minimum.
• As there is no central bank, trading can take place anywhere in the world and operates on a 24-hour basis part from weekends.
• An investor needs only small amounts of capital compared with other investments. Forex trading is outstanding in this regard.
• It is an unregulated market, meaning that there is no trade commission overseeing transactions and there are no restrictions on trade.
• In common with futures, forex is traded using a “good faith deposit” rather than a loan. The interest rate spread is an attractive advantage.

• The major risk is that one counterparty fails to deliver the currency involved in a very large transaction. In theory at least, such a failure could bring ruin to the forex market as a whole.
• Investors need a lot of capital to make good profits because the profit marginson small-scale trades are very low.