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Forex Market Case Study Analysis

Disclaimer: This work has been submitted by a student. This is not an example of the work written by our professional academic writers. You can view samples of our professional work here.

Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Published: Wed, 28 Feb 2018

Preface

Just as stranger walk on path & last arrive at their destination; project work is like a path after walking in which students can gain experience & knowledge that can be stepping stone towards their success. It is such a work that enhances each & every individual working capacity & knowledge.

The Importance of Thesis is that it is blending of both theoretical & practical knowledge. Through the thesis, I got a golden change to have guidance under professionals & senior executives which can definitely be a platform of establishing themselves.

During my thesis work I visited AMA Library, Gujarat Chamber of Commerce and SBI which helped us a lot to gain information about Forex derivatives.

This opportunist of thesis provided to me was not only a platform to develop & enhance my appetite of learning but also served a fusion of the theoretical concept & their practical application in corporate world.

INTRODUCTION:

To make a profit from the forex market of International trade you have a grip on mainly five key factors that affects a currency value. When making our trades we analyze five key factors which are as follows.

  • Interest Rates
  • Economic Growth
  • Geo-Politics
  • Trade and Capital Flows
  • Merger and Acquisition Activity

Interest Rates:

Interest income and capital appreciation these two methods we can use to make profit from different in terms of countries’ interest rates.

Interest Income.

Every currency in the world comes attached with an interest rate that is set by its country’s central bank. All things being equal, you should always

  • Buy currencies from countries with high-interest rates and
  • Finance these purchases with currency from countries with low-interest rates.

For example, as of the fall of 2006, interest rates in the United States stood at 5.25%, while rates in Japan were set at .25%. You could have taken advantage of this rate difference by borrowing a large sum of Japanese yen, exchanging it for US dollars and using the US dollars to purchase bonds or cds at the US 5.25% rate.

In other words, you could have borrowed money at .25%, lent it out at 5.25%, and made a 5% return.Or you could save yourself all the hassle of becoming a money lender by simply trading the currency pairto affect the same transaction.

Capital appreciation.

Asa country’s interest rate rises, the value of the country’s currency also tends to rise– this phenomenon gives you a chance to profit from your currency’s increased value, or capital appreciation.

In the case of the USD/JPY spread in 2005 and 2006, as the US interest rates stayed higher than Japan’s, the dollar continued to increase in value. Investors who traded yen for dollars gained from interest income as well as the US dollar’s capital appreciation.

Economic Growth.

Economic Growth is next factor when predicting a country’s currency movements.The stronger the economy, the greater the possibility that the central bank will raise its interest rates in order to the growth of inflation.Andthe higher a country’s interest rates, the bigger the likelihood those foreign investors will invest in a country’s financial markets.More foreign investors mean a greater demand for the country’s currency.A greater demand results in an increase in a currency’s value.

Hence economic growth inspires higher interest rates inspires more foreign investment inspires greater currency demand which inspires an increase in the currency’s value.

Geo-Politics.

The currency market is the only market in the world that can be successfully traded on political news as well as economic releases.Because currencies representcountries rather than companies and any disturbance to the political landscape will oftentimes affect the direction in which the exchange rate moves.

The key to understanding speculative behavior with respect to any geopolitical unrest is that speculators run first and ask questions later.In other words, whenever investors fear any threat to their capital, they will quickly retreat to the sidelines until they are certain that the political risk has disappeared.Therefore, the general rule of thumb in the currency market is thatpolitics almost always trumps economics.

Trade and Capital Flows

Before ever making a final prediction regarding the movement (or trend) of a particular currency you should determine whether or not the currency is dependent on its country’s capital or trade flow. Capital flow refers to the amount of investment a country receives from international sources. Trade flow is the income resulting from trade. Some countries can be very dependent their capital flow, while other countries are extremely sensitive to trade flows.

Mergers and Acquisitions

Merger and acquisition activity is the least important factor in determining the long-term direction of currencies. It can be the most powerful force in stagingnear-term currency moves.Merger and acquisition activity occurs when a company from one economic region wants to make a transnational transaction and buy a corporation from another country.

For example, a European company wants to buy a Canadian asset for $20 billion, it would have to go into the currency market and acquire the currency to affect this transaction.Typically, these deals are not price sensitive, buttime sensitivebecause the acquirer may have a date by which the transaction is to be completed. Because of this underlying dynamic, merger and acquisition flow can exert a very strong temporary force on FX trading, sometimes skewing the natural course of currency flow for days or weeks.

OBJECTIVE:

  • Main Objective is for getting in depth knowledge of my topic.
  • To critically analyze the Forex market of International trade.
  • To analyze the five key factors that moves the Forex market and how to make profit out of them.
  • To analyze the present data and forecasting a future movement of Forex market.

METHODOLOGHY:

* Introduction of the topic in detail.

* For predict market movement I am using two methods like fundamental analysis and technical analysis. Technical analysis includes Candlestick Charts and Moving Averages (Simple and Exponential)

SOURCES:

Primary source

· Taking interview of the expertise in the Forex market.

Secondary source

· Use Books, Magazines, Newspapers, Research papers and Internet as secondary sources

LIMITATIONS:

· I have to follow only these five factors for move the Forex market.

· Interview is the only primary research in the Forex market.

· Inflation is the main factor which moves the Forex market but which is not included in the five factors.

· Merger and Acquisition is the least important factor.

CHAPTER 1:

INTRODUCTION OF FOREIGN EXCHANGE

Foreign Exchange is the method or process of conversion/converting one currency into another currency. Currency becomes money and legal tender for a country. But for a foreign country it becomes the value as a commodity. Since the commodity has a value its relation with the other currency determines the exchange value of one currency with the other. It is just the game of supply and demand. For example, the US dollar in USA is the currency in USA but for India it is just like a commodity which has a value which varies according to demand and supply.

Foreign exchange is one of the economic activity which deals with the means and methods by which rights to wealth expressed in terms of the currency of one country are converted into rights to wealth in terms of the current of another country. It involves the investigation of the method which exchanges the currency of one country for that of another. Foreign exchange can also be defined as the means of payment in which currencies are converted into each other and by which international transfers are made also the activity of transacting business in further means.

Most countries of the world have their own currencies. The US has its dollar, France its franc, Brazil its cruziero and India has its Rupee. Trade between the countries involves the exchange of different currencies. The foreign exchange market is the market in which currencies are bought and sold against each other. It is the largest market in the world. Transactions conducted in foreign exchange markets determine the rates at which currencies are exchanged for one another, which in turn determine the cost of purchasing foreign goods & financial assets. The most recent, bank of international settlement survey stated that over $900 billion were traded worldwide each day. During peak volume period, the figure can reach upward of US $2 trillion per day. The corresponding to 160 times the daily volume of NYSE.

CHAPTER 2:

ORIGIN OF THE FOREX MARKET

The FOREX trading traces its history to centuries ago. Different currencies and the need of exchange them had existed since the Babylonians. They are credited with the first use of paper notes and receipts.

In that time the value of goods were expressed in terms of other goods which were called as Barter system. The obvious limitations of such a system encouraged establishing more generally accepted mediums of exchange. It was important that a common base of value could be established. In some economies, items such as teeth, feathers even stones served this purpose, but soon various metals, in particular gold and silver, established themselves as an accepted means of payment as well as a reliable storage of value. Trade was carried among people of Africa, Asia etc through this system.

Coins were initially minted from the preferred metal and in stable political regimes, the introduction of a paper form of governmental I.O.U. during the middle Ages also gained acceptance. This type of I.O.U. was introduced more successfully through force than through persuasion and is now the basis of today’s modern currencies.

Before the First World War, most Central banks supported their currencies with convertibility to gold. However, the gold exchange standard had its weaknesses of boom-bust patterns. As an economy strengthened, it would import a great deal from out of the country until it ran down its gold reserves required to support its money. As a result, the money supply would diminish, interest rates escalate and economic activity slowed to the point of recession. Ultimately, prices of commodities had hit bottom and it appearing attractive to other nations who would sprint into buying fury that injected the economy with gold until it increased its money supply, drive down interest rates and restore wealth into the economy.

However, for this type of gold exchange, there was not necessarily a Centrals bank need for full coverage of the government’s currency reserves. This did not occur very often, however when a group mindset fostered this disastrous notion of converting back to gold in mass, panic resulted in so-called “Run on banks”. The combination of a greater supply of paper money without the gold to cover led to devastating inflation and resulting political instability. The Great Depression and the removal of the gold standard in 1931 created a serious lull in FOREX market activity. From 1931 until 1973, the FOREX market went through a series of changes. These changes greatly affected the global economies at the time and speculation in the FOREX markets during these times was little.

Inorder to protect local national interests, increased foreign exchange controls were introduced to prevent market forces from punishing monetary irresponsibility.

Nearthe end of World War II, the Bretton Woods agreement was reached on the initiative of the USA in July 1944. The conference held in Bretton Woods, New Hampshire rejected John Maynard Keynes suggestion for a new world reserve currency in favor of a system built on the US Dollar. International institutions such as the IMF, The World Bank and GATT were created in the same period as the emerging victors of WWII searched for a way to avoid the destabilizing monetary crises leading to the war. The Bretton Woods agreement resulted in a system of fixed exchange rates that reinstated The Gold Standard partly, fixing the USD at $35.00 per ounce of Gold and fixing the other main currencies to the dollar, initially intended to be on a permanent basis.

TheBretton Woods system came under increasing pressure as national economies moved in different directions during the 1960’s. A number of realignments held the system alive for a long time but eventually Bretton Woods collapsed in the early 1970’s following president Nixon’s suspension of the gold convertibility in August 1971. The dollar was not any longer suited as the sole international currency at a time when it was under severe pressure from increasing US budget and trade deficits.

Thelast few decades have seen foreign exchange trading develop into the world’s largest global market. Restrictions on capital flows have been removed in most countries, leaving the market forces free to adjustforeign exchange ratesaccording to their perceived values.

TheEuropean Economic Community introduced a new system of fixed exchange rates in 1979, the European Monetary System. The quest continued in Europe for currency stability with the 1991 signing of The Maastricht treaty. This was to not only fix exchange rates but also actually replace many of them with the Euro in 2002. London was, and remains the principal offshore market. In the 1980s, it became the key center in the Eurodollar market when British banks began lending dollars as an alternative to pounds in order to maintain their leading position in global finance.

InAsia, the lack of sustainability of fixedforeign exchange rateshas gained new relevance with the events in South East Asia in the latter part of 1997, where currency after currency was devalued against the US dollar, leaving other fixed exchange rates in particular in South America also looking very vulnerable.

Whilecommercial companies have had to face a much more volatile currency environment in recent years, investors and financial institutions have discovered a new playground. The FOREX exchange market initially worked under the central banks and the governmental institutions but later on it accommodated the various institutions. At present it also includes the dot com booms and the World Wide Web. The size of the FOREX market now dwarfs any other investment market. Theforeign exchange marketis the largest financial market in the world. Approximately 1.9 trillion dollars are traded daily in theforeign exchange market. It is estimated that more than USD 1,200 Billion are traded every day. It can be said easily that FOREX market is a lucrative opportunity for the modern day savvy investor

SHORT INFO OF FOREX

The history of FOREX trading was traced centuries ago. Different countries need different currencies and the need of exchange them had existed since the Babylonians. It is said that Babylonians were the first one who used paper notes and receipts.

During those days, goods were exchanged for another goods based on the value of both the goods, which was known as barter system. But this system had some limitations and this lead to encourage establishing more generally accepted medium of exchange. It was also important that a common base of value could be established. In some economies, items such as teeth, feathers even stones served this purpose, but soon various metals, in particular gold and silver, established themselves as an accepted means of payment as well as a reliable storage of value. Trade was carried among people of Africa, Asia etc through this system.

Coinswere initially minted from the preferred metal and in stable political regimes, the introduction of a paper form of governmental I.O.U. during the middle Ages also gained acceptance. This type of I.O.U. was introduced more successfully through force than through persuasion and is now the basis of today’s modern currencies.

Beforethe First World War, most Central banks supported their currencies with convertibility to gold. However, the gold exchange standard had its weaknesses of boom-bust patterns. As an economy strengthened, it would import a great deal from out of the country until it ran down its gold reserves required to support its money. As a result, the money supply would diminish, interest rates escalate and economic activity slowed to the point of recession. Ultimately, prices of commodities had hit bottom and it appearing attractive to other nations who would sprint into buying fury that injected the economy with gold until it increased its money supply, drive down interest rates and restore wealth into the economy.

However, for this type of gold exchange, there was not necessarily a Centrals bank need for full coverage of the government’s currency reserves. This did not occur very often, however when a group mindset fostered this disastrous notion of converting back to gold in mass, panic resulted in so-called “Run on banks”. The combination of a greater supply of paper money without the gold to cover led to devastating inflation and resulting political instability. The Great Depression and the removal of the gold standard in 1931 created a serious lull in FOREX market activity. From 1931 until 1973, the FOREX market went through a series of changes. These changes greatly affected the global economies at the time and speculation in the FOREX markets during these times was little.

Inorder to protect local national interests, increased foreign exchange controls were introduced to prevent market forces from punishing monetary irresponsibility.

Nearthe end of World War II, the Bretton Woods agreement was reached on the initiative of the USA in July 1944. The conference held in Bretton Woods, New Hampshire rejected John Maynard Keynes suggestion for a new world reserve currency in favor of a system built on the US Dollar. International institutions such as the IMF, The World Bank and GATT were created in the same period as the emerging victors of WWII searched for a way to avoid the destabilizing monetary crises leading to the war. The Bretton Woods agreement resulted in a system of fixed exchange rates that reinstated The Gold Standard partly, fixing the USD at $35.00 per ounce of Gold and fixing the other main currencies to the dollar, initially intended to be on a permanent basis.

TheBretton Woods system came under increasing pressure as national economies moved in different directions during the 1960’s. A number of realignments held the system alive for a long time but eventually Bretton Woods collapsed in the early 1970’s following president Nixon’s suspension of the gold convertibility in August 1971. The dollar was not any longer suited as the sole international currency at a time when it was under severe pressure from increasing US budget and trade deficits.

Thelast few decades have seen foreign exchange trading develop into the world’s largest global market. Restrictions on capital flows have been removed in most countries, leaving the market forces free to adjustforeign exchange ratesaccording to their perceived values.

TheEuropean Economic Community introduced a new system of fixed exchange rates in 1979, the European Monetary System. The quest continued in Europe for currency stability with the 1991 signing of The Maastricht treaty. This was to not only fix exchange rates but also actually replace many of them with the Euro in 2002. London was, and remains the principal offshore market. In the 1980s, it became the key center in the Eurodollar market when British banks began lending dollars as an alternative to pounds in order to maintain their leading position in global finance.

InAsia, the lack of sustainability of fixedforeign exchange rateshas gained new relevance with the events in South East Asia in the latter part of 1997, where currency after currency was devalued against the US dollar, leaving other fixed exchange rates in particular in South America also looking very vulnerable.

Whilecommercial companies have had to face a much more volatile currency environment in recent years, investors and financial institutions have discovered a new playground. The FOREX exchange market initially worked under the central banks and the governmental institutions but later on it accommodated the various institutions. At present it also includes the dot com booms and the World Wide Web. The size of the FOREX market now dwarfs any other investment market. Theforeign exchange marketis the largest financial market in the world. Approximately 1.9 trillion dollars are traded daily in theforeign exchange market. It is estimated that more than USD 1,200 Billion are traded every day. It can be said easily that FOREX market is a lucrative opportunity for the modern day savvy investor

CHAPTER 3:

METHODS OF QUOTING EXCHANGE RATES

There are two methods of quoting exchange rates.

Direct method:

For change in exchange rate if foreign currency is kept constant and home currency is kept variable, then the rates are stated be expressed in ‘Direct Method’ E.g. US $1 = Rs. 45.50.

Indirect method:

For change in exchange rate if home currency is kept constant and foreign currency is kept variable, then the rates are stated be expressed in ‘Indirect Method’. E.g. Rs. 100 = US $ 2.5116

With the effect from August 2, 1993, all the exchange rates are quoted in direct method, i.e.

US $1 = Rs. 45.50 GBP1 = Rs. 79.82

Method of Quotation

In the Forex market there are two rates like one is for buying and one is for selling rates. This helps in eliminating the risk of being given bad rates i.e. if a party comes to know what the other party intends to do i.e., buy or sell, the former can take the latter for a ride.

There are two parties in an exchange deal of currencies. To begin the deal one party asks for quote from another party and the other party quotes a rate. The party asking for a quote is known as ‘Asking party’ and the party giving quote is known as ‘Quoting party’

The advantages of two way quote.

Ø It automatically ensures alignment of rates with market rates.

Ø The market constantly makes available price for buyers and sellers.

Ø Two-way price limits the profit margin of the quoting bank and comparison of one quote with another quote can be done immediately.

Ø It is not necessary for any player in the market to show whether he intends to buy or sell foreign currency but this ensures that the quoting bank cannot take advantage by manipulating the prices.

Ø Two-way quotes lend depth and liquidity to the market and which is very essential for efficient.

Ø In two-way quotes for the first rate is the rate for buying and another rate is for selling. We should understand here that in India the banks which are authorized dealers, always quote rates. So the rates quote – buying and selling is for banks will buy the dollars from him so while calculation the first rate will be used which is a buying rate, as the bank is buying the dollars from the exporter.

Ø The same case will happen inversely with the importer, as he will buy the dollars from the banks and bank will sell dollars to importer.

BASE CURRENCY

Even if a foreign currency can be bought and sold in the same way as a commodity but they’re use as a minor difference in buying/selling of currency aid commodities. Unlike in case of commodities, in case of foreign currencies two currencies are involved so, it is necessary to know which the currency to be bought and sold is and the same one is known as ‘Base Currency’.

BID &OFFER RATES

The buying and selling rates are also referred to as the bid and offered rates. In the dollar exchange rates referred to above, namely, $ 1.6288/96, the quoting bank is offering (selling) dollars at $ 1.6288 per pound while bidding for them (buying) at $ 1.6296. So in this quotation the bid rate for dollars is $ 1.6296 while the offered rate is $ 1.6288. The bid rate for one currency is automatically the offered rate for the other. In the above example, the bid rate for dollars $ 1.6296, is also the offered rate of pounds.

CROSS RATE CALCULATION

US Dollar is the most trading currency in the forex market. In other words one support of most exchange trades is the US currency so margins between bid and offered rates are lowest quotations if the US dollar. The margins tend to widen for cross rates, as the following calculation would show.

Consider the following structure:

GBP 1.00 = USD 1.6288/96

EUR 1.00 = USD 1.1276/80

In this rate structure, we have to calculate the bid and offered rates for the euro in terms of pounds. Let us see how the offered (selling) rate for euro can be calculated. Starting with the pound, you will have to buy US dollars at the offered rate of USD 1.6288 and buy Euros against the dollar at the offered rate for euro at USD 1.1280. The offered rate for the euro in terms of GBP, therefore, becomes EUR (1.6288*1.1280), i.e. EUR 1.4441 per GBP, or more conventionally, GBP 0.6925 per euro. Similarly, the bid rate the euro can be seen to be EUR 1.4454 per GBP (or GBP 0.6918 per euro). Thus, the quotation becomes GBP 1.00 = EUR 1.4441/54. It will be eagerly noticed that in percentage terms the difference between the bid and offered rate is higher for the EUR: pound rate as compared to dollar: EUR or pound: dollar rates.

CHAPTER 4:

ADVANTAGES OF FOREX MARKET

The Forex market is by far the largest and most liquid in the world but also day traders have up to now focused on looking for profits in mainly stock and futures markets. This is mainly due to the restrictive nature of bank-offered forex trading services. There are Advanced Currency Markets (ACM) offers both online and traditional phone forex-trading services to the small investor with minimum account opening values starting at 5000 USD.

There are many advantages to trading spot foreign exchange as opposed to trading stocks and futures. These are the some advantages as under.

Commissions:

ACM offers foreign exchange trading commission free. This is in sharp contrast to (once again) what stock and futures brokers offer. A stock trade can cost anywhere between USD 5 and 30 per trade with online brokers and typically up to USD 150 with full service brokers. Futures brokers can charge commissions anywhere between USD 10 and 30 on a round turn basis.

Margins requirements:

ACM offers a foreign exchange trading with a 1% margin. In layman’s terms that means a trader can control a position of a value of USD 1’000’000 with a mere USD 10’000 in his account. By comparison, futures margins are not only constantly changing but are also often quite sizeable. Stocks are generally traded on a non-margined basis and when they are, it can be as restrictive as 50% or so.

24 hour market:

Foreign exchange market trading occurs over a 24 hour period picking up in Asia around 24:00 CET Sunday evening and coming to an end in the United States on Friday around 23:00 CET. Although ECNs (electronic communications networks) exist for stock markets and futures markets (like Globex) that supply after hours trading, liquidity is often low and prices offered can often be uncompetitive.

No Limit up / limit down:

Futures markets contain certain constraints that limit the number and type of transactions a trader can make under certain price conditions. When the price of a certain currency rises or falls beyond a certain pre-determined daily level traders are restricted from initiating new positions and are limited only to liquidating existing positions if they so desire.

The controlling of daily price volatility is the main mechanism but in effect since the futures currency market follows the spot market anyway the following day the futures market may undergo what is called a ‘gap’ or we can say also in other words the futures price will re-adjust to the spot price the next day. In the OTC market no such trading constraints exist permitting the trader to truly implement his trading strategy to the fullest extent. Since a trader can protect his position from large unexpected price movements with stop-loss orders the high volatility in the spot market can be fully controlled.

Sell before you buy:

Equity brokers offer very restrictive short-selling margin requirements to customers. This means that a customer does not possess the liquidity to be able to sell stock before he buys it. When initiating a selling or buying position in the spot market a trader has exactly the same capacity in margin wise. In spot trading when you are selling one currency you are necessarily buying another.

CHAPTER 5:

FOREX EXCHANGE RISK

The Risk Management Guidelines are primarily an accent of some good and prudent practices in exposure management. They have to be understood and slowly internalized and customized so that they yield positive reimbursement to the company over time.

Any business is open to risks from movements in competitors’ prices, raw material prices, competitors’ cost of capital, foreign exchange rates and interest rates, all of which need to be (ideally) managed.

Forex Risk

Everywhere in the world risk is attached. Without risk there is no gain. Also the FOREX is not risk-free. Like if you are trading with substantial sums of money and there is always a possibility that trades will go against you.Also there are several trading tools so that can minimize your risk and with caution and above all education the FOREX trader can learn how to trade profitably and while minimizing losses.

Risks

Assuming you are dealing with a reputable broker and there are still risks to FOREX trading. Transactions are subject to unexpected rate changes, volatile markets and political events.

Exchange Rate Risk:

Exchange rate risk which refers to the fluctuations in the currency prices over a long trading period. The Prices can fall rapidly which are resulting in substantial losses unless and until stop loss orders are used when trading FOREX. And so stop loss orders specify that the open position should be closed if currency prices pass a predetermined level. Stop loss orders can be used in conjunction with limit orders to automate FOREX trading – limit orders specify an open position should be closed at a specified profit target.

Interest Rate Risk:

It can result from discrepancies between the interest rates in the two countries which represented by the currency pair in a FOREX quote. This discrepancy can result in variations from the expected profit or loss of a particular FOREX transaction.

Credit Risk:

It is the possibility that when the deal is closed one party in a FOREX transaction may not honor their debt and this may happen when a bank or financial institution declares insolvency. The Credit risk is minimized by dealing on regulated exchanges which require members to be monitored for credit worthiness.

Country Risk:

Country risk is connected with governments that may become involved in foreign exchange markets by limiting the flow of currency. There is more country risk associated with exotic currencies than with major currencies that allow the free trading of their currency.

Limiting Risk in your FOREX currency trading system

FOREX trading can be very risky but there are ways to limit your risk and financial exposure. Every FOREX trader should have a trading strategy for knowing when to enter and when to ex


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