Kamis, 06 Agustus 2009

The Currency Fund (FOREX)

THE CURRENCY FUND

Net Asset Value:10.26
Trade Time:Aug 6
Change:Down 0.04 (0.39%)
Prev Close:10.30
YTD Return*:N/A
Net Assets*:8.04M
Yield*:N/A

* As of 30-Jun-09

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The Currency Fund (FOREX)

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STATE COLLEGE, PA

Foreign exchange market

The foreign exchange market (currency, forex, or FX) trades currencies. It lets banks and other institutions easily buy and sell currencies. [1]

The purpose of the foreign exchange market is to help international trade and investment. A foreign exchange market helps businesses convert one currency to another. For example, it permits a U.S. business to import European goods and pay Euros, even though the business's income is in U.S. dollars.

In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.

The foreign exchange market is unique because of

  • its trading volumes,
  • the extreme liquidity of the market,
  • its geographical dispersion,
  • its long trading hours: 24 hours a day except on weekends (from 22:00 UTC on Sunday until 22:00 UTC Friday),
  • the variety of factors that affect exchange rates.
  • the low margins of profit compared with other markets of fixed income (but profits can be high due to very large trading volumes)
  • the use of leverage
Main foreign exchange market turnover, 1988 - 2007, measured in billions of USD.

As such, it has been referred to as the market closest to the ideal perfect competition, notwithstanding market manipulation by central banks. According to the Bank for International Settlements,[2] average daily turnover in global foreign exchange markets is estimated at $3.98 trillion. Trading in the world's main financial markets accounted for $3.21 trillion of this. This approximately $3.21 trillion in main foreign exchange market turnover was broken down as follows:

2008 G-20 Washington summit

The G-20 Leaders Summit on Financial Markets and the World Economy took place on November 14–15, 2008, in Washington, D.C. It achieved general agreement amongst the G-20 on how to cooperate in key areas so as to strengthen economic growth, deal with the financial crisis, and lay the foundation for reform to avoid similar crises in the future.[1][2] The Summit resulted from an initiative by the French and European Union President, Nicolas Sarkozy, and the British Prime Minister, Gordon Brown.[3] In connection with the G7 finance ministers on October 11, 2008, United States President George W. Bush stated that the next meeting of the G-20 would be important in finding solutions to the economic crisis. Since many economists and politicians called for a new Bretton Woods system (a monetary management which was instituted after World War II) to overhaul the world’s financial structure, the meeting has sometimes been described by the media as Bretton Woods II.[1]

Valuing FX options: The Garman-Kohlhagen model

As in the Black-Scholes model for stock options and the Black model for certain interest rate options, the value of a European option on an FX rate is typically calculated by assuming that the rate follows a log-normal process.

In 1983 Garman and Kohlhagen extended the Black-Scholes model to cope with the presence of two interest rates (one for each currency). Suppose that rd is the risk-free interest rate to expiry of the domestic currency and rf is the foreign currency risk-free interest rate (where domestic currency is the currency in which we obtain the value of the option; the formula also requires that FX rates - both strike and current spot be quoted in terms of "units of domestic currency per unit of foreign currency"). Then the domestic currency value of a call option into the foreign currency is

c = S_0\exp(-r_f T)\N(d_1) - K\exp(-r_d T)\N(d_2)

The value of a put option has value

p = K\exp(-r_d T)\N(-d_2) - S_0\exp(-r_f T)\N(-d_1)

where :

d_1 = \frac{\ln(S_0/K) + (r_d - r_f + \sigma^2/2)T}{\sigma\sqrt{T}}
d_2 = d_1 - \sigma\sqrt{T}
S0 is the current spot rate
K is the strike price
N is the cumulative normal distribution function
rd is domestic risk free simple interest rate
rf is foreign risk free simple interest rate
T is the time to maturity (calculated according to the appropriate day count convention)
and σ is the volatility of the FX rate.

Retail forex

In financial markets, the retail forex (retail off-exchange currency trading or retail FX) market is a subset of the larger foreign exchange market. This "market has long been plagued by swindlers preying on the gullible," according to The New York Times[1]. Whilst there may be a number of fully regulated, reputable international companies that provide a highly transparent and honest service, it's commonly thought that about 90% of all retail FX traders lose money. [2] [3]

It is now possible to trade cash FX, or forex (short for Foreign Exchange[4] (FX)) or currencies around the clock with hundreds of foreign exchange brokers through trading platforms. The reason that the business is so profitable is because in many cases brokers are taking the opposite side of the trade, and therefore turning client capital directly into broker profit as the average account loses money. Some brokers provide a matching service, charging a commission instead of taking the opposite site of the trade and "netting the spread", as it is referred to within the forex "industry."

Recently forex brokers have become increasingly regulated. Minimum capital requirements of US$20m now apply in the US, as well as stringent requirements now in Germany and the United Kingdom. Switzerland now requires forex brokers to become a bank before conducting FX brokerage business from Switzerland.[citation needed]

Algorythmic or machine based formula trading has become increasingly popular in the FX market,with a number of popular packages allowing the customer to program his own studies.

The most traded of the "major" currencies is the pair known as the EUR/USD, due to its size, median volatility and relatively low "spread", referring to the difference between the bid and the ask price. This is usually measured in "pips", normally 1/100 of a full point.[citation needed]

According to the October 2008 issue of e-Forex Magazine, the retail FX market is seeing continued explosive growth despite, and perhaps because of, losses in other markets like global equities in 2008.

Market size and liquidity

Presently, the foreign exchange market is one of the largest and most liquid financial markets in the world. Traders include large banks, central banks, currency speculators, corporations, governments, and other financial institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Daily turnover was reported to be over US$3.2 trillion in April 2007 by the Bank for International Settlements. [2] Since then, the market has continued to grow. According to Euromoney's annual FX Poll, volumes grew a further 41% between 2007 and 2008.[3]

Of the $3.98 trillion daily global turnover, trading in London accounted for around $1.36 trillion, or 34.1% of the total, making London by far the global center for foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and Tokyo accounted for 6.0%.[4] In addition to "traditional" turnover, $2.1 trillion was traded in derivatives.

Exchange-traded FX futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.

Several other developed countries also permit the trading of FX derivative products (like currency futures and options on currency futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Most emerging countries do not permit FX derivative products on their exchanges in view of prevalent controls on the capital accounts. However, a few select emerging countries (e.g., Korea, South Africa, India—[1]; [2]) have already successfully experimented with the currency futures exchanges, despite having some controls on the capital account.

FX futures volume has grown rapidly in recent years, and accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).

Top 10 currency traders [5]
% of overall volume, May 2008
Rank Name Volume
1 Flag of Germany Deutsche Bank 21.70%
2 Flag of Switzerland UBS AG 15.80%
3 Flag of the United Kingdom Barclays Capital 9.12%
4 Flag of the United States Citi 7.49%
5 Flag of the United Kingdom Royal Bank of Scotland 7.30%
6 Flag of the United States JPMorgan 4.19%
7 Flag of the United Kingdom HSBC 4.10%
8 Flag of the United States Lehman Brothers 3.58%
9 Flag of the United States Goldman Sachs 3.47%
10 Flag of the United States Morgan Stanley 2.86%

Foreign exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management assets, particularly of hedge funds and pension funds. The diverse selection of execution venues have made it easier for retail traders to trade in the foreign exchange market. In 2006, retail traders constituted over 2% of the whole FX market volumes with an average daily trade volume of over US$50-60 billion (see retail trading platforms).[6] Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 34.1% in April 2007. The ten most active traders account for almost 80% of trading volume, according to the 2008 Euromoney FX survey.[3] These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually 0–3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203 on a retail broker. Minimum trading size for most deals is usually 100,000 units of base currency, which is a standard "lot".

These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100/1.2300 for transfers, or say 1.2000/1.2400 for banknotes or travelers' checks. Spot prices at market makers vary, but on EUR/USD are usually no more than 3 pips wide (i.e., 0.0003). Competition is greatly increased with larger transactions, and pip spreads shrink on the major pairs to as little as 1 to 2 pips.