Monthly Archives: August 2007

How does an exchange rate affect the businesses directly?

Like all other trading markets of the capital world the forex rates are also subjected to volatility on account of various parameters like demand & supply, investment flow etc.

Due to such volatility the cost & revenue budgeting of the importers and exporters of various goods and services get affected.

The affect is due to the change is exchange rate.

For example a person Mr. A in US has exported fruits to country Mr. B in Japan.

Currency for US: USD

Currency for Japan: Yen

Hence Mr. B would be making payments to Mr. A on a specific date for a specific amount of USD.

Current exchange rates for Yen/USD is 115

Now, if the exchange rate holds stable on the date of payment its fine for both the stakeholders.

However an increase in the forex rate to 118 would mean that the costing for Mr. B in Japan has increased by around 2.50% whereas a decrease would mean that his costing has proportionately gone down.

On the other hand if the payment is to be done in Yen then an increase of forex rate of Yen/USD to 118 would result in lower revenues for Mr. A in US because the purchasing power of USD has gone up. Effectively Mr. B will get only 1 USD for 118 Yen against the earlier rates ( 115 Yen = 1 USD) where he would have secured 1.02 USD for 118 Yen (118/115)

In order to mitigate the risk of volatility in exchange rates, the risk managers indulge in forward forex bookings.

Repo rates and reverse repo rates

Repo rate is the rate at which the central bank lends money to the other banks.

The reverse repo rate is the rate at which the other banks park their excess funds with the central bank. The reverse repo rate is always lower than the repo rate and is generally equal to the lending rate between banks (excluding the central bank)

The word repo represents the collateral that is given by banks to the central bank for borrowing money. On repayment of the borrowing the banks repossess their collateral given to the central bank, hence the word repo rate.

What is the effect of an increase/decrease in the repo rate?

An increase in the repo rate reduces the money supply in the system whereas a decrease in the repo rate infuses money into the system

Foreign exchange traders

Forex traders are classified in line with their decision making tools. Broadly they fall into two categories –

Fundamental traders are those who base their trading on fundamental indicators like macro and micro economic information, interest rates, money supply and political stability. They are mainly long term traders and like to hold on to their positions.

Technical traders are those who use tools like charts, levels of support and resistance, trend lines, algorithms models and other such tools. They are mainly short term traders who trade frequently and take various positions in the market.

Things you should know before you invest

Investment is a decision that all of us have been or would be confronted with at one or the other point of time.

Let us look at what all should be considered while making an investment:

Risk appetite

First define you risk appetite. What is the quantum of risk that you are ready to take? i.e. what is the size or the percentage of the portfolio that you would like to devote to risky investments like equity/stocks? Always remember that higher the risks, higher are the returns. But a balance must be reached keeping in mind your personal requirements.

Once the portfolio percentiles have been finalized search for the types of investment modes that you want to get into.

Research

Always research before investing. A well researched investment is more likely to give you the expected returns than the one that has been invested based on tips and recommendations.

Liquidity

Check out the liquidity of the investment that you want to put your money into. Very low liquidity carries the risk of not being allowed to materialize your investments before the agreed period. In such a scenario you don’t get to use your money when in dire circumstances.

Safety and stability

What is the safety quotient of the investment? Check out for the ratings from the premier agencies and regulators. The corporate governance rating is also a good indicator. Also watch out the dividend history / market price movements of the investment tool.

Forex charts

Chart is one of the many tools frequently used technical tools for interpreting the market movements with respect to volumes and pricing:

  • Candlestick chart
  • Bar charts
  • Line charts
  • Point and Figure Chart
  • Kagi Chart
  • Three Line Break Chart
  • Tick Charts

Further all of such charts are classified into different timeframes

  • 60 second charts or The One Minute charts
  • The Five, Ten and Fifteen Minute charts
  • Thirty and Sixty Minute charts
  • 6 hours, Daily, Weekly and Monthly charts

 

The interpretation of the charts is easy but the catch lies in the choice of the charts. Which chart should be used under what circumstances would decide whether you interpretations are moderately appropriate or are bang on the target?

Some bankers also provide expertise of charts to their credit card users. On another line of thought credit cards and debts have provided a lot of help and assistance to its users. Undoubtedly credit cards and debts are very good and useful facilities. You can get a loan with the help of your credit card by just using and accessing the facility of credit card debt. Banks also provide you the facility of home loan and perform mortgage refinancing as well. The chase card is one such credit card service provider company. It is always recommended to have your credit card insured against theft and misuse. One must avail different insurance plans one for this purpose apart from the regular personal insurance plans. Now a days it is very easy to secure information about free insurance quotes through Internet.

 

Forex The basics

What is forex? The exchange of foreign currency is termed as foreign exchange business or forex.

The primary requirement for conducting exim business is having proficiency in forex activities. It consists of two currencies where currency A is traded for currency B. The rate at which a currency would be traded against the other is determined by a combination of various complex factors:

  • Convertibility of currency
  • Demand and supply of a particular currency
  • Government policies with regard to appreciation/depreciation of currency
  • The balance of payments – deficit or surplus
  • The foreign exchange reserves with the National Treasurer
  • The Gold holding of a state
  • The volume of international trade conducted
  • The degree of alignment of the state’s economy with the rest of the world
  • The degree of dependence on other economies for essential services and commodities
  • The stability of the national government(s)

There is no single determinant of the forex rates. They are vibrant of the happenings around the economy and the world. The popularity and acceptance of a currency is also an indicator of the faith of the people in that currency value.

Global markets shiver

The markets are witnessing a meltdown globally. Whether this bear market trend sustains or is it a matter of few trading session before the bulls ride back, would depend on how the US sub-prime mortgage saga unfolds.It would very premature to comment on the full impact of the sub-prime mortgage story at this point but fresh inroads into the mess clearly indicate that it is far from over. Couple it with the yen carry trade forward positions against the USD and we have a situation in our hands. If the yen is able to reach 117 with sustained levels against the USD, then the market might just start to tumble with greater intensity and acceleration.

Keep the fingers crossed and watch out for more on the story in this section.

Interest income during inflationary times

There are two main areas of interest income during inflationary times – Real interest and Prime Interest

In order to protect its capital losses arising out of inflation the companies tend to raise the interest rate. The flow of income due to such increase in interest rates does not represent the true picture of actual income from interest margin.

Hence it become necessary to segregate inflation adjusted interest income from the total interest income. The inflation adjusted interest or more popularly known as the Prime interest is the amount necessary to keep the purchasing power of the monetary value of the principal of the financial asset. The remaining amount is the actual interest income of the business.

It is common practice to increase interest rates or benchmark them to some index to protect against loss of capital arising out of inflation.

Investments

All investments are categorized as different asset classes.  The prime among them are real estate, bonds, equities and metal. Let’s have a look at each one of them – what they stand for, the risk they carry and the returns they give.

Real Estate 

Investments in real estate carry high risk quotient by virtue of the demand-supply unpredictablity in this industry and the over dependence on external factors which are beyond the control of most of the retail investors.

The price movement in real estate is cyclic in most of the economies and is a function of governemnt policies and the kind of economic development that a particular region is expereincing.

The returns are high which are in direct proportion to the risk factor. One should always expect the prices of real estate to be volatile.

The liquidity is low becuase of the ticket size of deals and absence of organised market in most of the countries.

Bonds 

They are the least risky among all the asset classes. Bond is a broader term and they comprise of infrastructure bonds, special investment bonds, government sponsored bonds, national savings certificates, post office savings, fixed deposits, commercial deposits etc.

The rate of interest earned on bonds in less compared to other asset classes. Returns on investments in bonds are generally guaranteed by the companies/institutions and are backed by sound government policies and guidelines. The liquidity of these investments is high.

Equities/Stocks

Equity investment is the most risky asset class.  The investments are made through the secondary market where one can purchase the shares/scrips of different listed companies. The stock markets are very well regulated in most of the developed countries and  some of the developing countries.  The returns vary depending upon the degree of the risk that has been taken in the investment choice of the scrip(s). The liquidity is high.

Metal

Gold remains to be the most stable metal with respect to liquidity and returns. The risk quotient is low and liquidity is high. As a long term investment tool they have always been in demand by investors of all kinds – retail and otherwise. Returns are moderate.

Subprime mortgage – US

Sub prime mortgage is the basket of lending done by financiers to people whose credit worthiness is sub standard or the credit rating is not up-to the mark.

Why did it happen?

During the course of competition and a dwindling rate of interest the net margins of the lenders in US fell from around 600 basis points to around 300 basis points. A reduced earning margin created pressure on the bottom lines. As a result of which the lending institutions like banks and Non banking financial institutions increased the volumes.

An increase in the volumes meant that one would have to conduct business with the non traditional customers also and venture into the uncharted territory. Although the pricing was done as per the risk assessment of sub standard lending, the situation became grim in the falling US home estate prices.

With an increasing real estate prices, the refinancing of the asset was quite easy since the equity participation increased by way of difference in the price between the two financing time points. But with the prices falling, refinancing became difficult.

How does it affect other financiers?

This basket of lending is bundled with other assets and sold to investors like hedge funds who are seeking higher returns. With the basket going wild, the investments done by the hedge funds go into the red thereby risking the capital – in other terms a loss of capital of the investors.

The impact

The severity of the sub prime mortgage seems to have been overblown. However it would take some time to rip off the layers and see how deep is the well. The investors worldwide stand to lose because of cross investments in other hedge funds which might have been affected by the sub-prime mortgage turmoil.