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FOREX stands for Foreign Exchange (Foreign Currency Exchange). The Foreign Exchange Market (FOREX) is the largest financial market in the world. But, what is a currency? What operations can be found in the forex market? What advantages can we draw from this market?

What is a currency? The currencies are means of payment nominated in foreign currency and maintained by the residents of a country (Not only foreign bills of legal tender). For example: - The deposits bank nominees in foreign currency at a financial institution (with which it operates through transfers). - The documents give entitled to dispose of these deposits without any restriction (checks, stubs, credit cards, etc.) - Bills or foreign currency in itself same. Seen that this definition is a bit abstract worth quoting some examples on what is Forex and what not. An example of currency is the travel check (the fee is applied or price of the currency at the moment of making it effective) or a check on a current account in a country other than of the owner. So, are not considered currency for example, bills of exchange or promissory notes issued by nonresidents (are credit instruments), stocks, bonds and other financial assets (although issued in foreign currency).

Classification of Currency There is a classification of badges according to their position in the market. It is known as convertible currency that one that can be exchanged freely for other currency and its price is determined by the market. At the other extreme are the non-convertible currency (or currencies bilateral), those that are subject to restrictions and the prices are set by the state. As an example we have convertible currency: the Euro, the Dollar, the Yen, etc, that are where we will base largely.. As its price is determined by the market we will be able easily access them. An example of a non-convertible currency would be the Nigerian Naira.

What are the currency markets? Currency markets are locations at which they exchange different currencies (means of payment in general) and the prices of change are fixed. The reason for the existence of such markets are the operations of change derived from the international trade and movements in international financial markets. The price fixed in this type of market is what is known as exchange rate, i.e. the amount of a country's currency that must be submitted to obtain a certain amount of coins from another country. Features FOREX It is characterized by: a) Is the world's largest market by volume of daily transactions. b) The extreme liquidity of the market. c) It is very volatile and its participants have little chance of market manipulation. d) The time in which it operates - 24 hours a day (except weekends). f) The geographical dispersion. While there is strong spatial concentration of activity. A few financial centers meet practically all transactions: London (with more than 30.10% of the total transactions of the world in 2001), New York (almost 15.7% of the total in 2001), Tokyo, Singapore, Zurich, Hong Kong, Frankfurt...

The six largest transaction currencies

Place Currency Code ISO 4217 Symbol
1 U.S. Dollar USD $
2 Euro EUR
3 Japanese Yen JPY ¥
4 Pound sterling GBP £
5 Swiss Franc CHF -
6 Australian Dollar AUD $

  The large number and variety of traders in the market. But it also is focused on the number of operators who are actively involved in it and set prices (only 200 dealers and 80 major brokers are significant in the market). The ten most active dealers account for nearly 73% of trading volume, according to The Wall Street Journal Europe. These large international banks provide the market with purchase price (bid) and sale (ask). The spread is the difference between these two prices. Usually the spread in most traded currency is only 1-3 pips or basis points. For example, the bid / ask at a price of EUR/USD might be 1.2200/1.2203. The minimum size is generally negotiated is USD $ 1,000,000. According to a study by the Bank for International Settlements (BIS) in 2004, the most traded currency pairs were: EUR/USD - 28% USD/JPY - 17% GBP/USD (also called cable) - 14% The U.S. currency was involved in 89% of transactions, followed by the euro (37%), the yen (20%) and pound sterling (17%).

Spot market and Forward market There are two types of market according to the moment in which the operations of change are liquidated. Segment or market spot (spot) the liquidation of the operation is carried out up to two working days of market after the date of hiring. The operation of this type of market is the most common. For example, at a certain moment we buy dollars and maintain our position until the dollar appreciates against the euro, at that time we would sell our dollars and would buy euros. Our benefit is determined by the difference between the price you buy dollars and by which sell them. Keep in mind that in the FOREX market there always a buy and a sale at the same  time, ie we buy dollars but also sell euros for those dollars, is a special difference with respect to the purchase or sale of shares. In the forward market the liquidation of the operation is performed after two business days, usually 1, 2, 3 or 6 months. In this type of market there are different ways of operating. To explain this type of operation is convenient to use examples to illustrate the theoretical concepts.

Currency futures contracts The currency futures contracts involve an obligation to buy or sell a specific currency at a pre-agreed exchange rate on a future date. For example, we are interested in buying shares of a U.S. company whose shares, of course, priced in dollars. Therefore, we should change euros into dollars in order to make the operation effective. Keep in mind that if we operate in dollars are assuming two types of risks: on one hand the risk that the company's shares to fall and on the other the risk associated with exchange rate of the euro against the dollar. So we might decide, assuming that our investment in shares will be for a period of time, a currency future contract, thereby establishing a agreed exchange rate (which is called exchange risk coverage). This type of change will be upwards or downwards depending on how we see the market trend at that particular time. With this contract we ensure that the agreed date may change our dollars for euros at a fixed exchange rate.

Contracts of options on currencies There other mode of safeguard our investment in the American company of which we have purchased actions: the currency options. Currency options are contracts that give the buyer of the option the right (not the obligation) to buy or sell a currency amount (underlying asset) at a predetermined rate (the price of exercise), in a future date (expiration date) paying a premium for it. Keep in mind that here there is a cost premium, which is paid at the time of purchase of the option and it never recovers.

There are two types of options: Call and Put The Put option gives its buyer the right to sell a specific currency to term. Continuing the previous example, suppose we have hired an option on the dollar at an exchange rate and fixed maturity, to hedge our currency risk in buying American stocks. Therefore, we have two scenarios: If the type of change to the expiration < E (agreed exchange rate) we would exercise the option and is able to change currencies to price E, one price greater than than we would have paid it in the market. If the type of change to the expiration > E, does not we would exercise the option and the premium would be lost. We would go to the market and we would change our dollars for euros at a price higher than we agreed for that particular expiration. The Call option gives the purchaser the right to buy a particular currency to term. Now imagine that we have hired a mortgage in yen, so if the yen appreciates our debt increases. To hedge the risk of changes in our mortgage could hire a Call on the yen. We can see two scenarios: If the type of change to the expiration > E, we would exercise the option and so we would get the currency exchange at one price lower than the market, therefore we would avoid that you increase our debt in euros. If the type of change to the expiration < E, not we would exercise the option and the premium would be lost. We would then have to avoid that our debt increase by changing euros for Yen in the market at that time. Contributions to rankia.wikispaces.com are licensed under a Creative Commons Attribution Share-Alike 2.5 License. 

Erick Gálvez
Author: Erick GálvezWebsite: http://www.asdforex..comEmail: This email address is being protected from spambots. You need JavaScript enabled to view it.
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ASDForex manager and professional trader since 2008. I am also Aleforex.com manager where you can view the services that I give
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