SPECULATION IN FOREIGN EXCHANGE AND MONEY MARKET

Presentation by: Rupali Dubey, Abid Ali, Niharika Rawat and Nitish Nagpal

TERMS AND CONCEPTS

Speculation is the practice of engaging in risky financial transactions in an attempt to profit from short or medium term fluctuations in the market value of a tradable good such as a financial instrument, rather than attempting to profit from the underlying financial attributes embodied in the instrument such as capital gains, interest, or dividends. Many speculators pay little attention to the fundamental value of a security and instead focus purely on price movements. Speculation can in principle involve any tradable good or financial instrument.

Contd.
Technically, anyone who buys or shorts a security with the expectation of a favorable price change is a speculator. For example, if a speculator believes XYZ Company stock is overpriced, they may short the stock, wait for the price to fall, and make a profit. It's possible to speculate on virtually every security, though speculation is especially concentrated in the commodities, futures, and derivatives markets. Methods of speculationDouble buy Double sell Buy /sell method.

FOREIGN EXCHANGE MARKET

The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is by far the largest market in the world, in terms of cash value traded, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. Major currenciesUS Dollar (USD) Euro (EUR) Japanese Yen (JPR) Pound Sterling (GBP) Swiss Franc (CPF) Major foreign exchange instrumentsSpot Market Future Market Future Market Options Market

MONEY MARKET
A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, from several days to just under a year.

SPECULATION IN THE FOREIGN EXCHANGE MARKET

Investors use foreign exchange transactions to speculate for profit, using foreign currency, that has both an element of risk and the chance of greater profit. Speculators are important in foreign exchange markets because they spot trends and try to take advantage of them. They can create demand for a currency by purchasing it in the market, or they can create a supply of the currency by selling it in the market. Speculation in spot marketSpeculation in spot market occurs when the speculator anticipates a change in the value of a currency. Suppose the exchange rate today is Rs. 40 /US $ . The speculator anticipates this rate to become Rs. 41/US within the coming three months . Under these circumstances , he will buy US $1,000 for Rs 40000 and hold this amount for three months , although he is not committed to this particular time horizon . when the target exchange rate is reached , he will sell US $1000 at the new exchange rate , that is at Rs 41 per dollar and earn a profit of Rs. 4100040000 =Rs. 1000

SPECULATION IN THE FORWARD MARKET

The source of profit to the speculators here is the difference between the forward rate and the future spot rate. SPECULATION IN FORWARD MARKET SUPPOSE A SPECULATOR SELLS US $ 1,000 THREE -MONTH FORWARD AT THE RATE OF Rs40.50/ US $. IF , ON MATURITY , THE US DOLLAR DEPRECIATES TO Rs. 40 , THE SPECULATOR WILL GET RS. 40,500 UNDER THE FORWARD CONTRACT . AT THE SAME TIME , HE WILL EXCHANGE RS. 40,500 AT THE THEN FUTURE SPOT RATE OF RS. 40/US $ AND WILL GET US $ 1,012.50. BOTH THESE ACTIVITIES THE SELLING AND THE PURCHASING OF US DOLLARS WILL BE SIMULTANEOUS. THUS WITHOUT MAKING ANY INVESTMENT , THE SPECULATOR WILL MAKE A PROFIT OF US $ 12.50 THROUGH THE FORWARD MARKET DEAL .

SPECULATION IN THE FUTURE MARKET

Currency future market is an organized market and not a over the counter market. SUPPOSE POUND IS EXPECTED TO APPRECIATE TILL JUNE AND THEN IT IS EXPECTED TO DEPRECIATE AT LEAST BY SEPTEMBER AT A FASTER RATE THAN HE FUTURES RATE . IN THIS CASE , A SPECULATOR WILL BUY A POUND FUTURES CONTRACT FOR JUNE DELIVERY AND SELL ANOTHER ONE FOR THE SEPTEMBER DELIVERY . SUPPOSE POUND FUTURES ARE AVAILABLE AT $ 0.650 / F OR JUNE DELIVERY AND AT $0.640/ FOR SEPTEMBER DELIVERY . THE SPOT RATE OF POUND RISES TO $ 0.655 IN THE JUNE MATURITY BUT , CONTRARY TO THE SPECULATORS EXPECTATONS , FALL ONLY TO 0.642/ BY SEPTEMBER MATURITY DATE. THE SPECULATOR WILL GAIN $ 0.005 PER POUND ON THE JUNE DELIVERY CONTRACT BUT WILL LOSE $ 0.002 ON THE SEPTEMBER CONTRACT . THE NET GAIN WILL BE EQUAL TO $ (0.005- 0.002) *62,500 = $187.5 SPECULATION WITH CURRENCY FUTURES

SPECULATION IN THE OPTION MARKET

Here the contract offers the right but not the obligation to exercise the contract. POUND IS EXPECTED TO APPRECIATE TO $1.930. POUND OPTION ARE AVAILABLE AT A STRIKE PRICE OF $ 1.830/ WITH A PREMIUM OF $0.03/ . HOW DO SPECULATORES REACT TO THE APPRECIATION OF POUND ? SOLUTION: SPECULATOR WILL BUY A CALL. ON THE MATURITY , HE WILL GET 62500 AT $1.830/ . IMMEDIATELY AFTER GETTING POUND , HE WILL SELL THOSE POUND IN THE OPEN MARKET TO GET DOLLAR BACK AND THIS WAY , HE WILL GAIN $ (1.930-1.830-0.03) * 62500 =$4375.

SPECULATION EXAMPLE
A garment manufacturer in India who exports garments to U.S. As the U.S. importer of Indian garments is paying her bill in U.S.$, the Indian exporter receives U.S. currency($). But the exporter has to pay her workers and suppliers in Indian currency(Rupee), and thus needs to exchange the U.S.$ into rupee. Someone has to buy U.S.$, so that she can buy rupee. Currency traders can make money from simply being middlemen in this process, buying the U.S.$ and charging transaction fees. But many also act as speculators, hoping that they can profit from selling the dollars at a higher price in the future

SPECULATION IN THE MONEY MARKET

ADVANTAGES OF SPECULATION
Sustainable consumption level Market efficiency

Bearing risks
Finding environmental and other risks Shorting

DISADVANTAGES OF SPECULATION
Winner's Curse Economic Bubbles Volatility