Currency

Floating and Fixed Exchange Rates

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Forex Trading for Beginners
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 Currency denoting
The International Organization for
Standardization introduced a system of three-
letter codes (ISO 4217) to denote currency, in
order to remove the confusion (Ex.: there are
dozens of currencies called the ‘dollar)’. The 3-
letter code uses country code for the first two
letters and the first letter of the name of the
currency. USD, UAH, JPY, GBP
Numeric code: $ - 840, € - 978, ¥ - 392, £ - 826,
Hyvnia – 804.
 Exchange rate is the rate at which one
currency will be exchanged for another.
Base and Quote Currency
Recall that a foreign exchange quote is simply the
ratio of one currency to another. Thus, a “complete”
quote consist of two ISO designations
USD/UAH
 The first ISO currency is the base currency.
 The second ISO currency is the quote currency.
 USD/UAH: USD is the base currency and UAH is the
quote currency.
 Foreign Exchange Rates & Quotations
Interbank quotes are given as bid and ask.
The bid is the price at which a dealer will buy base currency
The ask or offer is the price at which a dealer will sell base
currency.
USD/UAH: 27,5181/27,5189
bid ask margin/spread
Most currency pairs are priced out to 4 decimal places and
the pip change is the last (fourth) decimal point. A pip is thus
equivalent to 1/100 of 1% or one basis point. In our example
USD/UAH: 24,5189/24,5289
In some cases professional traders may only quote the last
two digits of both the bid and ask, “81-89”, because they
know what the other figures are.
 How Exchange Rate are Quoted
• Foreign exchange rate
– The price of a currency expressed in terms of another
currency
• Exchange rates are quoted in two ways:
– Direct quotation: 1 unit of foreign currency : X units of
domestic currency (used in Ukraine)
– Indirect quotation: X units of foreign currency : 1 unit of
domestic currency
• To translate a direct quotation to an indirect quotation
– 1 unit of foreign currency/ X units of domestic currency
• To translate an indirect quotation to a direct quotation
– 1 unit of local currency/ X units of foreign currency 1/x : x/x
 Exchange rate
Dollar in the XIX century in the USA was defined as
1/20 of a gold ounce, while the pound sterling was
defined as 1/4 of a gold ounce, and the French franc
was established at 1/100 of a gold ounce. The
exchange rates between the various currencies were
automatically fixed by their respective quantities of
gold. If a dollar is 1/20 of a gold ounce, and the pound
is 1/4 of a gold ounce, then the pound will
automatically exchange for 5 dollars. And it will
exchange for 25 francs. The definitions of weight
automatically set the exchange rates between them.
Law of One Price: Identical item must have an
identical price in all countries.
Purchasing Power Parity (PPP):
Relative ability of 2 nations’ currencies to buy the
same “basket” of goods in those 2 countries.
The relative version of PPP is calculated with the
following formula:
S= {P_1}/{P_2}
where:
S - Exchange rate of currency 1 to currency
P_1- Cost of good in currency
P_2=Cost of good in currency 2
 Big Mac Index
Estimates undervalued and overvalued currencies.
Price in the USA in 1959 was 57 cents
Big Mac is a representative basket that includes
standardized burger ingredients (vegetables, meat,
cheese, bread) and services (restaurant, trade,
logistics). Big Mac can be purchased in 120
countries.
Price: in the USA - US$5,67, In Ukraine – 62
UAH
 Ukraine Economy Profile

• GDP - (PPP) - $429,9 billion

(48 )
th

• GDP (official/nominal
exchange rate) - $161,8
billion (56 )
th
 Cross Rate
A cross rate is the currency exchange rate between two
currencies when neither are the official currencies of
the country in which the exchange rate quote is given.
Foreign exchange traders use the term to refer to
currency quotes that do not involve the U.S. dollar,
regardless of what country the quote is provided in.
The major crosses (EUR/CHF, GBP/JPY, EUR/JPY,
EUR/GBP) have bid-offer spreads slightly wider than the
major dollar-based pairs; they are quoted actively in the
interbank market. Spreads in the minor crosses are
generally much wider; some are not quoted directly.
 Cross Rate
• USD / UAH – 28,0600
• USD / EUR - 0,8300
28,0600 = 1$ = 0,8300
28,0600 UAH - 0,8300 EUR
X - 1
EUR/UAH – 33,8
 Fixed Exchange-rate System (pegged)
• • A system whereby the exchange rates of the member
countries were fixed against the U.S. dollar, with the
dollar in turn worth a fixed amount of gold.
• • Governments try to keep the value of their currencies
constant against one another.
• • A country’s government decides the worth of its
currency in terms of a fixed amount of another currency
or a basket of other currencies.
• • The central bank of a country remains committed at
all times to buy and sell its currency at a fixed price.
• • The central bank provides foreign currency needed to
finance payments imbalances.
 Managed Floating
• A floating exchange rate in which a government intervenes
at some frequency to change the direction of the float by
buying or selling currencies. Often, the local government
makes this intervention, but this is not always the case.
• The central bank does not have an explicit set value for the
currency; it also doesn’t allow the market to freely
determine the value of the currency.
• This allows for policy makers the benefit of planning with
some degree of certainty, for the macroeconomic affairs of
a country. Central bank intervenes to smoothen out ups
and downs in the exchange rate of home currency to its
own advantage.
 Flexible Exchange Rate Systems
• The value of the currency is determined by the market, ex.
by the interactions of thousands of banks, firms and other
institutions seeking to buy and sell currency for purposes of
transactions clearing, hedging, arbitrage and speculation.
• So higher demand for a currency, all else equal, would lead
to an appreciation of the currency. Lower demand, all else
equal, would lead to a depreciation of the currency. An
increase in the supply of a currency, all else equal, will lead
to a depreciation of that currency while a decrease in
supply, all else equal, will lead to an appreciation
• Most OECD countries have flexible exchange rate systems:
the U.S., Canada, Australia, Britain, and the European
Monetary Union.
As of 2018 the number of countries with:

• No separate legal tender 13 (Panama

uses dollars, Kosovo –Euro)
• Currency board – 11 (Bulgaria)
• Soft peg 102 (Iraq, Oman, Saudi
Arabia)
• Floating - 35 (Ukraine)
• Free floating 31
Importance of exchange rate stability
• Chamber of accounts: in 2019 Ukrainian budget
received less than due UAH 46,2 billion ($1,8
billion ) because of inflated expectations of
hryvnya exchange rate, including UAH 9 billion
because of hryvnya revaluation
• (in January 2020 budget fell short for UAH2
billion from customs)
• but at the same time state debt service provided
economy of UAH 11,5 billion ($464 млн).
 Classification of currency
• By the type of value embodiment
• By issuer
• By convertibility
• By spheres of use
• By availability of other currencies
• By physical form (paper / digital)
Classification by the type of value embodiment

• Precious metals
– Silver standard
– Gold standard
– Bimetallism
• Paper
• E-money
 Classification by issuer
national / local /regional / unit of account
• National currency is a legal tender, issued by a
country's central bank or monetary authority
• Foreign - the currency of any foreign country
• Local - not backed by a national government and
intended to trade only in a small area
• Regional currency is a form of local currency
encompassing a larger geographical area
• Unit of account – SDR
• Eurodollars
 Local currencies
• enables an economically depressed region to pull
itself up, by giving the people living there a
medium of exchange that they can use to
exchange services and locally produced goods
• in the USA > 200. Best known - BerkShares in
Massachusetts (cost 95 cents, can be used to make
a purchase worth 1 dollar; the currency is only
accepted by locally owned businesses, so when
you spend BerkShares you’re supporting a business
that is rooted in this community.
EURO – official currency of 19 countries
 Currency basket
a portfolio of selected currencies with different
weightings. The value of these currencies defines
the weighted average rate for a currency that is not
technically part of the basket.
A currency basket is commonly used to minimize
the risk of currency fluctuations. An example of a
currency basket is the European Currency Unit that
was used by the European Community member
states as the unit of account before being replaced
by the euro. Another example is the SDR of the IMF.
 Eurodollar - time deposits denominated in
foreign currency at banks outside the country
of this currency emission
The term eurodollar initially referred to U.S. time
dollar-denominated deposits at foreign banks or at
the overseas branches of American banks. By being
located outside the USA , eurodollars escape
regulation by the Federal Reserve Board, including
reserve requirements. Dollar-denominated deposits
not subject to U.S. banking regulations were originally
held almost exclusively in Europe, hence the name
eurodollar. They are also widely held in branches
located in the Bahamas and the Cayman Islands
 Basics of Eurodollar
• The fact that the Eurodollar market is relatively
free of regulation means such deposits can pay
higher interest.
• The fact that the Eurodollar market is relatively
free of regulation means such credits can be
cheaper.
• The volume of Eurodollars is not limited. The
eurodollar market is one of the world's primary
international capital markets.
 Special Drawing Right (SDR)
The SDR is an international reserve asset, created
by the IMF in 1969 to supplement its member
countries’ official reserves. So far SDR 204.2 billion
(equivalent to about US$291 billion) have been
allocated to members, including SDR 182.6 billion
allocated in 2009 in the wake of the global financial
crisis. The value of the SDR is based on a basket of
five currencies—the U.S. dollar, the euro, the
Chinese renminbi, the Japanese yen, and the
British pound sterling.
 Special drawing rights (price $1,367)
Currency Weight of Currency Exchange U.S. dollar
Unit currency in % amount rate equivalent

Chinese 10.92 1.0174 7.00545 0.145230

yuan
Euro 0.418614
30.93 0.38671 1.08250

Japanese 0.108463
yen 8.33 11.900 109.71500

U.K. pound
8.09 0.085946 1.30405 0.112078

U.S. dollar
41.73 0.58252 1.00000 0.582520
 Classification by convertibility and
spheres of use
• fully convertible currency is one that can be traded
without any limitations imposed by the monetary
authorities.
• non-convertible currencies are those that can’t be
traded without limitations imposed by the
monetary authorities.
• reserve currency is a currency that is held in
significant quantities by governments and
institutions as part of their foreign exchange
reserves. The reserve currency is commonly used in
international transactions, international
investments and all aspects of the global economy.
 Convertibility - The ease with which
one currency can be converted into
another currency
Differences in degree, depending on:
(a) the holders of the currency balances (external
convertibility and internal convertibility);
(b) the purposes for which convertibility is sought
(traditional distinction here is between current
account convertibility and capital account
convertibility:;
(c) the geographical scope of convertibility.
.
 External convertibility
External convertibility typically refers to extending to
foreign holders of currency the right to convert
their balances into foreign exchange. This form of
restricted convertibility becomes relevant in settings
where promotion of foreign capital inflows is a
relevant consideration. More generally, external
convertibility will provide incentives for foreigners to
engage in economic transactions in the countries
that provide this freedom to their currency
 Internal convertibility
Internal convertibility, in turn, typically relates to the
right given to domestic (resident) holders of currency to
convert their balances into foreign exchange. This
modality of restricted convertibility, although it is not
inconsistent with the promotion of foreign investment,
focuses more on other aspects of an economy’s
performance. Apart from providing incentives to
residents to hold domestic cash balances, internal
convertibility exposes domestic economic policies to
external competition. As such, it poses risks to the
policymaker, but it also contributes to making domestic
policies internationally competitive.
 Convertibility in the IMF: the usability of a
currency, its exchangeability, and its exchange value.

a currency would be deemed to be fully convertible

if it can be used for all purposes without
restrictions of a financial, or more precisely, a
currency character; it can be exchanged for any
other currency without limitations of a financial (or
currency) nature; and it can be used or exchanged
at a given rate of exchange, be it a par value,
central rate, official rate, or some legal exchange
rate.
 Convertibility in the IMF
• Subject to the provisions of Article VII, Section 3(b)
and Article XIV, Section 2, no member shall,
without the approval of the Fund, impose
restrictions on the making of payments and
transfers for current international transactions.
• The most important limitation on the scope of the
concept of convertibility in the Fund is the power
that members retain to restrict capital
transactions.
Reserve currency is currency maintained by central
banks and other financial institutions for investments,
transactions and international debt obligations, or to
influence their domestic exchange rate. 
Hard currency refers to money that is issued by a nation
that is seen as politically and economically stable. Hard
currencies are widely accepted around the world as a
form of payment for goods and services and may be
preferred over the domestic currency.
Soft currency is one with a value that fluctuates, as a
result of the country's political or economic uncertainty.
Key currency refers to a type of money which is stable,
does not fluctuate much, and provides the foundation
for exchange rates for international transactions.
 .

.
.
 Classification by level of substitution
Currency substitution (dollarization) is the use of a
foreign currency in parallel to or instead of the
domestic currency. It can be full or partial.
Full currency substitution usually takes place after a
major economic crisis. Some small economies, for
whom it is impractical to maintain an independent
currency, use those of their larger neighbors.
Partial currency substitution occurs when residents of
a country choose to hold a significant share
of their financial assets denominated in a foreign
currency.
It can be unofficial (de facto), official or semiofficial
 Currency Forward Contracts
Foreign currency forward contracts are used as a foreign
currency hedge when an investor has an obligation to either
make or take a foreign currency payment at some point in the
future.
For example, a U.S. exporter signs a contract today to sell
hardware to Ukrainian importer. The terms of the contract
require the importer to pay UAH in six months' time. The
exporter now has a known UAH receivable. Over the next 6
months, the dollar value of UAH receivable will rise or fall
depending on fluctuations in the exchange rate. To mitigate his
uncertainty about the direction of the exchange rate, the
exporter may elect to lock in the rate at which he will sell UAH
and buy dollars in 6 months. To accomplish this, he hedges the
euro receivable by locking in a forward.
 Currency Forward
A currency forward is essentially a hedging tool that
does not involve any upfront payment. The other
major benefit of a currency forward is that it can be
tailored to a particular amount and delivery period.
Currency forward settlement can either be on a cash
or a delivery basis, provided that the option is
mutually acceptable and has been specified
beforehand in the contract. Currency forwards are
over-the-counter (OTC) instruments, as they do not
trade on a centralized exchange.
 USD/UAH - 28
RUSD – 2%
rUAH - 15%
D - 360
•   Spot x r x D
Pm/dis = ----------------------
B x 100 + rbase x D
Hint
Spot x r x 360 28 x13
Pm/dis = ---------------------- = ----------- =3,57
B x 100 + Rbase x 360 102
 Foreign Exchange Swap
A swap transaction in the interbank market is the
simultaneous purchase and sale of a given amount of
foreign exchange for two different value dates. Both
purchase and sale are conducted with the same
counterpart. FX swaps usually have two legs; the first
leg which is the ‘near leg’ involves buying/selling of
one currency against another currency at a spot rate
while the second leg(‘the far leg’) involves reversing
the exchange direction of both currencies at the end of
the swap using a forward rate. Both legs are akin to
lending one currency and simultaneously  borrowing
another currency at the start of the agreement and
 Foreign Exchange Swap
• A common type of swap is a spot against forward. The
dealer buys a currency in the spot market and
simultaneously sells the same amount back to the same
bank in the forward market. Since this transaction occurs
at the same time and with the same counterpart, the
dealer incurs no exchange rate exposure
• In Forward-forward swaps both dates are in future.
Thus a swap can be viewed as a technique for borrowing
another currency on a fully collateralized basis
 CURRENCY SWAPS
entails the exchange of notional principals of two different
currencies by two parties at the start and at the end of the
agreement while paying/receiving interim cash flows in-
between either at a floating or fixed rate. E.g. At the start of
the contract, Party X pays 240 million hryvnia to Party Y
while Party Y pays 10 million dollars to party X. At the end of
the contract, Party Y returns 240 million naira to Party X
while Party X returns Io million dollars to Party Y.
A distinct feature - the payments made in-between by both
parties on the currency each party received at the start of
the agreement. E.g. Party X pays 3% on 10 million dollars
periodically to Party Y while Party Y pays 15% of 240 million
hryvnia periodically to Party X .
 Non-deliverable forward (NDF)
an outright forward in which counterparties settle the
difference between the contracted NDF rate and the
prevailing spot rate on an agreed notional amount.
NDF is a cash-settled and usually short-term forward
contract. NDFs possess the same characteristics as
traditional forward contracts except that the foreign
currency being sold or bought forward is not
delivered.
NDFs began to trade actively in the 1990s, being
developed for emerging markets with capital controls.
 The features of an NDF include
• notional amount: "face value" of the NDF, agreed between the
two counterparties.
• fixing date: the day and time whereby the comparison between
the NDF rate and the prevailing spot rate is made.
• settlement date (or delivery date): the day when the difference
is paid or received. It is usually one or two business days after
the fixing date.
• contracted NDF rate: the rate agreed on the transaction date.
• prevailing spot rate (or fixing spot rate): the rate on the fixing
date usually provided by the central bank, commonly calculated
by calling a number of dealers in the market for a quote at a
specified time of day, and taking the average. The exact method
of determining the fixing rate is agreed when a trade is initiated.
 Non-Deliverable Forward (NDF)
• One party will pay the other the difference
resulting from this exchange.
Cash flow = (NDF rate - Spot rate) * Notional
amount
• NDFs are traded over-the-counter (OTC) and
commonly quoted for time periods from one
month up to one year. They are most frequently
quoted and settled in U.S. dollars and have
become a popular instrument since the 1990's for
corporations seeking to hedge exposure to illiquid
currencies.
 Foreign exchange market
According to the Bank for International Settlements,
the preliminary global results from the 2019 Triennial
Central Bank Survey of Foreign Exchange and OTC
Derivatives Markets Activity show that trading in
foreign exchange markets averaged $6.6 trillion per day
in April 2019. The $6.6 trillion break-down is as follows:
• $2 trillion in spot transactions
• $1 trillion in outright forwards
• $3.2 trillion in foreign exchange swaps
• $108 billion currency swaps
• $294 billion in options and other products
 FOREX
• FOREX is short for foreign exchange, but the actual
asset class we are referring to is currencies. Foreign
exchange is the act of changing one country's
currency into another country's currency for a
variety of reasons,
• the FOREX  market is an interbank market, which
means it's all connected together in a network of
banks and institutions. Mostly traded by phone,
telex or SWIFT.
• Open 7/24, any sum or pair
 Market Participants
The FOREX market consists of two tiers, the
interbank or wholesale market, and the client or
retail market. Five broad categories of
participants operate within these two tiers:
• Bank and non bank foreign exchange dealers,
• Individuals and firms conducting commercial
or investment transactions,
• Speculators and arbitragers,
• Central banks and treasuries
• Foreign exchange brokers
 Advantages
• 1. Flexibility in trading:= 24/7,
• 2. Individual Control:
• High Liquidity:
• Volatility
• Accessibility
• Leverage
• Easy Short Selling
 What are you really selling or buying in the
currency market
You are buying and selling money, or more specifically,
some nation’s currency. Generally, in the FOREX market,
it helps to think of money as a commodity. When you
buy a currency you hope that its value will strengthen
compared to the currency that you are selling. If you are
selling, you are betting that the currency you are selling
will weaken compared to the currency you look to buy.
Like any other commodity, currencies are displayed in
quotes based on the current rate in the market, known
as the spot rate, and traded in currency pairs.
 Mechanics of trading
• An open position in investing is any trade, established or
entered, that has yet to be closed with an opposing trade.
• Closing a position refers to executing a security transaction
that is the exact opposite of an open position, thereby
nullifying it and eliminating the initial exposure.
• Orders are the instructions to buy or sell currencies traders
give to brokers. Those orders are usually issued directly to
the broker through the trading platform.
• Closing a long position in a security would entail selling it,
while closing a short position in a security would involve
buying it back.
 High leverage
By offering high leverage some market makers encourage
traders to trade extremely large positions. This increases the
trading volume cleared by the market maker and increases
their profit, but increases the risk that the trader will receive
a margin call. While professional currency dealers such as
banks and hedge funds tend to use no more than 10:1
leverage, retail clients may be offered leverage between 50:1
and 400:1.
The broker may at any time revise the value of the collateral
(margin), based on market factors. If market value of the
collateral falls below the revised margin, the broker
immediately issues a "margin call", requiring the investor to
bring the margin account back into line. If he does not do it –
forced closure followed.
 Margin trading
a method of trading assets using funds provided by a third
party. When compared to regular trading accounts, margin
accounts allow traders to access greater sums of capital,
allowing them to leverage their positions. Margin trading
amplifies trading results so that traders are able to realize
larger profits on successful trades. This ability to expand
trading results makes margin trading especially popular in
low-volatility markets, particularly the international Forex
market.
Margin trading is also used in stock, commodity, and
cryptocurrency markets. In traditional markets, the
borrowed funds are usually provided by an investment
broker.
 In Ukraine
Лохотрон and FOREX
About 118 000 results
 Foreign exchange fraud
Google gives 8 030 000 sources
Foreign exchange fraud is any trading scheme used to defraud
traders by convincing them that they can expect to gain a high
profit by trading in the foreign exchange market.
The market is at best a zero-sum game, meaning that whatever
one trader gains, another loses. However, brokerage
commissions and other transaction costs are subtracted from
the results of all traders, making foreign exchange a negative-
sum game.
Frauds might include churning of customer accounts for the
purpose of generating commissions, selling software that is
supposed to guide the customer to large profits, improperly
managed "managed accounts”, false advertising, Ponzi
schemes and outright fraud.
 Increase in fraud
The U.S. Commodity Futures Trading Commission
(CFTC), which loosely regulates the foreign exchange
market in the United States, has noted an increase in
the amount of unscrupulous activity in the non-bank
foreign exchange industry.
• Between 2001 and 2006 the U.S. Commodity Futures
Trading Commission has prosecuted more than 80
cases involving the defrauding of more than 23,000
customers who lost $350 million.
• From 2001 to 2007, about 26,000 people lost $460
million in FOREX frauds.
 Hometask
• How Did George Soros Break the Bank of
England?
or
• FOREX in Ukraine
 Future value
• Annual payment of 5000 in 5 years, interest
rate 12% - (compound interest)
• 25000 for 5 years, interest rate 12%
(compound interest)
• What is more profitable:
 To receive 20 000 at once 15%
 To receive 4200 each year for 5 years 15%