American Terms/European Terms

American Terms

When the USD is the numerator

European Terms

When the USD is the denominator.

→ NOTE:

In a ratio, the numerator number before the backslash, and the denominator is the number after

the backslash, i.e. numerator/denominator.

→ EXAMPLE:

USD/CHF (American terms)

EUR/USD (European terms

Base/Quote/Terms/Secondary Currency

Base Currency

In Forex markets, the base currency is the first currency in a currency pair (a quotation of two different

currencies, depicting how many units of the counter currency are needed to buy one unit of the base

currency).

Quote Currency

The quote currency is the second currency quoted in a currency pair. In a direct quote, the quote

currency is the domestic currency. In an indirect quote, the quote currency is the domestic currency.

Terms Currency

Terms currency is another way to refer to a quote currency—a currency quotation shows how many

units of the terms currency will equal 1 unit of the base currency.

Secondary Currency

Also known as ‘variable currency’ or ‘counter currency’, the secondary currency is the currency that the

investor trades the base currency against (i.e. USD in EUR/USD).

→ EXAMPLES:

(1)

Australian Dollar (AUD) against United States Dollar (USD): AUD/USD 0.6660

Australian Dollars is the base currency, and US Dollars is the terms currency. One Australian Dollar is

equal to 0.666 US Dollar (66.6 US cents).

(2)

EUR/USD = 1.35

EUR = Base Currency

USD = Counter Currency

Price = to buy one Euro you will need to spend $1.35US

If a quotation goes up then it means that the base currency is getting stronger vis-à-vis the counter

currency.

(3)

EUR/USD = 1.6

Now, one euro is exchanges for $1.6US.

If a quotation goes down then it means that the base currency is getting weaker vis-à-vis the counter

currency.

(4)

EUR/USD = 1.2

Now, one euro is exchanges for $1.2US.

Bid/Ask Spread

Bid/Ask Spread

Like in the securities markets, the forex markets have a bid price (the price at which a broker is willing to

buy the base currency) and an ask price (the price at which a broker is willing to sell the base

currency). When you enter into a forex transaction you buy at the ask and you sell at the bid. The

difference between the bid price and the ask price is the spread. Spreads are usually quoted in pips.

→ EXAMPLE:

EUR/USD = 1.2345/1.2349

Bid= 1.2345; Ask = 1.2349; Spread = 0.0004 (4 pips)

May also be quoted in the following manner:

EUR/USD = 1.2345/49 /USD = 45/49

→ Why does bid/ask spread matter?

The spread matters because this effectively indicates how much a currency pair must move before the

position becomes profitable for the trader. If there is a large spread then the currency pair will need to

move further in order to make a profit. It the spread is small (as in many of the “major” currencies) then

the movement needed for a position to become profitable is much smaller.

Collateral/Security Deposit/Margin

Collateral/Security Deposit/Margin

Margin, also called collateral or security deposit, is the amount that must be deposited in a trading

account in order to control a lot of a currency. If the leverage in the account is 100:1, then the margin

required will be 1% of the value of the lot. If the leverage in the account is 200:1, then the margin

required will be 0.5% of the value of the lot.

Forex Counterparty & Regulated Entities

Forex Counterparty & Regulated Entities

Counterparties or dealers act as counterparties to off-exchange retail forex transactions.

Examples of counterparties are Futures Commission Merchants (FCMs), Retail Foreign

Exchange Dealer (RFEDs), and other regulated entities listed in the Commodity Exchange Act

Futures Commission Merchant (FCM)

The term “futures commission merchant” means an individual, association, partnership,

corporation, or trust that:

(A) is engaged in soliciting or in accepting orders for the purchase or sale of any commodity for

future delivery on or subject to the rules of any contract market or derivatives transaction

execution facility;

and

(B) is in or in connection with such solicitation or acceptance of orders, accepts any money,

securities, or property (or extends credit in lieu thereof) to margin, guarantee, or secure any

trades or contracts that result or may result there from.

Retail Forex Exchange Dealer (RFED)

A retail forex exchange dealer is a firm acting only as the counterparty to retail off-exchange

foreign exchange contracts. These firms will be required to register as Retail Foreign Exchange

Dealers (RFEDs).

→ NOTE:

An RFED or an FCM that is substantially engaged in on-exchange activities and acts as a retail

forex counterparty will be designated under NFA rules as an approved forex dealer member

(FDM) of NFA.

Forex Dealer Member

The term “forex dealer member” is not defined in the Commodities Exchange Act (CEA) and is

not a specific CFTC registration category. The term “forex dealer member” was simply created

by the NFA. In general, forex dealer members are NFA Members who act as counterparties to

forex transactions. This is a self-executing requirement, which means that any NFA Member

who qualifies is automatically a forex dealer member. There is no application form and no

approval requirement.

Commodity Pool Operator (CPO)

A CPO is a person engaged in a business similar to an investment trust or a syndicate and who

solicits or accepts funds, securities, or property for the purpose of trading commodity futures

contracts or commodity options. The commodity pool operator either itself makes trading

decisions on behalf of the pool or engages a commodity trading advisor (CTA) to do so.

Commodity Trading Advisor (CTA)

A CTA is a person who, for pay, regularly engages in the business of advising others as to the

value of commodity futures or options or the advisability of trading in commodity futures or

options, or issues analyses or reports concerning commodity futures or options.

Associated Person (AP)

An AP is an individual who solicits or accepts (other than in a clerical capacity) orders,

discretionary accounts, or participation in a commodity pool, or supervises any individual so

engaged, on behalf of a futures commission merchant, an introducing broker, a commodity

trading advisor, a commodity pool operator, or an agricultural trade option merchant.

Principal

A principal of a firm is:

a sole proprietor of a sole proprietorship or a general partner of a partnership;

a director, president, CEO, COO, CFO, or a person in charge of a business unit, division

or function subject to regulation by CFTC of a corporation, limited liability company or

limited partnership; or

a manager, managing member, or a member vested with the management authority for a limited

liability company or limited liability partnership; or an individual who directly or indirectly,

through agreement, holding companies, nominees, trusts or otherwise:

is the owner of 10% or more of the outstanding shares of any class of an entity’s stock;

is entitled to vote 10% or more of any class of an entity’s voting securities;

has the power to sell or direct the sale of 10% or more of any class of an entity’s voting

securities;

has contributed 10% or more of an applicant or registrant’s capital;

is entitled to receive 10% or more of an applicant or registrant’s net profits; or

has the power to exercise a controlling influence over an applicant or registrant’s

activities that are subject to regulation by the Commission; or

an entity that

is a general partner of a partnership;

is the direct owner of 10% or more of any class of an entity’s securities; or

has directly contributed 10% or more of an applicant or registrant’s capital unless such

capital contribution consists of subordinated debt contributed by:

an unaffiliated bank insured by the Federal Deposit Insurance Corporation;

a United States branch or agency of an unaffiliated foreign bank that is licensed under the

laws of the United States and regulated, supervised and examined by United States

government authorities having regulatory responsibility for such financial institutions; or

an insurance company subject to regulation by any State.

Introducing Broker (IB)

An IB is a firm or individual that solicits and accepts futures orders from customers but does not

accept money, securities or property from the customer. An IB must be registered with the CFTC

and must carry all of its accounts through an FCM on a fully disclosed basis. The new CFTC

rules have made it a requirement for all introducing broker to be guaranteed by an FCM. This

type of IB has no minimum capital or financial reporting requirements. All of the accounts of a

guaranteed IB must be carried by the guaranteeing FCM.

Cross Rates

Cross Rates

These are basically the exchange rate of two currencies when the USD is not involved. There are

times when a person may want to trade a currency against another currency but the currency pair

is not offered through the FDM. In these instances, a trader wishing to execute such a trade will

need to do so by making a trade in the middle. This practice is called a cross trade (the exchange

rate on a cross trade is referred to as cross rates). Cross trades take place automatically through

your FCM/FDM, and some are quoted automatically.

Common Crosses are:

CHF/JPY

EUR/GBP

EUR/JPY

EUR/CHF

→ EXAMPLE:

If someone in the US wants to make a EUR/JPY trade and it is not available at the FDM the

trader will need to:

Buy USD/JPY

Then buy EUR/USD

Currency Crosses

Currency Crosses

Currency pairs which do not involve the USD. Currency crosses that use the Euro are called

“Euro crosses.” Currency crosses are less liquid than the major crosses and trading hours may

be restricted. They represent a smaller portion of the foreign exchange markets.

→ EXAMPLE: GBP/JPY

Currency Pair

Currency Pair

This is the individual product being bought by and sold to the customer. It is a quotation of two

different currencies. The base currency (first currency also called the transaction currency) is

traded against the secondary currency (also known as the counter currency, quote currency or

payment currency). The currency pair is priced in terms of the base currency expressed in the

secondary currency.

Direct Quote & Indirect Quote

Direct Quote

This is the amount of one currency (the local currency) needed to purchase one unit of a foreign

currency. Domestic currency is the base currency and is in the terms of one unit.

Indirect Quote

This is the amount of one currency (the local currency) you get when you sell one unit of a

foreign currency. Domestic currency is the counter currency and is in the terms of one unit.

→ EXAMPLE:

For US person a direct quote would be USD/EUR.

For US person an indirect quote would be EUR/USD.

Direct quotation: 1 foreign currency unit = x home currency units

Indirect quotation: 1 home currency unit = x foreign currency units

For more information see: http://en.wikipedia.org/wiki/Exchange_rate

Exchange Rate

Exchange Rate

This is the rate at which one currency can be converted into another.

→ EXAMPLE:

An exchange rate of 102 Japanese yen (JPY, ¥) to the United States dollar (USD, $)

This can also be expressed as: JPY 102 = USD 1.

Forex Forward Rate

Forex Forward Rate

The exchange rate of which a currency can be exchanged for another currency for settlement on

a predetermined future date (the maturity date). The rate is the forward rate as of the time of the

trade. The rate is determined with regard to the current spot exchange rate and then forward

points or added or subtracted.

Forward Point

Forward Point

With regard to a specific currency, the difference between the spot price and the futures

price. The forwards point may be at a premium or a discount.

→ EXAMPLE:

Spot Rate: EUR/USD = 1.2655

Forward Rate: EUR/USD = 1.2661

This means there is 6 forward basis point premium.

Interest Rate Differential (IRD)

Interest Rate Differential (IRD)

The difference between the interest rates of two similar assets and will vary based on the cross being

traded; in forex the IRD may positively or negatively affect your account balance if positions are held

overnight/for a long time. In the NOK/JPY trade you will get 7% (annual) interest and will pay 0% for

borrowing the JPY. This is a positive IRD. Usually this will not matter for most traders.

The IRD is a key component of the carry trade. For example, say an investor borrows US $1,000 and

converts the funds into British pounds, allowing the investor to purchase a British bond. If the purchased

bond yields 7% while the equivalent U.S. bond yields 3%, then the IRD equals 4% (7-3%). The IRD is the

amount the investor can expect to profit using a carry trade. This profit is ensured only if the exchange

rate between dollars and pounds remains constant.

Interest Rate Parity

Interest Rate Parity

An economic concept which basically states that there should be no arbitrage opportunity through use

of a foreign currency and interest rate vis-à-vis another.

The relationship can be seen when you follow the two methods an investor may take to convert

foreign currency into U.S. dollars. Option A would be to invest the foreign currency locally at

the foreign risk-free rate for a specific time period. The investor would then simultaneously enter

into a forward rate agreement to convert the proceeds from the investment into U.S. dollars,

using a forward exchange rate, at the end of the investing period. Option B would be to convert

the foreign currency to U.S. dollars at the spot exchange rate, then invest the dollars for the same

amount of time as in option A, at the local (U.S.) risk-free rate. When no arbitrage opportunities

exist, the cash flows from both options are equal.

→ EXAMPLE:

Interest rate parity is a non-arbitrage condition which says that the returns from borrowing in one

currency, exchanging that currency for another currency and investing in interest-bearing

instruments of the second currency, while simultaneously purchasing futures contracts to convert

the currency back at the end of the holding period, should be equal to the returns from

purchasing and holding similar interest-bearing instruments of the first currency. If the returns

are different, an arbitrage transaction could, in theory, produce a risk-free return.

Source: http://en.wikipedia.org/wiki/Interest_rate_parity

Mark-Ups & Mark-Downs

Mark-Ups

The difference between what the market maker/broker bought the currency for on the market and

what it sold the currency to the buyer. Can be done on both the bid and ask to make more money.

→ NOTE:

A broker receives commission and a dealer receives a mark up or mark down. Can be done on both the

bid and ask to make more money.

→ EXAMPLE:

A dealer may decide that a markup on a security issue held in inventory is appropriate because of a

rising stock market

Mark-Downs

The broker offers a lower price to try to stimulate trading in hopes that they will the money back on the

extra commissions.

→ EXAMPLE:

A bond trader may take a markdown in long-term bonds held in inventory when market interest rates

rise.

→ NOTE:

A markdown is the amount subtracted from the selling price, when a customer sells securities to a

dealer in the over-the-counter (OTC) market. Had the securities been purchased from the dealer, the

customer would have paid a markup, or an amount added to the purchase price. When broker/dealers

charge a markup or markdown on a securities transaction, they are acting as principals (dealers). If

broker/dealers act as agents, they charge a commission. A broker/dealer cannot charge a markup and a

commission or a markdown and a commission on the same transaction.

The National Association of Securities Dealers (NASD) Rules of Fair Practice established 5% as a

reasonable guideline in markups and markdowns, though many factors enter into the question of

fairness, and exceptions are common. However, this is more of a guide than a rule. If a broker/dealer

charges a markup in excess of 5%, s/he will have to be able to justify it based on all relevant

circumstances concerning the transaction.

Forex PIPs

Forex PIPs

Shorthand for “percentage in point.” In forex trading, a pip is the smallest incremental

movement available in any currency pair. Most pips are calculated to the fourth place after the

decimal point.

→ NOTE:

Pip value can be either fixed or variable depending on the currency pair.

→ EXAMPLE:

The pip value for EUR/USD is always $10 for standard lots, $1 for mini lots, and $0.10 for micro lots.

A lot is a standard unit size of a transaction. Typically, one standard lot is equal to 100,000 units of the

base currency, 10,000 units if it’s a mini lot, or 1,000 units if it’s a micro lot. Some dealers offer the

ability to trade in any unit size, down to as little as 1 unit.

→ HOW TO CALCULATE:

To express the value in the terms currency, multiply 1 pip with the lot value:

EURUSD pip = 0.0001 X 100,000 = $10.00

EURUSD pip = 0.0001 X 10,000 = $1.00

USDCHF pip = 0.0001 X 100,000 = SFr 10.00

USDCHF pip = 0.0001 X 10,000 = SFr 1.00

Forex Rollovers

Forex Rollovers

In a forex transaction, you are basically long the base currency and short the quote currency. While

settlement of the spot transaction is supposed to take place within two days, this does not happen

because accounts are never fully funded and delivery is never actually contemplated. Accordingly,

accounts are “rolled over” every night (usually at 4pm EST) which means that positions are closed and

then re-initiated (if not closed out during the day). Some traders will offset their positions at 3:50pm EST

to avoid this. Because you have one currency in an account (and are “borrowing” the currency that is

sold), you should also receive interest on the currency in the account (and pay interest on the borrowed

currency). The difference between the two interest rates (the interest rate differential) is deposited in

the account and can affect performance.

As mentioned above, a spot transaction is generally due for settlement within two business days (the

value date). The cost of rolling over a transaction, or the rollover fee, is calculated by the difference in

the interest rates that apply to the two currencies in the currency pair that you’re trading. If you buy a

currency pair where the base currency has a higher interest rate, then you’ll receive interest, and vice

versa. Most brokers will automatically roll over your open positions allowing you to hold your position

indefinitely.

→ EXAMPLE:

For a short position in 3 standard contracts ($300 000) in the EUR/USD:

14th June 2006 6:18 am : Buy: Rate 1.2542 : Counter amount 376 260 DB

14th June 2006 6:18 am : Sell: Rate 1.25425: Counter amount 376 275 CR

In this situation, the rollover fee as you can see is 0.5 pips, which is $5 per contract. Because we’re in 3

contracts, this is 1.5 pips or $15 for that day. Currently the trade is 31 pips in profit per contract (profit

of $930).

Source: www.theforextrader.net

Tomorrow Next Day & Spot Next

Tomorrow Next Day (Tom Next)

The act of rolling over the currency is known as “tom next”, which stands for tomorrow next day, and is

basically part of the forex rollover process. Off-exchange foreign currency trades typically settle two

days after the transaction is initiated. However, traders typically do not want to do this (avoiding actual

delivery of the currency).

Spot Next

This is currency to be delivered the day after the delivery date (also known as the spot date or value

date). Spot means “immediately”. One could said, “He overnight swapped from the spot date to the

next business day.“

In Spot forex, the majority of the time the end of the business day is 21:59 (London time). Any positions

still open at this time are automatically rolled over to the next business day, which again finishes at

21:59.

Spot Rate/Spot Price

Spot Rate/Spot Price

This is basically the current exchange rate of the currency pair. The spot price is different from

the price of a futures or forward contract on the currency pair.

Trade Date & Settlement Date

Trade Date (Entry Date)

The day that a currency trade is initiated; the day on which you “buy” a currency pair.

Settlement Date

The business day which the base currency in a transaction is to be delivered. For spot

transactions, the settlement date is two business days from the trade date (T+2).

→ NOTE:

For USD/CDN trades, the settlement date is one business day (T+1). Because positions are rolled over,

the settlement date is always being pushed back.

The trade date is the on which a transaction occurs, especially the trade of a security or derivative. It is

important to note that the trade date differs from the settlement date, which can range from one to five

days following the trade date, depending on the type of security being traded. On the trade date,

ownership of the securities being traded transfers from the seller to the buyer, but the seller does not

receive payment until the settlement date.

Forex Swaps

Forex Swaps

A forex swap consists of two legs: (i) current spot transaction and (ii) a forward contract. The

effect of this is to exchange your currency and then get the currency back in the future. Spot and

forward trades are rolled into one. This is generally done for businesses for various reasons.

Swap is a forex trading term and it means a real-time purchase and sale of the same amount of a

selected currency for two different dates for the sale and purchase of another selected currency.

Thus, a forex swap is in a way a borrowing mechanism. You basically borrow one currency while lending

another for a selected period of time. In other words, swap is interest rates for the currency pairs you

sell or buy. Depending on the pair, you may either earn or pay swap interests. By utilizing a forex swap,

you can buy/sell a base currency today and sell/buy that currency sometime in the future.

→ NOTE:

Regular forwards are referred to as “outright forwards” because they are more often used.

→ EXAMPLE:

Swapping the US Dollar for a Euro:

Forex trader enters a swap and buys $100,000 with exchange rate of $0.1 per euro. At the same time,

another trader agrees to sell in 3 month the same $100,000 dollars to buy Euros at the exchange rate of

$0.09. During this trade the trader makes up to 50,000 euro profit because the value of dollar changed.

Balance of Payments (BOP)

Balance of Payments (BOP)

An economic indicator that takes the following factors into account over a certain time period: (i)

trade balance (balance of trade), (ii) foreign investments and (iii) investments by foreigners. If

there is a positive BOP then money is flowing into the country; if there is a negative BOP then

then money is flowing out of the country. Some traders use this to determine currency prices.

Bank for International Settlements (BIS)

Bank for International Settlements (BIS)

International organization which fosters international monetary and financial cooperation and

serves as a bank for central banks. Importantly, it acts as a prime counterparty for central banks

in their financial transactions and also acts as an agent or trustee in connection with international

financial operations. The BIS is involved with the Basel Committee and Basel Accords. Its goal

is to act as a financial safety net through strong regulation and supervision.

Capital Account

Capital Account

Increase in foreign ownership of domestic assets – increase in domestic ownership of foreign assets +

portfolio investment (stocks, bongs) + other investment (loans, bank accounts). This measures money

flowing into and out of a country because of capital flows. If a country is doing well, then money will

flow into that country, and these flows are reflected in the capital account. When there are strong

inflows or outflows of capital, the currency will be affected.

→ EXAMPLE:

Large inflows = currency value will go up.

Large outflows = currency value will go down.

→ NOTE:

http://www.informedtrades.com/24711-capital-account-measuring-capital-flows.html

Current Account

Current Account

Current account measures money flowing into and out of a country as a result of trade flows. It

can be measured through the following formula:

→ FORMULA:

[Exports – Imports = BOT] + Net Factor Income From Abroad (interest, dividends) + Net

Transfer Payments (aid to other countries)

Surplus: generally strengthens currency

Deficit: generally weakens currency

The value of currency theoretically should increase or decrease depending on whether there is a

surplus or a deficit.

→ NOTE:

http://www.informedtrades.com/24555-measuring-trade-flows-move-currencies-current

account.html

Clearing House Interbank Payment System (CHIPS)

Clearing House Interbank Payment System (CHIPS)

The aggregated (netted) transactions between counterparties are settled at the end of the trading

day and then debited/credited through Fedwire. The netting allows banks to hold onto their

capital during the day (instead of being debited instantly through Fedwire) allowing the

transferring bank to earn interest. CHIPS is run by a private New York clearing house

system. Often used to settle EURO transactions. Usually higher value payments than for

Fedwire.

→ NOTE:

http://en.wikipedia.org/wiki/Clearing_House_Interbank_Payments_System

Discount Rate

Discount Rate

The rate set by the Federal Reserve Bank for short term lending to eligible depository

institutions. This interest rate is used to determine the present value of futures cash flows. The

discount rate can influence currency exchange rates. Most lending is not done through this

system and it seems to be more of a symbolic rate as it will imply policy decisions.

Lower discount rate: Federal Government trying to stimulate economy (increase amount of

money in system)

Increase discount rate: Federal Government trying to reign in the threat of inflation (decrease

amount of money in system)

→ NOTE:

http://www.investopedia.com/terms/d/discountrate.asp

http://www.forextradingfloor.com/index.php?page=articles&gparent_id=15&parent_id=15&type

=view&cat_id=20

http://www.ibtimes.com/articles/20081021/the-monetary-policy-tools-of-the-federal-reserve.htm

Exchange Rate Elasticity

Exchange Rate Elasticity

Price transmission elasticity and exchange rate elasticity define the mechanism of international export

market and changing market positions of exporting countries.

Exchange Rate Intervention

Exchange Rate Intervention

The monetary authority of a country (usually the country’s central bank) will intervene in the

forex markets in order to counter disorderly market conditions. The authority will buy or sell its

currency in order to bring the exchange rates up or down. Interventions can be coordinated with

the central banks of other countries. In the US, the Federal Government will do this on through

spot transactions instead of forward transactions.

→ NOTE: http://www.ny.frb.org/aboutthefed/fedpoint/fed44.html

Exchange Rate Volatility

Exchange Rate Volatility

Probably the most important characteristic of alternative exchange rate systems is the feature used to

describe them, namely fixed or floating. Fixed exchange rates, by definition, are not supposed to

change. They are meant to remain fixed for, ideally, a permanent period of time. Floating rates do just

that—they float up and down, down and up, from year to year, week to week, and minute by minute.

What a floating exchange rate will be a year from now, or even a week from now, is often very difficult

to predict.

Volatility represents the degree to which a variable changes over time. The larger the magnitude of a

variable change, or the more quickly it changes over time, the more volatile it is.

Since fixed exchange rates are not supposed to change, by definition, they have no volatility. A floating

exchange rate may or may not be volatile depending on how much it changes over time. However, since

floating exchange rates are free to change, they are generally expected to be more volatile. Volatile

exchange rates make international trade and investment decisions more difficult because volatility

increases exchange rate risk. Exchange rate risk refers to the potential to lose money because of a

change in the exchange rate.

Source: “International Finance Theory and Policy”, by Steven M. Suranovic:

www.internationalecon.com/Finance/F-toc.php

→ NOTE: http://internationalecon.com/Finance/Fch110/F110-1.php

Fiscal Policy

Fiscal Policy

A government’s decisions regarding spending and revenue collection (taxation). Fiscal policy

influences the economy. It is to be contrasted with monetary polcy which focuses centrally on

the supply of money. the following are types of fiscal policy:

Neutral: spending equals taxation

Expansionary: spending is greater than tax revenue; usually associated with budget deficit

Contractionary: tax revenue is greater than spending; usually associated with a budget surplus

Fisher Effect

Fisher Effect

The effect proposes that if the real interest rate is equal to the nominal interest rate minus the

expected inflation rate, and if the real interest rate were to be held constant, that the nominal rate

and the inflation rate have to be adjusted on a one-for-one basis.

→ NOTE: Real interest rate = nominal interest rate - inflation rate

→ EXAMPLE: In simple terms: an increase in inflation will result in an increase in the nominal

interest rate. For example, if the real interest rate is held at a constant 5.5% and inflation

increased from 2% to 3%, the Fisher Effect indicates that the nominal interest rate would have to

increase from 7.5% (5.5% real rate + 2% inflation rate) to 8.5% (5.5% real rate + 3% inflation

rate).

Source: http://www.investorwords.com/6519/Fisher_effect.htm

Gross Domestic Product (GDP)

Gross Domestic Product (GDP)

The market value of goods and services produced in the US by US residents or non residents

over a period of time (typically a year). Increasing GDP is better than decreasing GDP.

Inflation

Inflation

The rise in level of prices of goods and services in an economy over time (the decline in the real

value of money over time). The supply of money and inflation are linked. Inflation has a large

effect on interest rates, which in turn effect exchange rates. Over the long term inflation means

that the value of a currency will drop.

Inflation numbers influenced by GDP numbers, PPI (produce price index), CPI (consumer price

index)

→ NOTE:

http://en.wikipedia.org/wiki/Inflation

http://www.forexfloor.com/inflation-indicators.html

Theory of Purchasing Power Parity (PPP)

Theory of Purchasing Power Parity (PPP)

Also called the law of one price, the theory that the price of a currency (as defined by the

exchange rate with another currency) is determined by the relative level of prices of the two

countries. Basically the theory says that the price of a basket of goods should be the same in two

countries. If 10 HC buys 15 FC then PPP says that the same basket of goods which cost 10HC

should also cost 15FC. Essentially, the prices of currencies tend to move toward equilibrium.

The problem with the theory is that it does not accurately predict variations in exchange

rates. PPP cannot be used along as a decision making tool with regard to forex

transactions. PPP often does not take into account issues such as transportation costs, demand

within the country, etc.

→ EXAMPLE:

Big Mac Index, see http://www.actionforex.com/financial-glossary/financial-glossary/big-mac-

index-20041204335/

Forex Trading Calculations

Forex Trading Calculations:

Cross rate transactions

Effects of leverage calculations

Netting of positions

Open trade variation

Profit & loss calculations

Pip values, price after pips

Option and exotic option profit & loss calculations

Return on collateral, security deposit, margin

Transaction costs

Cross Rate Transactions

Cross Rate Transactions

Cross-rate transactions occur when two currencies are equal which follows from their forex currency

exchange rate according to a forex rate of the third currency. There are a couple of ways that cross rate

transactions can be executed. First, some FDMs will actually offer these pairs. Second you can buy

EUR/USD and then USD/JPY to affect a EUR/JPY cross.

Currency pairs that do not involve the USD are referred to as cross rates. Even though the USD is not

represented in the quote, the USD rate is usually used in the quote calculation. An example of a cross

rate is the EUR/GBP.

→ EXAMPLE: Assume that the following major exchange rates are known:

EUR/USD = 1.0060/65

GBP/USD = 1.5847/52

USD/JPY = 120.25/30

USD/CHF = 1.4554/59

→ CALCULATE GBP/CHF:

GBP/USD: Bid: 1.5847 Offer: 1.5852

USD/CHF: 1.4554 1.4559

GBP/USD X USD/CHF = 1.5847 X 1.4554 1.5852 X 1.4559

Effects of Leverage Calculations

Effects of Leverage Calculations

Leverage calculations allow you to see basically how much equity is in your account so you will not be

subject to a margin call. Most forex brokers allow a very high leverage ratio, or, to put it differently,

have very low margin requirements. The margin in a forex account is a performance bond, the amount

of equity needed to ensure that you can cover your losses.

If you have 100:1 leverage, then the margin in your account must be at least 1% of the contract value. If

you have 200:1 leverage, then the margin in your account must be at least 0.5% of the contract value.

To calculate margin, you take the price of the currency X the number of units X the margin requirement.

→ EXAMPLE: EUR/USD = 1.35

1.35 x 100,000 x 1% = 1,350 USD that must be used as margin to control the 100,000 units of EUR

Netting of Positions

Netting of Positions

At the end of the day institutions will net their long and short positions between one another so

that they do not have to settle every single transaction – only the net positions are settled. This

can save on fees and commissions.

Open Trade Variation

Open Trade Variation

Profit and Loss Calculations

Profit and Loss calculations – []

Example:

USD is base currency

Profit = Price Change in Pips x Units Traded

USD is secondary currency

Profit = Price Change in Pips x Units Traded / Exit Price

Good Websites:

http://www.forex.com/calculating_forex_pl.html

http://www.streetdirectory.com/travel_guide/148460/foreign_exchange/forex_trading___profit_a

nd_loss_calculations.html

Pip Values & Price After Pips

Pip Values

Forex pip value refers to the amount of money gained/lost for each pip that is gained/lost in currency

trading. The easiest way to find out pip value of a currency pair is by observing how much money you

gain/lose for each pip you gain/lose when you are in-trading. To do the manual calculation, you need to

know what ‘1 pip’ is for the related currency pair. The pip value for each currency pair is different and

the value can be determined according to the following formula:

→ FORMULA: Pip Value = 1 pip x Trade Size

Price After Pips

I am not sure what they are trying to get at…maybe the fact that there are spreads and that when you

initiate a position you are automatically starting with a loss the size of the spread….

Example:

USD/JPY at an exchange rate of 119.90

(.01 / 119.80) x $100,000 = $8.34 per pip

USD/CHF at an exchange rate of 1.4555

(.0001 / 1.4555) x $100,000 = $6.87 per pip

In cases where the US Dollar is not quoted first, the formula is slightly different.

EUR/USD at an exchange rate of 1.1930

(.0001 / 1.1930) X EUR 100,000 = EUR 8.38 x 1.1930 = $9.99734 rounded up will be $10 per

pip

GBP/USD at an exchange rate or 1.8040

(.0001 / 1.8040) x GBP 100,000 = 5.54 x 1.8040 = 9.99416 rounded up will be $10 per pip.

Good Website:

http://www.babypips.com/school/know_your_ps_and_ls.html

Option & Exotic Option P&L Calculation

Option & Exotic Option P&L Calculation

Buying an Option

You pay the premium (quoted in pips). If at expiration the option is in the money then the profit

equals the difference between the strike price and the current market price (closing spot price)

less the amount of the premium paid. Profit potential is unlimited and the potential loss is

limited to the amount paid for the premium

Exotic Option P&L Calculation - [Need to include]

→ NOTE:

Using options: http://www.forexcapital.com/options.htm

Exotic options: http://www.elitetrading.de/forum/forex/exotic_forex_options_1865.html

Return on Collateral/Security Deposit/Margin

Return on Collateral/Security Deposit/Margin

Leverage allows the trader to increase the possible ROI on an investment. The amount of the

ROI is expressed as a percentage of the margin amount. For instance, if you gain $200 on a

trade which was initiated with $1,000 on margin, your return on margin is 20%.

Example:

The Trader buys 100,000 GBP at 1.9505 USD (using US$1000 as the margin amount).

The Trader calculates a potential profit and places a limit order of 1.9620 (Potential profit of US$1,115.00)

The Trader calculates a potential loss and places a stop at 1.9475 (Potential loss of US$300) Within the next hour the GBP rallies to 1.9592, stalls and begins to reverse. The Trader decides the limit will not be reached, so he closes his position by selling the GBP at

1.9558 and locks in a profit of US$530.00 The Trader made a profit of US$530 on a margin amount of $1000 = 53% return on margin in an

hour.

Source:

http://209.85.173.132/search?q=cache:F1AKfPCKJVEJ:www.silversandcapital.com/investinginf

orex.aspx+forex+return+on+margin&cd=7&hl=en&ct=clnk&gl=us&client=firefox-a

Transaction Costs

Transaction Costs

Most FDMs do not have separate commissions or other fees per transaction, but this will be

decided at each FDM. Instead FDMs make money through the spread that they make on each

side of the transaction (i.e. they buy the currency for less than they sell it to you). The pip spread

actually works as a kind of transaction cost, for more on this see

http://www.babypips.com/school/how_leverage_affects_transacti.html.

Transaction costs vary from FDM to FDM. You should consider:

1. Commissions. If there is a commission, add it to the spread to determine total cost. Also, you need to determine whether the commission is calculated on a per side or round trip basis.

2. Spread on currency pairs. This is the value of the pip multiplied by the spread (pip X spread). The spread may fluctuate throughout day, based on the FDM.

3. Rollover rates. These are important for longer term strategies (and are not necessarily important for day traders).

4. Quality of execution, including slippage and the consistency of rates versus other platforms.

→ NOTE:

http://www.aboutcurrency.com/university/fxvideocourse/how_to_evaluate_forex_transaction_co

sts.shtml

Country Risk/Sovereign Risk

Country Risk/Sovereign Risk

Some countries still interfere (i.e. limit supply of currency available) with the natural market

mechanisms of the forex markets. Such interference could affect a currency in a number of

different ways including the liquidity of the currency. If significant enough the trader may not

be able to receive a rightful payment. Country risk is most acute with the so called “exotics.”

Credit Risk

Credit Risk

The risk that the counterparty defaults. The counterparty to an off-exchange transaction may not,

for a variety of reasons, be able to complete a transaction. Such non completion of any portion

of a transaction may be to the detriment to the other party. In such cases, the other party will be

subject to all or partial loss.

In the event of bankruptcy of the counterparty the trader may be unable to recover assets held at

the counterparty (for example, the Refco scandal). Generally there is no segregated customer

protection in the event of a bankruptcy. However, in many cases, credit risk for many forex

transactions is restricted because of the short term contract execution.

Exchange Rate Risk

Exchange Rate Risk

Exchange rate risk is the currency fluctuations on the worldwide currency market, fluctuation of

demand and supply for a particular currency. The most effective way to control the risk of

exchange rate is to get rid of the positions that lose too much, and to increase the number of

those who keeps the lose limits taken into account; essentially, limit the position and the limit

loss. Maintaining a limit position allowed for a particular investor’s currency, in each

transaction, during the transaction will be determined by it. The loss limit is also an instrument of

the investor that may set the limit to which it is admitted to lose in the foreign exchange

transactions, the limit above which the loss will be automatically stopped.

The exchange rates between currencies can change quickly and by a significant amount. These

changes could produce large losses for the trader. Some traders utilize stop losses or limit orders

in order to mitigate this risk.

Interest Rate Risk

Interest Rate Risk

The value of a foreign currency investment can be affected negatively by a number of factors

related to the interest rate or one or other of the currencies traded.

Liquidity Risk

Liquidity Risk

There is a risk that it may be impossible to liquidate a position. This can happen when a

currency is deregulated or fixed trading bands are widened. Some potential currencies include

(but are not limited to): Thai Baht, South Korean Won, Malaysian Ringitt, Brazilian Real, Hong

Kong Dollar.

Forex Exotic Options

Forex Options and Exotic Options

Options are a great tool for traders during anticipated periods of market volatility. During these

periods of volatility it is expected that huge drawdowns could occur. It is also during this time

that prices can gap up or down so slippage during these times is expected to increase.

Forex options are not traded on an exchange so they are usually privately negotiated contracts

between the FDM and the trader.

→ NOTE:

Managers who utilize these types of instruments may be subject to regulation under state

investment advisory laws. Many state securities laws are written broadly so as to include

“investment contacts” in the definition of “security.” While I have not personally heard of a

state making a claim like this, it is not hard to see a state making such a claim.]

Barrier Forex Option

In its most basic form, the barrier option is an option which is triggered upon the happening of an

event (the barrier) (i.e. a currency pair reaching a previously determined exchange rate). A

double barrier option has a barrier both above and below the current market price. There are two

central ways to play barrier options: knock-in or knock out.

These pay off if an asset reaches a certain price. Knock-in options are created with predetermined

characteristics when the underlying reaches a certain price. Knock-out options are options that

terminate if the underlying reaches a certain price. Since the option ceases to exist, there is no payoff

even if the price moves back within the knock-out barrier before the original expiration. Thus, an option

with a knock-out barrier has a maximum specified value and payoff.

Because the option may either not come into existence or pass out of existence, barrier options are

generally cheaper the standard options, with the double-barrier option being cheapest. Most exotic FX

options are barrier options.

Knock-in Barrier Option

The knock-in triggers an option contract upon a certain price which is hit by the currency

pair. This means that there is no option contract in existence until a barrier is hit. [What does

this mean for long and short?] The knock in can be structured so it is triggered upon a price

increase (the up and in option) or upon a price decrease (the down and in option).

Knock-out Barrier Option

The knock-out cancels an existing option contract which will be effective unless a certain price is

hit by the currency pair. Unlike a knock-in option, the knock-out option is currently in existence;

it will cease to be once the barrier is hit. [What does this mean for long and short?] Like the

knock-in, the knock-out can be structured to be triggered upon a price increase (the up and out)

or upon a price decrease (the down and out).

Single-Barrier Options

These have a single trigger price that is either above or below the strike price, and double-barrier

options have trigger prices that are above and below the strike price.

Double Barrier Options

[Need to include]

Compound Options

This is an option to purchase an existing option. This has two potential premiums: the first to

purchase the compound option and the second to purchase the underlying option. Because there

are two premiums compound options are more expensive than vanilla options. Advantage is that

they provide the opportunity for large amounts of leverage and that they are cheaper (initially)

than vanilla options.

A compound option or “split fee option” is an option on an option. It gives the holder the right to buy or

sell another option, and are generally used for currency or fixed income markets where insecurity exists

regarding the option’s risk protection. The exercise payoff of a compound option involves the value of

another option. Compound options thus have two strike prices and two exercise dates. There are four

types of compound options:

call on a call put on a put call on a put put on a call

→ NOTE:

http://en.wikipedia.org/wiki/Barrier_option

http://www.financial-spread-betting.com/exotic-options.html

http://www.traderslog.com/forex-options.htm

http://www.forexdirectory.net/exover.html

Market Risk

Market Risk

Risk that the general forex market may cause the value of a position to change.

Operational Risk

Operational risk

Risk inherent in the trader’s operational structure. For instance if a trader’s decision making

skills are spread out and decisions are dependant on a number of different systems, any thing that

happens to one part of the system could affect the whole. This may affect the trader’s ability to

enter and exit trades as it would normally do.

Additionally, forex dealers typically have operational risk related to their quoting and execution

systems.

Settlement Risk/Herstaat Risk

Settlement Risk/Herstaat Risk

Because of the time differences involved in the forex trading markets, there was the possibility

that there would be differences in the time of the settlement of the forex contracts. This meant

that it was possible that the counter party would not pay the trader (i.e. you would send them

your currency and they would not send you their currency). This has been mitigated through the

CLS system. Herstatt risk refers to a situation in 1974 when a German bank called Herstatt was

shut down by German banking regulators prior to paying off its counterparties; this left the

counterparties with substantial losses.

CFTC Jurisdiction and Jurisdictional limitations

CFTC Jurisdiction and Jurisdictional Limitations

CFTC:

The Commodities Futures Trading Commission (CFTC) is a government agency which is

charged with enforcing the laws under the Commodities Exchange Act, as amended (CEA). The

CFTC, with regard to the CEA, is functionally equivalent to the SEC. With regard to off-

exchange foreign currency transactions, Congress has provided a mandate to the CFTC to

propose rules which will require the registration of forex managers and solicitors. Once a

registration structure is enacted the CFTC will ultimately be in charge of making sure that these

maangers and solicitors are operating pursuant to the regulations promulgated by the CFTC. The

CFTC will provide the NFA with the authority to monitor these managers and solicitors and

oversee the registration process.

CFTC Jurisdiction:

On May 22, 2008, the Congress passed H.R. 6124, the Food, Conservation, and Energy Act of

2008 (also known as “the Farm Bill”) which contains several amendments to the Commodity

Exchange Act (“CEA”). In particular, Title XIII of the FarmBill (1) clarifies that the CFTC’s

anti-fraud authority applies to certain retail off-exchange foreign currency transactions, (2)

creates a new registration category for retail foreign exchange dealers, (3) requires registration

for those who solicit orders, exercise discretionary trading authority and operate pools with

respect to retail off-exchange foreign currency transactions, and (4) imposes minimum capital

requirements for futures commission merchants and retail foreign exchange dealers that act as

counterparties to such transactions. Parts of the legislation, particularly those confirming the

Commission’s anti-fraud authority, were effective upon passage. Other parts of the legislation,

such as those requiring the registration of parties engaged in these transactions and minimum

capital requirements, will only be effective upon the Commission’s issuance of final

regulations. Any such changes to the information below will be accomplished through notice

and comment rulemaking and will be made available in the Federal Register section of

CFTC.gov.

A complete description of the amendments to the CEA effected by Title XIII of the Farm Bill

can be found in the Joint Statement of Managers, pp. 291-299, which can be accessed through

the House Agriculture Committee’s Farm Bill Homepage. Interested parties should monitor the

Commission’s website as well as the National Futures Association’s website, for developments.

The CFTC has witnessed increasing numbers, and a growing complexity, of financial investment

opportunities in recent years, including a sharp rise in foreign currency (forex) trading scams.

The Commodity Futures Modernization Act of 2000 (CFMA) made clear that the CFTC has

jurisdiction and authority to investigate and take legal action to close down a wide assortment of

unregulated firms offering or selling foreign currency futures and options contracts to the general

public. The CFTC also has jurisdiction to investigate and prosecute foreign currency fraud

occuring in its registered firms and their affiliates. The CFTC issued an advisory in 2001 that

discussed these CFMA amendments to the Commodity Exchange Act (CEA), 7 USC 1, et seq.

The Division of Trading and Markets (now Division of Clearing and Intermediary Oversight, or

DCIO) issued an advisory in 2002 concerning foreign currency trading by retail customers

(PDF). The advisory affirms that off-exchange trading of foreign currency futures and options

contracts with retail customers by a counterparty that is not a regulated financial entity as set

forth in the CFMA is unlawful. The advisory further states that, if there is a lawful counterparty

to the transaction, such as a person registered as a futures commission merchant, the persons

acting as intermediaries to such a transaction, that is, in the manner of an introducing broker,

commodity trading advisor or commodity pool operator, would not need to register under the

CEA if that is their only involvement in futures or option transactions.

DCIO issued an additional advisory in 2007 concerning foreign currency trading by retail

customers (PDF). The DCIO Advisory addresses the following issues: (1) registration

requirements for associated persons of firms registered as introducing brokers (IBs), commodity

trading advisors, and commodity pool operators that are involved in forex transactions; (2) the

permissibility of certain unregistered affiliates of a futures commission merchant (FCM) to act as

proper counterparties in forex transactions; (3) claims that forex customer funds are segregated;

(4) introducing entities acting as FCMs; (5) the applicability of the IB guarantee agreement to

forex transactions and prohibiting guaranteed IBs from introducing forex transactions to an FCM

that is not its guarantor FCM; (6) prohibiting forex account statements of an FCM’s unregistered

affiliate from being included in the FCM’s account statements to its customers; and (7)

prohibiting retail customers from acting as counterparties to each other in forex transactions.

CFTC Jurisdictional Limitations:

CFTC Chairman Gary Gensler addressed the following limitations to the authority of the CFTC in his

address to the U.S. Senate:

Retail Fraud: In the 2008 Farm Bill the Congress clarified the CFTC’s jurisdiction over fraud in retail

foreign currency transactions. Since the passage of the Farm Bill, unscrupulous firms have been offering

the same type of fraudulent “rolling spot” commodity contracts that were prohibited in the Farm Bill,

but in other commodities that were not covered by the bill. Since the enactment of the Farm Bill, the

CFTC has received more than 50 complaints from the public relating to potential fraud from such

contracts. The regulatory reform package should include a provision to expand the CFTC’s jurisdiction

over this type of retail fraud to all types of commodities.

Foreign Boards of Trade: As part of regulatory reform legislation, the Congress should also

provide the CFTC with clear statutory authority to ensure that traders that are trading on a

foreign board of trade through trading terminals in the U.S. comply with the same U.S. position

limits and reporting requirements when trading a foreign contract that settles against any price of

a contract traded on a U.S. exchange.

Source: CFTC Chairman Gary Gensler Address to the US Senate

http://www.cftc.gov/customerprotection/fraudawarenessandprevention/forex/index.htm

Conflicts of Interest

Conflicts of Interest

I am not sure what they are getting at here. In general, all conflicts of interest would need to be

disclosed. The interpretive notices to Rule 2-29 and Rule 2-9 give us some insight into this

general principal.

Interpretive notice to Rule 2-29: Disclosing conflicts of interest for securities futures products.

Firms must make sure they:

disclose all conflicts of interest

review promotional material; firms must make sure that promotional material is accurate

and does not gloss over any conflicts of interest

Interpretive notice to Rule 2-9: Ethics training.

Ethics program should address: avoidance of conflicts of interest and proper disclosure and

handling of conflicts of interest.

Disclosures to Customers

Disclosures to Customers

[Need to include] See NFA Interpretive Notice on Rule 2-36(e).

NFA Interpretive Notice Compliance Rule 2-36(e):

Supervision of the use of Electronic Trading Systems

NFA Interpretive Notice Compliance Rule 2-36(e): Supervision of the use of Electronic

Trading Systems

General: this part of the rule applies generally to FDMs and, inc certain instances, the APs of the

FDM. It will also apply to Members which solicit, introduce, or manage customer accounts

(those parts applicable to FDMs will also apply to these members if the customer deals with a

counterparty that is not a FDM).

Issues for white labelers: if the firm providing the white label product is a FDM, the member

may rely on the FDM. If the firm providing the product is not a FDM then the Member is

ultimately liable. In the former situation the Member must (i) Provide required notifications and

disclosures to customers; (ii) Maintain records; and (iii) Respond to situations where it has

reason to believe the white labeler is not complying with the Notice.

Focus on the following areas: the security, capacity, credit and risk-management controls, and

records provided by the firm’s electronic trading systems.

Rule 2-36(e) provides:

Supervision. Each Forex Dealer Member shall diligently supervise its employees and agents in

the conduct of their forex activities for or on behalf of the Forex Dealer Member. Each Associate

of a Forex Dealer Member who has supervisory duties shall diligently exercise such duties in the

conduct of that Associate’s forex activities for or on behalf of the Forex Dealer Member.

Specific Items Discussed in Interpretive Notice

Security

Authentication & Encryption. User should be authenticated when logging on (passwords,

secured, digital certificates, etc) and this information should be appropriately encrypted;

firewalls should be used when and if appropriate

Customers should be able to tell the Member about access issues

Periodic testing. Annual independent internal audit or qualified outside audit; report

docemented and provided to senior management; if any deficiency there should be follow

up

Electronic trading system should be monitored by appropriate personnel; procedures in

place for updating the system as needed

Capacity

Adopt and enforce written procedures to evaluate capacity of ETS

ETS should go through initial stress test; subject to periodic reviews thereafter by

independent inside pary or qualified outside party; audits documented and reviewed by

management

ETS should be tested for both capacity and performance; system should be designed to

provide adequate capacity to meet estimated peak volume needs

Firm should also have procedures for following up on customer compliancts regarding

these issues

Disaster recovery. Contingency plan should be in place should the system go down or

abnormal volume; backup systems can include telephone

If operational issues, these should be relayed to the customers through the website, email,

im, or through the phone

Firm should disclose that there may be system issues in advance and what customers can

do. This can be in the customer agreement

Credit and risk-management controls

Procedures should be in place to make sure there is not undue financial risk on the firm or

the other customers from a customer trade

ETS should be designed to allow the firm to limit the customers trading; ETS should

block order the exceed pre-set limits

ETS should be designed so that if stop-losses are exceeded positions will be closed out

prior to a position becoming a deficit; there is a greater duty to make sure this is the case

if the fdm states that the customer cannot lose more than they invest

If ETS does not automatically liquidate a position, the ETS should generate an aler to the

customer

Periodic review of the system to make sure proper credit and risk management

Recordkeeping

Written procedures to record and maintain essential information re: customer order and

account activity

Records should include: Date and time the order is received by the system; Price (or

premium for an option) at which the order is placed; Price (or premium for an option)

quoted on the trading platform when the order was placed (if the system is a trading

platform); Account identification; Currency pair; Size; Buy or sell; Type of order (if not a

straight market order); Date and time the order is transmitted to the trading platform (if

the system is an AORS); Date and time of execution (if the system is a trading platform);

Size and price (or premium) at which the order is executed; Date and time the execution

information is received (if the system is an AORS); andDate and time the execution

information is reported by the system.

Options also need: Put or call; Strike price; and Expiration date.

Time recorded to nearest second

Rollover information should include: Account identification; Currency pair; Size; Long

or short; Date and time of the rollover; Price of the position after the rollover; Bid and

ask prices quoted on the platform when the rollover occurred; Amount of interest credited

or debited to the account, if any; Any other fees charged for the rollover.

ETS should be designed so that it is searchable for any one of a number of different items

Daily account records should include the following items: Account identification; Funds

in the account (net of any commissions and fees); Open trade equity (the net profits and

losses on open trades); and Account balance (funds in the account plus or minus open

trade equity). Options should also include: Long option value; Short option value; and

Net option value.

ETS must have dynamic information on price changes, to the nearest second.

Daily exception reports. Those trades which fill outside the price range at the time order

was entered into; these reports should be reviewed by management on a daily basis for

suspicious or unjustifiable activity

Month end assessment fee reports – number and size of forex transactions for the month

Record retention. 5 years, first 2 in an accessable place

Trade Integrity

Written procedures to maintain integreity of the ETS

ETS should be designed to provide bids and officers related to current market activity

If firm advertises a particular spread (x pip) then the ETS should be able to handle this

ETS designed for minimal slippage, and only then based on market conditions

Price adjustments should be done pursuant to objective criteria identified in written

procedures; otherwise management approval needed for an adjustment

APs should be prohibited from adjustinc prices for any reason once the order hits the ETS

If automatic rollover, the ETS should be designed to follow the procedures detailed in the

written agreement

Annual Certification

By all FDMs

AP who is also a principal, filed with the NFA

Also members who are involved with counterparties which are not FDMs

Futures requirements:

Know Your Customer

Know Your Customer

Members and Associates have a duty to acquaint themselves sufficiently with the personal and

financial circumstances of each forex customer to determine what further facts, explanations and

disclosures are needed in order for the customer to make an informed decision on whether to

enter into forex transactions.

Every Member should determine what information it will obtain from a prospective forex

customer. At a minimum, the Member soliciting the customer to engage in forex transactions

should obtain the customer’s name, address, principal occupation or business, current estimated

annual income and net worth, approximate age, and an indication of the customer’s previous

investment and trading experience. Members and their Associates need to ensure that each

customer they solicit has received adequate information concerning the risks of forex

transactions so that the customer can make an informed decision as to whether forex transactions

are appropriate for the customer. These obligations fall on the Forex Dealer Member when a

non-Member solicits the customer.

Members and APs have a duty to make sure customer makes informed decision with regard to

forex transactions (FDMs have this duty if non-member solicits customer):

Should consider personal and financial circumstances

Should provide additional facts, explanations, disclosures if necessary

Members must decide what information to request from a customer

Minimumum information – customer’s name, address, principal occupation or business,

current estimated annual income and net worth, approximate age, and an indication of the

customer’s previous investment and trading experience

Minimum information: customer’s name, address, principal occupation or business,

current estimated annual income and net worth, approximate age, and an indication of the

customer’s previous investment and trading experience.

Registration Requirements

Registration Requirements

Forex managers and solicitors generally will need to make sure that both the firm and the

individual (associated person or AP) are registered with the CFTC. The firm will also need to be

a member of the NFA.

Firms must complete and submit Form 7R through the NFA’s online registration system. The

cost for firm registration is likely to be $200 for Forex CPOs, Forex CTAs, and Forex

IBs. These firms will also need to become members of the NFA which costs $750 on an annual

basis. These firms will also need to become members of the NFA which costs $750 on an annual

basis. Guaranteed forex IBs need a guarantee form signed by the FDM [Form 1-FR-IB (Part B)].

Individuals must complete and submit Form 8-R through the NFA’s online registration system. Each

individual (whether a principal or an AP) will need to have passed both the Series 3 exam and the Series

34 exam. Individuals will need to submit a fingerprint card as well.

→ NOTE: Individuals who were APs of a registered firm as of May 22, 2008 may be “grandfathered” in

and may not need to take the Series 34 exam.

Forex CPOs and forex CTAs will need to have their disclosure documents reviewed by the NFA prior to

soliciting clients with those documents.

Security of Customer Funds, No Segregation

Security of Customer Funds, No Segregation

Generally customer funds are not held in segregated customer accounts separate from the

FDM. Accordingly, in the event of a bankruptcy at a FDM, the customer funds would be

administered by a trustee according to the US bankruptcy laws (if based in the US). Customers

would be entitled to a pro rate distribution of available assets. There is no guarantee they would

be able to recover all of the customer funds.

Security Deposit Rules

Security Deposit Rules

The following is the text of Section 12 of NFA’s Financial Requirements from NFA’s Rules

Manual:

[Adopted Effective December 1, 2003. Effective dates of amendments: June 6, 2004; September

15, 2005; February 13, 2007; May 14, 2008; October 31, 2008; and November 30, 2009.]

(a) Each Forex Dealer Member shall collect and maintain the following minimum security

deposit for each forex transaction between the Forex Dealer Member and a person that is not an

eligible contract participant as defined in Section 1a(12) of the Act:

(i) 1% of the notional value of transactions in the British pound, the Swiss franc, the Canadian

dollar, the Japanese yen, the Euro, the Australian dollar, the New Zealand dollar, the Swedish

krona, the Norwegian krone, and the Danish krone;

(ii) 4% of the notional value of other transactions;

(iii) for short options, the above amount plus the premium received; and

(iv) for long options, the entire premium.

(b) The Executive Committee may temporarily increase these requirements under extraordinary

market conditions.

(c) For purposes of this rule:

(1) “Forex” has the same meaning as in Bylaw 1507(b); and

(2) “Forex Dealer Member” has the same meaning as in Bylaw 306.

(d) In addition to cash, a Forex Dealer Member may accept those instruments described in CFTC

Rule 1.25 as collateral for customers’ security deposit obligations. The collateral must be in the

FDM’s Possession and control and is subject to the haircuts in CFTC Rule 1.17.

Two general security deposit requirements are 1% or 4%. Between the FDM and customer (who

is not an Eligible Contract Participant (ECP):

1% (British pound, the Swiss franc, the Canadian dollar, the Japanese yen, the Euro, the

Australian dollar, the New Zealand dollar, the Swedish krona, the Norwegian krone, and

the Danish krone);

4% (All other currencies);

For short options, the above amount plus the premium received; and

For long options, the entire premium.

FDMs complying with the 150% rule (pursuant to Section 11(a)(i) or (ii)), can have

lower security deposits

Acceptable Collateral – cash and other items pursuant to CFTC Rule 1.25, subject to

haircuts

Reports to Customers/Confirmations/Monthly Summaries

Reports to Customers/Confirmations/Monthly Summaries

See generally Rule 2-44 Forex Customer statements

here: www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=RULE%202-44&Section=4.

Written confirmation provided to customers within one business day of activity.

Written confirmation must include the following information:

1. Date; 2. Transaction type (e.g., new position, offsetting position, rollover, adjustment); 3. Currency pair; 4. Buy or sell (if a new or offsetting position); 5. Size; 6. Price or premium (for new or offsetting positions or price adjustments); 7. Price or premium change (for price adjustments); 8. Monetary adjustments (debit or credit); 9. Net profit or loss for offsetting positions; and 10. Charges for each transaction (e.g., rollover interest and/or fees).

Daily statements must be provided to customers on a daily basis and must show account equity

as of the end of the previous day. They can be provided electronically and can be combined with

confirmations and provided electronically with the customers consents

Monthly statements are required for all accounts that have open positions at the end of the

month or changes in the account balance or equity since the prior statement. Quarterly

statements are required for all other open accounts. The monthly or quarterly statements must

contain the following information regarding the transactions during the reporting period and the

funds in the account:

The account equity at the beginning of the reporting period; All initiating or offsetting transactions, deliveries, option exercises, or option expirations that

occurred during the reporting period, with the following information for each: date, currency pair, buy or sell, size, and price or premium (with any price or premium adjustment noted);

All open positions in the account, with the following information for each position: date initiated, currency pair, long or short, size, price or premium at which it was initiated (with any price or premium adjustment noted), and the unrealized profit or loss;

All deposits and withdrawals during the reporting period; All other monetary adjustments (debits and credits) to the account; The amount of cash in the account (excluding non-cash collateral and unrealized profits and

losses); A breakdown by type of all fees and charges during the period, including commissions and

interest expense or rollover fees; and The account equity at the end of the reporting period.

Promotional Material & Solicitation

Promotional Material

This is quite a nebulous topic which is explored in greater depth elsewhere in the materials. I

provide an overview below.

See generally NFA rule 2-36(h) Filing Promotional Materials with NFA:

The Compliance Director may require any Forex Dealer Member for any specified period to file

copies of all promotional material with NFA for its review and approval at least 10 days prior to

its first use or such shorter period as NFA may allow. The Compliance Director may also require

a Forex Dealer Member to file for review and approval copies of promotional material prepared

or used by some or all of the non-Members it is responsible for under Section (d).

The Forex Transactions Guide states:

Communications with the Public and Promotional Material - No Member or Associate shall

make any communication with potential or current customers that operates as a fraud or deceit;

uses a high-pressure approach; or implies that forex transactions are appropriate for all persons.

Promotional material used by the Member or Associate shall not:

Deceive the public or contain any material misstatement of fact or omit a fact that makes the promotional material misleading;

Include any statements of opinion unless they are clearly identified as such and have a reasonable basis in fact;

Mention the possibility of profit unless accompanied by an equally prominent statement of the risk of loss;

Include any reference to actual past trading profits without mentioning that past results are not necessarily indicative of future results;

Include any statistical or numerical information about past performance of actual accounts unless the Member can demonstrate that the performance is representative of actual performance of all reasonably comparable accounts for the same period (calculated in accordance with the formula in CFTC Regulation 4.35(a)(6) and NFA Compliance Rule 2-34); or

Include testimonials unless they are representative of all reasonably comparable accounts, the material prominently states that the testimonial is not indicative of future performance or success, and the material prominently states that they are paid testimonials (if applicable).

No Member or Associate may represent that forex funds deposited with a Forex Dealer Member

are given special protection under the bankruptcy laws. No Member or Associate may represent

or imply that any assets necessary to satisfy its obligations to customers are more secure because

the Member keeps some or all of those assets at a regulated entity in the United States or a

money center country.

No Member or Associate may represent that its services are commission free without

prominently disclosing how it is compensated in near proximity to that representation.

No Member or Associate may represent that it offers trading with “no-slippage” or that it

guarantees the price at which a transaction will be executed or filled, unless:

It can demonstrate that all orders for all customers have been executed and fulfilled at the price initially quoted on the trading platform when the order was placed;9 and

No authority exists, pursuant to a contract, agreement, or otherwise, to adjust customer accounts in a manner that would have the direct or indirect effect of changing the price at which an order was executed.

Members and Associates may not solicit customers based on the leverage available unless they

balance any discussion regarding the advantages of leverage with an equally prominent

contemporaneous disclosure that increasing leverage increases risk.

No Member shall use or directly benefit from any radio or television advertisement that

recommends specific forex transactions or describes the extent of any profit obtained in the past

or that can be obtained in the future unless the member submits the advertisement to NFA’s

Promotional Material Review Team for its review and approval at least 10 days prior to its first

use or such shorter period as NFA may allow.

Every Member should adopt and enforce written procedures to supervise communications with

potential and current customers and promotional material. A supervisory employee that is, or is

under the ultimate supervision of, a listed principal who is also an NFA Associate should review

and approve all promotional material and make a written record of such review and approval.12

All promotional material should be maintained by each Member and be available for

examination for the periods specified in the recordkeeping section of this notice, measured from

the date of last use.

See also Notice I-08-15:

(i) Hypothetical Results

Any Member who uses promotional material that includes a measurement or description or

makes any reference to hypothetical forex transaction performance results that could have been

achieved had a particular trading system of the Member or Associate been employed in the past

must comply with Compliance Rule 2-29(c) and the related Interpretive Notice as if the

performance results were for transactions in on-exchange futures contracts.

Solicitation

See NFA Rule 2-39 at www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=RULE%202-

39&Section=4

NFA Interpretive Notice Regarding Forex Transactions

NFA Interpretive Notice Regarding Forex Transactions

→ See NFA Bylaw 306

at: www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=BYLAW%20306&Section=3

Forex Dealer Member (FDM) is an NFA member who acts a counterparty to forex transaction. It is a self-

executing title, meaning that an NFA member is an FDM solely by nature of acting as a counterparty to

forex transactions. No applications or approvals are required to be considered an FDM. If you do not act

as a counterparty to a forex transaction (IB, CTA, or CPO), then you are not considered an FDM, but you

may be subject to parts of NFA Rule 2-36 pursuant to NFA Rule 2-39.

The following are not FDMs and not subject to NFA Rule 2-36:

financial institutions (e.g., banks and savings associations); certain insurance companies and their regulated subsidiaries or affiliates; financial holding companies; investment bank holding companies; registered broker-dealers that are members of FINRA; and Material Associated Persons of registered broker-dealers that are members of FINRA.

→ General Disclosures:

Disclosure of characteristics and risks of forex transactions (members and associates should know what information has been provided to the customer)

→ Specific Disclosures:

disclaimer regarding non-protection under the Bankruptcy Code manner in which member will be compensated for services 2 paragraph uppercase disclaimer re: trading not conducted on exchange, conflict of interest,

trading exposure disclose bid and offer when customer enters an order duty to update information if a material change would make prior information misleading

(member)

Reporting: NFA is concerned that the customer receives timely and accurate notice of account status:

Confirmations: Written confirmation must be submitted within one business day of any account activity (including offsetting transactions, rollovers, deliveries, etc.). Information should include all costs, fees, commission, third party fees, etc.

Monthly/Quarterly Summaries: If (1) there has been activity in an account during the month or (2) there are any open positions in the account at the end of the month, the FDM will need to provide a monthly summary of all forex transactions and other account activity to the customer. For customer accounts not fitting within the above, summaries should be provided quarterly.

Delivery: both confirmation and summaries may be transmitted by electronic means.

Supervision:

NFA Notice to Members: Supervision of Forex Promotional

Materials

NFANotice to Members – Supervision of Forex Promotional Materials (Notice I-08-15;

March 27, 2008) - there are three main parts to this notice.

Supervisory employee responsible for reviewing FDM promotional materials must be under the

ultimate supervision of a principal of the FDM who is also an AP (means that an individual

principal of a FDM will ultimately be held liable for fraudulent or midleading promotional

materials)

FDM must have policies on reviewing the activities of non-Members with which they do

business, including:

Regular review of trading

Procedures for customer complaints

Review of promotional materials

Review of activites of non-Members must also be done by an AP under the ultimate

supervision of an FDM principal/AP

Gross National Product (GNP)

Gross National Product (GNP)

The market value of all goods and services produced by US residents in the US or abroad (i.e. regardless

of where they were produced) over a period of time (typically a year).

World Trade Organization

World Trade Organization

The World Trade Organization (WTO) is an international organization designed by its founders

to supervise and liberalize international trade. The organization officially commenced on January

1, 1995 under the Marrakesh Agreement, succeeding the 1947 General Agreement on Tariffs and

Trade (GATT).

The World Trade Organization deals with regulation of trade between participating countries; it

provides a framework for negotiating and formalizing trade agreements, and a dispute resolution

process aimed at enforcing participants’ adherence to WTO agreements which are signed by

representatives of member governments and ratified by their parliaments.

Among the various functions of the WTO, these are regarded by analysts as the most important:

It oversees the implementation, administration and operation of the covered agreements.

It provides a forum for negotiations and for settling disputes.

Additionally, it is the WTO’s duty to review and propagate the national trade policies,

and to ensure the coherence and transparency of trade policies through surveillance in

global economic policy-making.

Another priority of the WTO is the assistance of developing, least-developed and low-

income countries in transition to adjust to WTO rules and disciplines through technical

cooperation and training.

The WTO is also a center of economic research and analysis: regular assessments of the

global trade picture in its annual publications and research reports on specific topics are

produced by the organization.

Finally, the WTO cooperates closely with the two other components of the Bretton

Woods system, the IMF and the World Bank.

Theory of Elasticities

Theory of Elasticities

The theory of elasticities holds that the exchange rate is simply the price of foreign exchange that

maintains the balance of payments in equilibrium. In other words, the degree to which the exchange

rate responds to a change in the trade balance depends entirely on the elasticity of demand to a change

in price.

For instance, if the imports of country A are strong, then the trade balance is weak. Consequently, the

exchange rate rises, leading to the growth of country A’s exports, and triggers in turn a rise in its

domestic income, along with a decrease in its foreign income.

Whereas a rise in the domestic income (in country A) will trigger an increase in the domestic

consumption of both domestic and foreign goods and, therefore, more demand for foreign

currencies, a decrease in the foreign income (in country B) will trigger a decrease in the domestic

consumption of both country B’s domestic and foreign goods, and therefore less demand for its

own currency. The elasticities approach is not problem-free because in the short term the

exchange rate is more inelastic than it is in the long term and additional forex rate variables arise

continuously, changing the rules of the game.

Source: http://www.iforex.org

Central Bank Activities

Central Bank Activities

A central bank, reserve bank, or monetary authority is the entity responsible for the monetary policy of

a country or of a group of member states. It is a bank that can lend money to other banks in times of

need. Its primary responsibility is to maintain the stability of the national currency and money supply,

but more active duties include controlling subsidized-loan interest rates, and acting as a lender of last

resort to the banking sector during times of financial crisis (private banks often being integral to the

national financial system). It may also have supervisory powers, to ensure that banks and other financial

institutions do not behave recklessly or fraudulently.

Intervention

Official intervention in the foreign exchange market means that the central bank or other agent of the

government buys or sells foreign currency in an attempt to influence the exchange rate value. Purchases

of foreign exchange usually are intended to push down the home currency value of the exchange rate,

and sales usually are intended to push it up.

Sterilized Intervention

In a sterilized intervention, the central bank offsets the purchase or sale of foreign exchange by selling

or purchasing domestic securities so as to keep the domestic interest rate at its target. Since the

domestic interest rate usually is considered the main determinant of the value of the domestic currency,

many argue, it must change in order to influence the exchange rate. Sterilized intervention may be

especially useful when the exchange rate is under speculative attack (that is, when a change in the

exchange rate is not justified by fundamentals) or to help coordinate private sector expectations

Role of Central Banks

Role of Central Banks

The role of central banks in microfinance is related to their broader role in the financial system

and in the economy more generally.

Central banks have a number of objectives:

tactical or macroeconomic objectives (relating primarily to the domestic price level and

the exchange rate);

long-term strategic objectives of financial sector development (including the

development of an effective payments system and other forms of financial infrastructure);

and

sectoral or microeconomic objectives (such as prudential supervision and deposit

insurance).

Portfolio Balance

Portfolio Balance

One of the problems stock investors have is losing their balance in an investment portfolio spread. This

balancing problem can occur in a rising market or in a falling market. The balance is the ratio in your

portfolio of stocks, bonds and cash. Investors should have a ratio in mind (some leave out cash) of how

they want their investments to be in proportion to their total portfolio.

International Monetary Fund (IMF)

International Monetary Fund (IMF)

The IMF promotes international monetary cooperation and exchange rate stability, facilitates the

balanced growth of international trade, and provides resources to help members in balance of

payments difficulties or to assist with poverty reduction.

Through its economic surveillance, the IMF keeps track of the economic health of its member

countries, alerting them to risks on the horizon and providing policy advice. It also lends to

countries in difficulty, and provides technical assistance and training to help countries improve

economic management. This work is backed by IMF research and statistics.

The IMF supports its membership by providing:

policy advice to governments and central banks based on analysis of economic trends and

cross-country experiences;

research, statistics, forecasts, and analysis based on tracking of global, regional, and

individual economies and markets;

loans to help countries overcome economic difficulties;

concessional loans to fight poverty in developing countries; and

technical assistance and training to help countries improve the management of their

economies.

International Fisher Effect (IFE)

International Fisher Effect (IFE)

An economic theory that states that an expected change in the current exchange rate between any two

currencies is approximately equivalent to the difference between the two countries’ nominal interest

rates for that time.

→ CALCULATE:

% change in the exchange rate =

(country A’s interest rate - country B’s interest rate)/(1 + country B’s interest rate)

≈ (country A’s interest rate - country B’s interest rate)

→ EXAMPLE:

If country A’s interest rate is 10% and country B’s interest rate is 5%, country B’s currency

should appreciate roughly 5% compared to country A’s currency.

The rational for the IFE is that a country with a higher interest rate will also tend to have a higher

inflation rate. This increased amount of inflation should cause the currency in the country with the high

interest rate to depreciate against a country with lower interest rates.

Interbank Funds Transfers & Settlement System

Interbank Funds Transfers & Settlement System

In the United States, payment and securities settlement systems consist of numerous financial

intermediaries, financial services firms, and non-bank businesses that create, distribute, and process

large-value payments. The bulk of the dollar value of these payments are processed electronically and

are generally used to purchase, sell, or finance securities transactions; disburse or repay loans; settle

real estate transactions; and make large-value, time-critical payments, such as payments for the

settlement of interbank purchases and sales of federal funds, settlement of foreign exchange

transactions, or other financial market transactions.

There are two primary networks for interbank, or large-value, domestic, funds transfer payment orders.

The first, Fedwire® Funds Service, is operated by the Federal Reserve Banks and is an important

participant in providing interbank payment services, as well as safekeeping and transfer services for U.S.

government and agency securities and mortgage-backed securities. In addition, Fedwire Funds Service

and the Federal Reserve’s National Settlement Service (NSS) are critical components used in other

payment systems’ settlement processes. The Clearing House Interbank Payments Company L.L.C. (CHIP

Co.) operates the second, the Clearing House Interbank Payments System (CHIPS).

Processing large-value funds transfers involves two key elements: clearing and settlement. Clearing is

the transfer and confirmation of information between the payer (sending financial institution) and

payee (receiving financial institution). Settlement is the actual transfer of funds between the payer’s

financial institution and the payee’s financial institution. Settlement discharges the obligation of the

payer financial institution to the payee financial institution with respect to the payment order. Final

settlement is irrevocable and unconditional. The finality of the payment is determined by that system’s

rules and applicable law.

In general, payment messages may be credit transfers or debit transfers. Most large-value funds transfer

systems are credit transfer systems in which both payment messages and funds move from the payer

financial institution to the payee financial institution. An institution initiates a funds transfer by

transmitting a payment order (a message that requests the transfer of funds to the payee). Payment

order processing follows the predefined rules and operating procedures of the large-value payment

system used. Typically, large-value payment system operating procedures include identification,

reconciliation, and confirmation procedures necessary to process the payment orders. In some systems,

financial institutions may contract with one or more third parties to help perform clearing and

settlement activities on behalf of the institution.

The legal framework governing payment activity and the regulatory structure for financial

institutions that provide payment services is complex. There are rules for large-value payments

that are distinct from retail payments. Large-value funds transfer systems differ from retail

electronic funds transfer (EFT) systems, which generally handle a large volume of low value

payments including automated clearinghouse (ACH) and debit and credit card transactions at the

point of sale.

Source: www.ffiec.gov

Balance of Trade

Balance of Trade

The value of a country’s exports minus its imports. A nation’s balance of trade is favorable when the

exports of goods exceed imports, and is said to be unfavorable if imports exceed exports.

Economic Indicators

Economic Indicators

Employment

Consumer Spending

Income

Industrial and Inflation Indicators

Foreign Investment Indicators

Foreign Investment Indicators

The forex market is sensitive to changes in the economy and will react accordingly. As the

economy is affected by investment performance, the expected returns may change due to the

influence of inflation or deflation. Thus, it’s important to consider foreign economy trends while

planning investment strategies.

→ EXAMPLE:

Foreign Investment Indicators

The Business Cycle has 4 stages: 1) recovery (also known as expansion); 2) peak; 3) contraction (also

known as recession); and 4) trough. The growth of business activity, increase of demand and production,

as well as expansion of employment should also be observed.

Gross National Product (GNP) is one of the key indicators of the economic activity. All the services

provided and the goods produced within the US economy form the GNP. There are 4 components

included in the GNP. They are: 1) consumer spending; 2) government spending; 3) investments; and 4)

net exports.

Jurisdictional & Regulatory Framework

Jurisdictional & Regulatory Framework

[Need to include]

NFA Membership & Associate Membership Requirements

NFA Membership & Associate Membership Requirements

Membership in NFA and CFTC registration are mandatory for futures commission merchants (FCMs),

commodity trading advisors (CTAs), commodity pool operators (CPOs), floor brokers, and introducing

brokers (IBs) working with customer accounts, as well as floor traders. The CFTC also requires associate

membership in NFA and CFTC registration for most associated persons (APs). APs solicit orders,

customers, or customer funds for FCMs, IBs, CTAs, or CPOs. Membership is voluntary for futures

exchanges.