LESSON 1 : MONEY MARKET Types of Money Market Securities

- Is the market for short-term funds, wherein • Treasury Bills

lending and borrowing of funds varies from • Federal Funds (Fed Funds)
overnight to a year. It is an important part of • Repurchase Agreements
the financial system that helps in fulfilling the • Negotiable Certificate of Deposit (NCD)
short-term requirements of companies, banks, • Commercial Paper (CP)
financial institutions, government agencies,
• Banker’s Acceptance
and so forth.
Treasury bills - are issued by the government when
- The money market refers to the market for
they need to raise/ borrow funds and come with a
highly liquid, very safe, short-term debt
very short maturity.
securities.
- Issued when the U.S. government needs to
- The money market consists of a range of
borrow funds.
financial instruments that are short-term in
- Are sold at a discount from par value.
nature and offer low-risk investment
opportunities.
For example:
Deep markets;
- Money market securities are debt securities
Liquid markets
with a maturity of one year or less. They
provide liquidity to investors.
Fed funds (Federal Funds) - are short-term funds
transferred between financial institutions, usually
- Money market securities Issued in the primary
for a period of one day. Provide banks with an
market through a telecommunications
immediate infusion of reserves should they run
network by the Treasury, corporations, and
short of minimum reserve requirements.
financial intermediaries that wish to obtain
short-term financing.
Repurchase Agreement (Repo) - One party sells
securities to another with an agreement to
- Money market securities - Are commonly
repurchase the securities at a specified date and
purchased by households, corporations, and
price. A reverse repo is the purchase of securities
governments that have funds available for a
by one party with an agreement to sell them. A
short time period.
repurchase agreement (or repo) represents a loan
backed by the securities.
- Money market securities are short-term
securities use to obtain short-term credit or to
Negotiable Certificate Of Deposit (NCD)
invest temporarily free funds. These securities
- Bank-issued securities that document a deposit
have maturities of less than one year, typically
and specify the interest rate and the maturity date.
ranging from overnight to 364 days.
Bearer instruments.
- The longer the maturity, the lesser the demand
for it.
- Money market securities are securities that
- Certificates issued by large commercial banks and
provide businesses, banks, and the
other depository institutions as a short-term
government with large amounts of low-cost
source of funds.
capital for a short time.
- The minimum denomination is $100,000.
- Maturities on NCDs normally range from two
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weeks to one year.
Commercial Paper - Unsecured promissory notes, Key Reasons Why Money Market Securities Are
issued only by the largest and most creditworthy Important:
corporations, that mature in a short period of time.
1. Short-term funding- refers to borrowing or
Issued on a discount, just like T-bills.
lending money for a relatively short period,
- Maturities are normally between 20
typically one year or less. This type of funding is
and 45 days but can be as short as 1day or as long
used by individuals, businesses, and governments
as 270 days.
to meet their short-term liquidity needs. Short-
- The minimum denomination of commercial
term funding can be used for a variety of purposes,
paper is usually $100,000.
including financing working capital, purchasing
- Normally issued to provide liquidity or to finance
inventory, or covering short-term expenses.
a firm’s investment in inventory and accounts
receivable. 2. Low-risk investment - is an investment that has
a low probability of losing value or defaulting. Low-
Banker’s Acceptance - Indicates that a bank risk investments are typically associated with
accepts responsibility for a future payment. An lower returns compared to high-risk investments,
exporter that is sending goods to an importer but they provide investors with greater certainty
whose credit rating is not known will often prefer and stability.
that a bank act as a guarantor.
3. Liquidity - refers to the ability of an asset or
security to be bought or sold quickly without
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significantly affecting its price. In other words,
liquidity is the ease with which an investment can
According to Geoffrey Crowther in his book be converted into cash without incurring a
“An outline of Money” has stated: significant loss of value.
“Money market is a collective name given to the 4. Diversification Money - Diversification refers to
various forms and institutions that deal with the the practice of spreading investments across
various grades of near money.” different asset classes, industries, sectors, and
geographical regions to reduce risk and maximize
returns. The goal of diversification is to minimize
Why is it called the Money Market? the impact of any single investment or event on
the overall portfolio performance.
The money market refers to the market for highly
liquid, very safe, short-term debt securities. 5. Benchmark rates - refer to interest rates that
Because of these attributes, they are often seen as serve as a reference point for various financial
cash equivalents that can be interchangeable for instruments and transactions. These rates are used
money at short notice. as a benchmark or standard to determine the
pricing of financial products and investments.
Commonly Used Money Market Security
Objectives of Money Market
1. Treasury bills
• To provide reasonable access to users of short-
- Short-term debt securities issued by the U.S.
term funds to meet their requirements quickly
government that mature in less than one year.
and adequately at a reasonable cost
2. Commercial paper
• To provide a parking place to employ short-
-Short-term debt issued by corporations to
term surplus funds
meet their short-term funding needs.
• To enable the central bank to influence and 3. Certificates of deposit (CDs)
regulate liquidity in the company through -Time deposits offered by banks and other
intervention in this market
financial institutions that mature in less than
------------------------------------------------------------------ one year.
4. Repurchase agreements The top five (5) Institutions of Money Market are:
-Short-term loans backed by collateral, such as 1.Commercial Bank- Commercial banks are the
government securities. backbone of the money market. They form one of
5. Banker's acceptances the major constituents of the money market.
-Short-term financial instruments used to These banks use their short-term deposits for
facilitate international trade transactions. financing trade and commerce for short periods.
6. Municipal notes Commercial banks invest their funds in the
-Short-term debt securities issued by state and discounting of bills of exchange.
local governments to finance their short-term
2.Central Bank- plays a vital role in the money
funding needs.
market. It is the monetary authority and is
7. Federal Funds (Fed Funds)
regarded as an apex institution. No money market
-Fed funds are short-term funds transferred
can exist without the central bank. The central
between financial institutions, usually for a
bank is the lender of the last resort and controller
period of one day. Provide banks with an
and guardian of the money market. It raises or
immediate infusion of reserves should they run
reduces the money supply and credit to ensure
short of minimum reserve requirements.
economic stability in the economy.
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3.Acceptance Houses- The acceptance houses
INSTITUTIONAL USE OF MONEY MARKETS and bills brokers are the main institutions dealing
The top five (5) Institutions of Money Market are: in the bill market. The institution of acceptance
1. Cash Management-Institutional investors use houses developed in England where merchant
money market securities as a way to manage their bankers transferred their headquarters to London
cash balances and meet their short-term funding Money Market in the late 19th and the early 20th
needs. For example, banks may use money market century. They function as intermediaries between
securities to manage their overnight cash balances importers and exporters, and between lenders and
and meet their reserve requirements. borrowers in the short period.
2.Investment of excess cash-Institutional investors 4.Non-banking Financial Intermediaries- there
may invest their excess cash in money market are non-banking financial intermediaries who
securities to generate a modest return on their resort to lending and borrowings of short-term
cash balances while maintaining liquidity. funds in the money market. In non- banking
financial intermediaries, we include savings banks,
3. Collateral for loans-Money market securities
investment houses, insurance companies, building
can be used as collateral for short-term loans and
societies, provident funds, and other business
other financial transactions.
corporations like chit funds.
4. Funding for operations-Corporations may issue
5.Bill Brokers- private companies act as discount
commercial paper to fund their short-term needs,
houses. The main function of these companies is
such as inventory purchases or payroll expenses.
to discount bills on behalf of others.
5.Portfolio Diversification-Institutional investors
may use money market securities as part of a
diversified investment portfolio to reduce risk and VALUATION OF MONEY MARKET SECURITIES
generate income.
• Valuation means determining the worth of the
security.
• The value of a security is derived from the cash
flows associated with that security.
• Time period associated with the securities
• Required rate of return
Valuation of money market securities is important Valuation Of Money Market Securities
to determine what amount an investor is willing to Indicators of future money market security prices.
pay in exchange for security. This can be valued • Economic growth
using the present value approach where the • Employment
interest rate used in the valuation shall reflect the • GDP
required return from the instrument based on the • Retail sales
investors’ perceived risk. • Industrial production
Why Present Value is important? • Consumer confidence
• Indicators of inflation
The concept of present value is one of the most
fundamental and prevalent in the world of finance.
It is the basis for bond prices, financial models of
stock prices, bank, insurance, and pension fund
LESSON 2: DERIVATIVES MARKET
valuations. Present value represents the time DERIVATIVES - contracts that derive their value
value of money. from the performance of an underlying asset,
event, or outcome-hence their name.
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- An agreement between two parties which has
MARKET PRICE OF MONEY MARKET SECURITY
a value determined by the price of something
else.
- The term “Derivative” stands for a contract
whose price is derived from or is dependent
upon an underlying asset.
where Par = par value or principal amount to be
provided at maturity
k = required rate of return by investors MARKET – are used to transfer goods, services,
n = time to maturity funds, or risks.
DERIVATIVES MARKET – is a market developed
over time to transfer risk from one party to
another.
DERIVATIVE CONTRACT – derives its value from an
underlying asset such as stock, currency, or
commodity.
----------------------------------------------------------------- COMPONENTS OF DERIVATIVE CONTRACT
• Underlying
INTEREST RATE RISK
• Counterparties with long/short positions
• If short term interest rates increase, the • An expiration or maturity date
required rate of return on money market
securities will increase and the prices of money DERIVATIVE CONTRACT UNDERLYING ASSETS
market securities will decrease. • Stocks
• An increase in interest rate is not as harmful to • Bonds
a money market security as it is to a longer- • Currencies
term bond. • Commodities
• Market Indices
• Interest Rates
Over-the-counter derivatives – are those which DERIVATIVES MARKET
are privately traded between two parties involves -A common place where such transactions take
no exchange pr intermediary. place
-a market in which derivatives are traded. In short,
Derivative exchange - is a market where it is a market for derivatives.
individuals trade standardized contracts that have
been defined by the exchange. - Derivatives can be created on any asset, event, or
- Acts as an intermediary to all related outcome, which is called the UNDERLYING.
transactions, and takes initial margin from
both sides of the trade to act as an guarantee. - Derivatives can be used to manage risks
associated with the underlying, but they may also
result in increased risk exposure for the other
party to the contract.
OVER-THE-COUNTER VS EXCHANGE TRADED
Over-the-counter – customized contracts made Hedgers – use future or options market to reduce
through a broker-dealer, or directly between the or eliminate the risk associated with price of an
two counterparties. asset.
Exchange- Traded – Standardized contracts that Speculators – use futures and options contract to
are freely traded on a formal, organized exchange. get an extra leverage in betting on future
------------------------------------------------------------------ movements in the price of an asset.
Basic Terminologies Arbitrageurs – are in business to take advantage of
Spot contract- an agreement to buy or sell an asset a discrepancy between prices in two different
today. markets.

Spot price - the price at which the asset changes Uses of Derivatives
hands on the spot date. • Risk Management -Hedging
• Speculation- Essentially making bets on
Spot Date – the normal settlement day for a the price of something.
transaction done. • Reduce transaction cost-Sometimes
cheaper than manipulating cash portfolios.
Long position – the party agreeing to buy the • Regulatory arbitrage- Tax loopholes,
underlying asset in the future assumes a long
position.
Types of Derivatives
1. Commodity Derivatives - underlying
Short position – the party agreeing to sell the asset
instrument is a commodity which may be
in the future assumes a short position.
wheat, cotton, pepper, sugar, jute, …

Delivery Price – the price agreed upon at the time 2. Financial Derivatives - underlying
the contract is entered into. instrument may be treasury bills, stocks,
----------------------------------------------------------------- bonds, foreign exchange, stock index, …
USES OF DERIVATIVES CONTRACTS
Hedging – involves protecting a current financial
Features Of Financial Derivatives
position from potential losses.
• It is a contract
Speculating – involves trying to make guesses
about the underlying assets value to make a profit. • Derives value from underlying asset
• Specified obligation
• Direct or exchange traded
• Related to notional amount
 2. FUTURES CONTRACT
Types of Derivatives Contracts/Markets
- similar to forward, is an agreement between two
• Forward contracts
parties to buy or sell an asset at a certain time in
• Futures contracts Forward Commitment
the future at a certain price. Futures contracts are
• Swap contracts special types of forward contracts in the sense that
• Options contracts – Contingent Claims the former are standardized exchange-traded
contracts.

The most commonly used derivatives contracts are The major differences however include:
forwards, futures and options. • Futures contracts have standardized contract
1. FORWARD CONTRACT terms.
-is a customized contract between two entities, • Future contracts are traded on exchanges
where settlement takes place on a specific date in rather than over the counter.
the future at today's pre-agreed price. • Future contracts involve margins.

- is an agreement between two parties to exchange Components of a Future Contract:

an asset for a pre-specified price on a specific date • Underlying assets
in the future. • Delivery date
• Specified Price
Components of a Forward contract • Contract Size
• Underlying asset • Type of Delivery
• Delivery date • Tick size
• Specified Price • Initial and maintenance margin
• Quantity
• Type of Delivery How are Futures Prices Calculated?
Cost = Spot price + Carry cost ( internet + Storage )
Basic terms used in forward contracts – Carry return
• Underlying asset- it refers to the real financial
asset or security that a financial derivative is 3. OPTION CONTRACT – gives one party the right,
based on. but not obligation, to buy or sell an underlying
assets as a specific price or at a specific date.
• Quantity – this mainly refers to the size of the
contract that gives the specific amount in units The two basic/types of options
of the asset that is being bought and sold. 1. Call option
- is the option to buy an underlying asset at a
• Price – this is the price that will be paid on the specified price in the future.
expiration date must also be specified. - give the buyer the right but not the obligation to
buy a given quantity of the underlying asset, at a
• Expiration date – this is the date when the given price on or before a given future date.
agreement is settled and the asset is delivered
and paid. 2. Put option
- is the option to sell an underlying asset at a
Risk involved in forward contract specified price in the future.
1. Regulatory risks - give the buyer the right, but not the obligation to
2. Liquidity risks sell a given quantity of the underlying asset at a
3. Default risks given price on or before a given date.
Components of an Option Contract: Components of Swap Contract:
• Underlying asset • Underlying asset
• Expiration date • National account
• Strike price • Maturity date
• Contract size • Fixed/floating rates
• Type of delivery • Payment Frequency
• Option premium
• American vs. European TYPES OF SWAPS ARE:
1. Interest rate swaps
Moneyness- refers to whether an option has 2. Currency swaps
intrinsic value by comparing the strike and spot 3. Commodity swaps
prices. 4. Debt- Equity swaps
5. Credit default swaps
Some Terminologies:
1. Call option - right but not the obligation to 1.Interest rate swaps:
buy - An interest rate swap “ swaps” a fixed rate of
2. Put option - right but not the obligation to interest for a floating rate of interest.
sell.
3. Option price - the amount per share that - This entail swapping only the interest related cash
an option buyer pays to the seller. flows between the parties in the same currency.
4. Expiration date - the day on which an
option is no longer valid. - involve parties exchanging cash flows so that they
5. Strike price – the reference price at which can hedge against an interest rate risk or
the underlying may be traded. speculate.
6. Long position - buyer of an option assumes
long position. 2.Currency Swaps
7. Short position - seller of an option - These entail swapping both principal and interest
assumes short position. on different currency than those in the opposite
direction.
Option Styles: - a transaction in which two parties exchange an
1. European option – an option that may only equivalent amount of money with each other but
be exercised on expiration. in different currencies.
2. American option – an option that may be 3.Commodity Swaps
exercised on any trading day on or before - is an agreement to exchange payments based on
expiry. a pre-agreed notional quantity of raw material on
3. Bermudan option – an option that may be future dates.
exercised only on specified dates on or
before expiration. 4.Debt-equity swap
----------------------------------------------------------------- - a transaction in which a company or individual
4. SWAP CONTRACT exchanges debt owned for something valuable.

- is a derivative in which two counterparties

5.Credit default swaps
exchange cash flow (known as “legs”) over a
- both the parties get into an agreement in which
period of time.
the one pays the lost principal and interest of a
- private agreements between two parties to loan.
exchange cash flows in the future according to a ------------------------------------------------------------------
prearranged formula. They can be regarded as
portfolios of forward contracts.
FUNCTIONS OF DERIVATIVES Futures Contracts Are Superior To Forward
• Risk aversion tools Contracts
• Prediction of future prices • NO COUNTER-PARTY RISK
• Enhance liquidity • LIQUIDITY
• Catalyze growth of financial markets • UNIFORMITY
• Brings perfection in market • MARKED TO MARKET

FUNCTIONS OF DERIVATIVES MARKETS

Features of Futures Contracts
• Discovery of price
• Organized Exchanges
• Risk transfer
• Standardization
• Linked to cash markets
• Clearing House
• Check on speculation
• Margins
• Increases savings and investments
• Marking to Market
PARTICIPANTS IN THE DERIVATIVES MARKETS • Actual Delivery is Rare

• Hedgers ADVANTAGES OF FUTURES CONTRACTS

• Speculators • Opens the Markets to Investors
• Arbitrageurs • Stable Margin Requirements
• Margin Traders • No Time Decay Involved
------------------------------------------------------------- • High Liquidity
• Simple Pricing
FORWARD CONTRACT - an agreement made
• Protection Against Price Fluctuations
directly between two parties to buy or sell an
• Hedging Against Future Risks
Asset on a specific date in the future, at the terms
decided today.
DISADVANTAGES OF FUTURES CONTRACTS
- Forwards are widely used in commodities, foreign
exchange, equity and interest rate markets. • No Control Over Future Events
• Leverage Issues
ESSENTIAL FEATURES OF A FORWARD ARE: • Expiration Dates
• It is a contract between two parties (Bilateral
contract). OPTIONS - It is a contract whereby one party (the
• All terms of the contract like price, quantity holder or buyer) has the right, but not the
and quality of underlying, delivery terms like obligation, to exercise the contract (the option) on
place, settlement procedure etc. are fixed on or before a future date (the exercise date or expiry)
the day of entering into the contract. - The amount the buyer pays the seller
for the option is called the option
FEATURES OF FORWARD CONTRACTS premium
• Bilateral -----------------------------------------------------------------
• More Risky Than Futures Participants of Options
• Customized Contracts • Buyers of calls
• Long and Short Positions • Sellers of calls
• Delivery Price • Buyers of puts
-------------------------------------------------------------- • Sellers of puts
People who buy options are called holders and
FUTURE CONTRACT – A legal agreement to buy or those who sell options are called writers.
sell a particular commodity asset, or security at a
predetermined price at a specified time in the TWO MAIN TYPES:
future. - Calls
- Puts
CLASSIFICATION OF OPTIONS •A swap is a contract made between two parties
that agree to swap cash flows on a date set in the
• Calls
future.
• Puts
• American Style •A futures contract obligates a buyer to buy and a
• European Style seller to sell a specific asset, at a specific price to
• Exchange Traded Options be delivered on a predetermined date.
• Over The Counter Options ----------------------------------------------------------------
• Option Type By Expiration
- Regular Options LESSON3 : FOREIGN EXCHANGE MARKET
- Weekly Options Foreign exchange market
- Quarterly Options - is where participants come to buy and sell foreign
- Long - Term Expiration Anticipation currencies
- Also known as Forex Market
Securities
- typically refers to large commercial banks in
• Employee Stock Options
financial centers.
• Cash Settled Options - Is a place where foreign money are bought and
• Exotic Options sold.
- Barrier Options -It is the market where exchange rates are
- Binary Options determined.
- Chooser Options - is the largest and most liquid financial market in
- Compound Options the world where currencies and trillions are traded
- Look Back Options daily.
- It operates 24 hours a day, five days a week,
across major financial centers worldwide,
SWAPS - refers to an exchange of one financial
including New York, London, Tokyo, Zurich,
instrument for another between the parties
Frankfurt, Hong Kong, Singapore, Paris, and
concerned. Sydney.
- A custom tailored bilateral agreement in which
cash flows are determined by applying a Exchange rates of currency - are the mechanisms
prearranged formula on a notional principal. by which one currency will be exchanged for
another. It is also regarded as the value of one
- an instrument used for the exchange of stream of country's currency in terms of another currency
cash flows to reduce risk. foreign exchange rates. This rate depends on the
local demand for foreign currencies and their local
supply, country's trade balance, strength of its
EQUITY SWAPS - an agreement between two economy, and other such factors.
counterparties where one party receives the
return on an asset from the other party and makes The forex market involves various participant:
a payment to the other party based on a fixed or - central banks,
floating rate of interest. - commercial banks
- investment banks
- hedge funds
DIFFERENCE BETWEEN SWAP & FUTURES - corporations
- retail traders
CONTRACT
- speculators
•Swaps and futures are both derivatives, which -----------------------------------------------------------
are special types of financial instruments that - Commercial Banks
derive their value from a number of underlying - Hedge funds
assets. - Real money
- Retail traders
- Sovereign wealth funds
- Prime brokers Factors influencing Currency Exchange
- Proprietary trading firms Rate
- Money transfer/remittance companies • Interest rates
- Foreign exchange fixing • Inflation
- Commercial companies • Economic indicators
- Governments and Central banks • Geopolitical events
- Corporations • Market sentiments
- Governments Currency Exchange Rates
- Central banks 1.Inflation - is the relative purchasing power of a
- Investment banks currency compared to other currencies.
- Commercial banks
- Hedge funds 2.Interest rates - are tightly tied to inflation and
- retail brokers exchange rates.
- investors
- vacationers 3.Public Debt - most countries finance their
budgets using large-scale deficit financing.
Central banks play a crucial role by setting
monetary policies and occasionally 4.Political Stability – a politically stable country
intervening in the market to stabilize their attracts more foreign investment, which helps
currencies. prop up the currency rate.

Role of Forex Market in the Global 5.Economic Health - is another way exchange
Economy rates are determined.
1. Facilitate currency conversion
2. Provide instruments to manage foreign 6.Balance of Trade – is the relative difference
exchange risk (such as forward exchange) between a country’s imports and exports.
3. Allow investors to speculate in the market
for profit. 7.Current Account Deficit - is closely related to
the balance of trade.
How currencies are traded?
- Currencies are traded in pairs, so that in every 8.Confidence/ Speculation - currency changes
trade one currency is exchanged for another at a from speculation tend to be irrational, abrupt,
given rate, determined by the market. and short-lived.
.
The rate of exchange being a price of national 9.Government Intervention – governments have
currency in terms of another, is determined in a collection of tools at their disposal through
foreign exchange market in accordance with which they can manipulate their local exchange
general principle of the theory of value i.e., by the rate.
interaction of forces of demand and supply.
Factors Influencing Exchange Rates:
Major currency pairs 1) Economic Indicators: Economic data, such as
CURRENCY PAIR - is the quotation of two different GDP growth, inflation, employment figures,
currencies, with the value of one currency being and consumer spending, influence currency
quoted against the other. valuations.
Major currency pairs - are the most traded 2) Interest Rates: Central banks adjust interest
currency pairs in the forex market. They rates to control inflation and stimulate
involve the most liquid currencies and are traded economic growth.
in the highest volumes. 3) Political Stability and Geopolitical Events:
Political stability and geopolitical tensions
affect investor confidence and currency prices.
4) Market Sentiment: Trader sentiment,
reflected in market positioning and risk
 appetite, can drive short-term currency -is a contract that gives the buyer the right, but
movements. not the obligation, to buy or sell a certain
5) Speculation: Speculators trade currencies to currency at a specified exchange rate on or
profit from short-term price fluctuations. Their before a specified date.
actions can amplify volatility in the forex 5.CURRENCY SWAPS
market, especially during periods of -are financial contracts between two parties to
heightened uncertainty. exchange a specific amount of one currency for
an equivalent amount of another currency.

Forex instruments: TYPES OF FOREX INSTRUMENT

1) Spot Forex Contracts: Spot forex contracts 1.SPOT TRANSACTION
involve the buying or selling of currencies for -The spot transaction is when the buyer and seller
immediate delivery at the current market of different currencies settle their payments
price. These transactions settle "on the spot," within the two days of the deal. It is the fastest
typically within two business days. way to exchange the currencies. Also known as FX
2) Forward Contracts: Forward contracts are spot.
agreements between two parties to exchange 2.FORWARD TRANSACTION
currencies at a specified price (exchange rate) -Is a binding contract in the foreign exchange
on a future date. market that locks in the exchange rate for the
3) Futures Contracts: Forex futures contracts are purchase or sale of a currency on a future date.
standardized agreements to buy or sell a 3.FUTURES TRANSACTION
specified amount of a currency pair at a -are futures contracts for currencies that specify
predetermined price and future date. the price of exchanging one currency for another
4) Options Contracts: Forex options give traders at a future date. It can be customized clients
the right, but not the obligation, to buy (call request and can only be traded on the organized
option) or sell (put option) a currency pair at a exchange.
predetermined price (strike price) on or before 4.OPTION TRANSACTION
a specified date (expiration date). -is a contract that gives the buyer the right, but
5) Currency Swaps: Currency swaps are not the obligation, to buy or sell a certain
agreements between two parties to exchange currency at a specified exchange rate on or
currencies at a specified exchange rate on a before a specified date.
predetermined date and reverse the 5.SWAPS TRANSACTION
transaction at a later date. -Involve a simultaneous borrowing and lending of
two different currencies
TYPES OF FOREX INSTRUMENT: between two investors.
1.SPOT TRANSACTION
-also known as FX spot, is an agreement between Types of Forex Instruments
two parties to buy one currency against selling 1.Spot Contracts
another currency at an agreed price for -contract of exchanging currencies, securities,
settlement on the spot date. and commodities at the price of the settlement
2.CURRENCY FORWARD date.
-is a binding contract in the foreign exchange - It involves the immediate purchase and sale of
market that locks in the exchange rate for the currencies, securities, and commodities.
purchase or sale of a currency on a future date. -It is suitable for short-term arrangements.
3.CURRENCY FUTURES
-are futures contracts for currencies that specify 2.Forward Contracts
the price of exchanging one currency for another -an agreement of buying or selling of particular
at a future date. asset on a mentioned future date at the specified
4.CURRENCY OPTION rate.
- (also known as a forex option) -It is utilized by players to restrict the risk of
exchange rate uncertainty.
-It is foreign exchange derivatives.
 2.Commodity swaps - is derivative contract in
3.Options which two parties agreed to exchange their cash
-parties can exercise options on favorable terms. - flows related to the fundamental assets or
-It is also a type of forex derivative used to commodity up to a defined period of time.
mitigate forex trading risks. Generally commodity swaps used to protect
- It gives the purchaser the right, but not a against the cost variance of commodities in the
responsibility to transfer any underlying asset, market.
currencies, security, etc.
3.Equity swaps - is an arrangement in which total
Two kinds of Options: return on equity or dividends and equity capital is
1.Call option - It is a commitment that offers the exchanged with floating or fixed rate of interest.
purchaser the right, but not responding to buy a
particular number quantity of assets from the 4.Currency swap- is a derivative, which allows two
seller of the option at a pre-determined price on parties to agree to transfer sameamount of money
the specified date. but in various currencies. Currency swap permits,
organizations operated in foreign can avail loans at
2.Put option - It is a commitment that offers the lower interest rates from their home country.
purchaser the right, but not responding to sell a
particular number quantity of assets from the Participants of forex market
seller of the option at a pre-agreed price on the 1.Central Banks
specified date. - influence the Forex Market extensively through
their enact foreign exchange policies. They also
4.Future aim to stabilize the domestic currency of a country
-an arrangement between two agencies that by intervening the market.
make one agent purchase an asset, financial - Their main task is exchange regulations in the
instruments, securities, currencies, and foreign market, namely, the prevention of spike
counterparty to sell an asset, financial rates of national currencies in order to prevent
instrument, securities, and currencies at a economic crises, maintaining the exports and
fixed future date. imports balance.
-Derivative instrument that is used by investors to - they have a direct impact on the Forex market.
make huge profits on Their influence can be direct - in the form of
their investments. currency intervention, or indirect – via regulation
of money supply and interest rates.
5.Swap
-the agreement between two agencies to 2.Commercial Banks
exchange their revenue or cash flows from any - these institutions act as intermediaries for
assets or liabilities, which is occurred during clients, including corporations, governments, and
particular intervals. retail traders, facilitating currency transactions
- Swaps are an exchange between two parties to and providing liquidity.
trade currencies for a pre-determined - they execute most of foreign exchange
period of time. operations.

3. Multinational Corporations (MNC)

Kinds of Swap: - companies that have branches spread across
1.Interest rate swaps - are derivative contracts other countries. They engage in forex to hedge
which involves exchange of interest rates between against inflation by converting currencies and to
two agencies. It is a forward contract which enable also profit.
two parties to interchange their interest rate from - Multinational Corporations in business are
fixed to floating or floating to fixed to pay their companies that have branches spread across
debts. It helps to reduce the movement in interest other countries. MNCs act as an umbrella
rates. covering various companies based in different
countries, yet they are listed in one country that
hosts their headquarters. MNCs deal extensively the market. They are essential for providing
in forex since they have to convert the currencies liquidity and are the backbone of the forex market.
they earn in different countries into that of their
home/listed country. Often they hedge against 2.Real Money - Investment funds that do not use
inflation by converting their main currencies into leverage, hence the term 'real money'. Those are
that of the new country’s currency or a stronger usually pension and mutual funds, which manage
one to profit over time. large sums of money and use the FX market for
transactions when dealing in foreign securities.
4. Hedge Funds
- a private investment funds who trade currencies 3.Retail Traders - Individual traders usually access
as part of their investment strategies. It is handled the market through a retail broker, but may also
by a Hedge Fund Manager or seasoned trader and use a prime broker if they have the necessary
their funds came from a wealthy investor or capital. Given the small amount of money needed
individual. to open a trading account, retail traders have
- Make up the second-biggest collection of players access to utilize leverage.
in the forex market next to banks and central
banks. Investment managers trade currencies for 4.Hedge funds - Hedge funds are the most
large accounts such as pension funds, foundations, prominent members of the group of speculators.
and endowments. While there are several types of hedge funds, the
ones that are most active in the FX market are the
5. Retail Traders global macro funds and the currency funds. Hedge
- Individual investors and speculators trade funds can handle huge positions in the
currencies through the help of brokers. market and are important participants.
- or individual traders constitute the largest
population of people trading the forex 5.Sovereign Wealth Funds -State-owned
market today. However, the amount of capital investment funds manage the country‘s money
contributed by the retail investors is relatively and invest it in various markets. Sovereign wealth
small compared to other participants. As a result, funds manage huge amounts of money and hence,
individual traders often tend to rely heavily on the their transactions can have a large impact on the
leverage provided by their broker to enable FX market.
them to trade the forex market.
6.Retail Brokers - Brokerage firms that allow
6. Governments individual forex traders to access the FX market.
- engage in forex markets for various reasons, They can be market makers, STP brokers, or ECNs.
including managing currency values, financing Market makers take the opposite side of all the
international trade, and intervening to influence client’s trades and are basically acting as dealers,
exchange rates. not brokers.
- Just like the individual and commercial banks
seek profits by trading the Forex Market, so does 7.Proprietary trading firms - Firms hire individual
the government. Most governments invest a large traders to trade the company’s money and give
number of their funds into the forex market to them in return a certain share of the profits they
hedge against inflation and boost their local have realized. The trader can benefit from
economy. As a result, governments are estimated professional tools that would be too expensive to
to contribute over 5% of the total amount traded purchase as an individual.
in forex markets.
8.Prime brokers - Firms that offer liquidity,
Forex Market Participants leverage, and supporting services to other market
1.Commercial banks - are one of the most participants. Most major banks have prime
important participants in the foreign exchange brokerage operations, but there are also non-bank
market. They trade on their own behalf but also prime brokers active in the business. The client of
provide a channel for their clients to participate in prime brokers are usually other institutional
participants.
9.Money transfer/ remittance companies
- Companies specializing in money transferring 4.The US dollar and Swiss franc: USD/CHF
have been able to significantly gain market share “The Swissie” is a combination of the US dollar and
in the past 10 years. This was primarily driven by the Swiss franc.
digitalization and consumers becoming more
informed. Money transfer companies generally 5.The Euro and British pound : EUR/GBP
do not engage in speculative trading. “The Chunnel” is a combination of the Euro and
the British pound sterling, a play on words for the
10.Commercial companies - This group includes Channel Tunnel that connects both continents .
various corporations, like
multinational firms or exporters/importers. Their The major currency pairs include:
main goal is not to make a profit from currency ➢ EUR/USD - Euro/US Dollar
trading but rather to hedge their currency - accounts for approximately one-quarter of
exposure or get the foreign currency they need to trading in global foreign exchange markets,
pay their workers in other countries and similar. according to the BIS. The EURUSD is the most
liquid pair, meaning the ability to enter and
11.Governments and central banks exit a trade is easier and will consistently have
– Central banks intervene in the market when the most competitive spreads.
their currency becomes a problem for the ➢ USD/JPY exchange rate - US Dollar/ Japanese
domestic economy, by either being too strong or Yen
too weak. This applies to all exchange-rate - is one of the most commonly traded currency
regimes – the floating, pegged, and fixed. Central pairs in the world, and its movements can have
banks are also active in the market when they a significant impact on the global economy.
have to manage their foreign currency reserves. The exchange rate is influenced by a variety of
factors, including economic indicators,
12.Foreign exchange fixing political events, and market sentiment.
- The foreign exchange fix is a benchmark that is
based on trades that were executed in a particular ➢ GBP/USD currency pair - British Pound/US
time window. Dollar
- is one of the most commonly traded currency
MAJOR CURRENCY PAIRS pairs in the world, and its movements can have
• EUR/USD (Euro/US dollar) a significant impact on the global economy.
• USD/JPY (US dollar/Japanese yen) The exchange rate is influenced by a variety of
• GBP/USD (British pound/US dollar) factors, including economic indicators,
• USD/CHF (US dollar/Swiss franc) political events, and market sentiment.
• AUD/USD (Australian dollar/US dollar)
• USD/CAD (US dollar/Canadian dollar) ➢ USD/CHF – US Dollar/Swiss Franc
• NZD/USD (New Zealand dollar/US dollar) - is a major currency pair representing the
exchange rate between the US dollar (USD) and
MAJOR CURRENCY REFAIRS the Swiss franc (CHF). It is a popular
1.The euro and US dollar: EUR/USD currency pair that attracts investors and traders
“The Fiber” is a combination of the Euro and the due to the stability of the Swiss economy and the
US dollar. safe-haven status of the Swiss franc.

2.The US dollar and Japanese yen: USD/JPY

“The Gopher” is a combination of the US dollar and Currency Exchange Rates
the Japanese yen. The exchange rate of a currency is how much of
one currency can be bought for each unit of
3.The British pound sterling and US dollar: another currency.
GBP/USD
“The Cable” is a combination of the British pound
sterling and the US dollar.
Currency Speculations and trading strategies 4. News Trading
Currency speculation - Traders aim to capitalize on the immediate
-involves betting on the future movements of market volatility and price movements triggered
exchange rates between different currencies with by significant economic news releases and events.
the aim of making a profit. Various trading --is a strategy that seeks to take advantage of
strategies are employed by currency traders to opportunities that arise in the markets when
capitalize on these movements. relevant economic data and information hit the
- involves making bets on the future direction of headlines..
exchange rates in order to profit from
fluctuations in currency values. Trading strategies
in the forex market refer to systematic Forex market structure
approaches or methods used by traders to make - characterized by its decentralized nature and the
decisions about when to buy, sell, or hold diverse range of participants involved.
currencies. - is a worldwide decentralized over-the-counter
(OTC) financial market for trading currencies.
Currency Speculation - refers to the organization and arrangement of
-speculative investing involves the purchase of a participants, trading mechanisms, and
foreign currency infrastructure within the foreign exchange market.
- It is an act where investor aims to buy the - It includes the interbank market, electronic
currency at a lower rate and sell it later at an trading platforms, and over-the-counter (OTC)
appreciated value, rather than using it for a long- trading.
term financial purpose

Here are some common CURRENCY TRADING FOREX MARKET STRUCTURE

STRATEGIES: 1.Market structure - refers to the overall
1.Carry Trading framework of the forex market, including its highs,
- Taking advantage of interest rate differentials lows, and trends. It consists of three main
between currencies by buying a currency with a elements: peaks, troughs, and trends.
higher interest rate and selling a currency with a
lower interest rate. 2.Interbank Market -is a global network utilized by
-is a trading strategy that involves borrowing at a financial institutions to trade currencies and other
low-interest rate and investing in an asset that currency derivatives directly between themselves
provides a higher rate of return. A carry trade is
typically based on borrowing in a low-interest rate Interbank Market -is a global network utilized by
currency and converting the borrowed amount financial institutions to trade currencies and other
into another currency. currency derivatives directly between themselves

2.Trend Following 3.Electronic currency platform - is a method of

- Identifying and trading in the direction of trading currencies through an online broker or via
established trends, either uptrends or an online currency exchange.
downtrends.
-is when you try to capture extended moves in the 4.Over-the-counter (OTC) - Forex trading also
financial markets, either up or down, mostly for takes place in over-the-counter markets as
long-term gains. transactions are executed outside of a centralized
exchange.
3.Range Trading
- Trading within defined support and resistance 5.Market liquidity- refers to the extent to which a
levels, buying near support and selling near market, such as a country’s stock market or a city’s
resistance. real estate market, allows assets to be bought and
-is an active investing strategy that identifies a sold at stable, transparent prices.
range at which
the investor buys and sells at over a short period.
6.Forex spread -is the difference between the direct interventions, interest rate policies, and
exchange rate that a forex broker sells a currency quantitative easing programs.
and the rate at which the broker buys it.
-These interventions are typically undertaken to
7.Trading hours - The forex market is open 24 achieve specific economic objectives such as
hours a day during the weekdays which allows controlling inflation, managing exchange rates, or
traders to potentially trade all day and all night. ensuring financial stability. This report aims to
provide an overview of central bank interventions,
The Role of Interbank Market their objectives, tools used, effectiveness, and
The interbank market is a global network used by potential implications.
financial institutions to trade currencies and other
currency derivatives directly between themselves. Purpose of Central Bank Intervention:
Banks use the interbank market to manage their ▪ Exchange Rate Stability
own exchange rate and interest rate risk. They can ▪ Inflation Control
also use the market to take speculative positions ▪ Financial Stability
based on research. ▪ Economic Growth

Electronic Trading Currency Crises and Pegged Exchange Rates

Traders using an electronic brokerage system are have been central to the functioning of global
able to know instantly the best price available in economies, often influencing economic stability
the market. Electronic trading platforms gained and growth. This report aims to provide an
market share almost overnight. The share of overview of currency crises, their causes, effects,
electronic trading went from 2% in 1993 to almost and the role of pegged exchange rates in
20% in 2001. In the last BIS survey, in 2022, the mitigating or exacerbating such crises.
share of electronic trading in the spot foreign
exchange market was close to 60%. Currency crisis occur when a country's currency
experiences a rapid depreciation or devaluation
Market Hours due to economic instability or speculative attacks.
The spot FX market is unique to any other market
in the world, as trading is available 24-hours a day. Currency Crisis is brought on by a sharp decline in
Somewhere around the world, a financial center is the value of a country's currency. This decline in
open for business, and banks and other value, in turn, negatively affects an economy by
institutions exchange currencies, every hour of the creating instabilities in exchange rates, meaning
day and night with only minor gaps on the one unit of a certain currency no longer buys as
weekend. much as it used to in another currency.

Electronic Trading Platform Pegged exchange rate regimes involve maintaining

- This platform provides a venue for trading fixed exchange rates
currencies electronically. relative to a reference currency or basket of
-It also gives more accessibility to a broader range currencies.
of participants.
One example of currency crisis is the ending of
Over-the-Counter Trading Bretton Woods system.
-Forex trading is predominantly conducted over
the counter, meaning trades occur directly Speculative Attacks: Speculators betting against a
between parties without the supervision of an currency can trigger a crisis by selling off large
exchange. amounts of the currency, causing its value to fall.

Central bank intervention Speculative Attack occurs in the foreign exchange

-refers to /involves actions taken by a country's markets when speculators attack the currency of a
central bank to influence the value of its currency country attempting to maintain a fixed, or pegged
or to stabilize financial markets. This may include exchange rate.
Macroeconomic Imbalances: High inflation, large Forex Regulation and Compliance:
budget deficits, excessive borrowing, and weak Forex regulation - refers to the set of rules and
economic fundamentals can undermine guidelines governing the operations of the forex
confidence in a currency. market, including the conduct of market
participants and the protection of investors.
External Shocks: Economic crises, geopolitical
instability, or sudden changes in global market Regulatory bodies such as the Commodity Futures
conditions can also precipitate currency crises. Trading Commission (CFTC) in the United States
and the Financial Conduct Authority (FCA) in the
Asian Financial Crisis (1997): Countries like UK oversee forex trading activities.
Thailand, Indonesia, and South Korea experienced
severe currency crises due to overvaluation of
their currencies, excessive borrowing, and weak
financial systems.

Forex Regulation and Compliance

Foreign exchange (Forex) market
- is the largest and most liquid financial market
globally, with trillions of dollars traded daily.
Given its scale and complexity, regulatory
oversight is crucial to maintain market integrity,
protect investors, and ensure fair competition.
This report provides an overview of Forex
regulation and compliance, highlighting key
aspects and recent developments in this dynamic
regulatory
landscape.

Regulatory Bodies
▪ Global regulators: Institutions such as the
International Organization of Securities
Commissions(IOSCO) and the Financial
Stability Board (FSB) provide international
coordination and standards for Forex
regulation.

▪ National regulators: Each country has its own

regulatory authority responsible for
overseeing Forex activities. For instance, in the
United States, the Commodity Futures Trading
Commission (CFTC) and the National Futures
Association (NFA) regulate Forex trading.