A currency is an annotation in an account. If you have a foreign currency account at a financial institution in the country where you live, the money is actually deposited into an entity of a country that has said official currency, so a currency never leaves its country of origin.

The relationship between the various currencies is called the exchange rate and is traded on the International Market of Foreign Exchange (FOREX). The market participants are:

Banks and Financial Institutions: They offer their customers purchase / sale of currency as a business. They can be an operational counterpart for central banks and may even carry out a market maker function. About two-thirds of all deals take place between these entities.

Business: Importers need to buy foreign currency to meet their payments and delivery costs in exchange for their own currency. The exporter makes the deal.

Funds or Institutional Investors: The net amount of their investment has an impact on the currency.

Central Banks and Government Agencies: They must manage and invest their foreign exchange reserves, causing substantial flows of capital.

The exchange rate is the number of units of any currency exchanged for one unit of another currency; the base currency. There are really two deals taking place; the buying one currency which we then sell in exchange for another. In addition, the price depends on which currency is established as the base.

It should also be noted that there is a spread between the price at which the first currency is bought and the second sold, and the price for the opposite deal.

On the other hand, a spot deal done today will have value date within 2 days (D+2), except in Canada where the value date is the following day (D+1).

On many occasions the relationship between two currencies is not quoted directly in the market and we will have to calculate it through another currency.

It should also be taken into account that the price which relates the two currencies will also have a spread: If you want to buy currency 1 you will use the purchase price of currency 1 against the common currency and the selling price of the currency against common currency 2.

A forward transaction is done today but will be liquidated at a future time. It consists of two transactions for the purchase / sale of currency, a one-way deal at an close date to today or even today (usually spot rate), and another in the opposite direction at later date.

• I buy the base currency and sell the counter currency.


• I buy the counter currency and sell the base currency.

An exchange of currencies in a given period takes place in which there will have to be a difference in the price term with respect to the spot rate to make up for the difference in interest rates or yields. Swap points are expressed by the following.

• Swap points>0: They should "join" the spot rate to find the price term. This implies that the currency has an interest rate lower than its foreign currency counterpart.


• Swap points<0: They should be subtracted from the spot rate to find the price term. This implies the currency has an interest rate higher than its foreign currency counterpart.

Calculation of the theoretical price (swap points = = [(r2-r1)*t*spot]/[360+(r1*t)]

N.B.

Spot: Mid-point of the spread.

r = Interest rate

Buying currency 1: borrower interest rate for currency 1, lender interest rate for currency 2

Selling currency 2: lender interest rate for currency 1 and borrower interest rate for currency 2

t = Time: The days between the two transactions.

• It is a true 24 hour market that begins in Sydney and moves around the world. The global financial centre moves on first to Tokyo, then to London and finally to New York.


• It is the highest volume financial market with the greatest degree of liquidity.


• Reduced spreads: Comparatively, in equity markets only very liquid securities offer lower spreads. Even then, they typically represent between 0.04% and 0.06% of the value of the shares, while in FOREX  they are at around 0.02% and 0.03%.


• Fees: Generally Forex Market clients operate without paying any commission. The only "cost" assumed by the client is the difference between buying and selling (spread).


• Ability of very high leverage: Up to 100:1


• Ability to operate both bearishly and bullishly without any of the restrictions which exist in other markets such as the stock market.

Fundamental analysis tries to predict the supply and demand for each currency, which will have to take into account the macroeconomic indicators and the political situation in each country. Here are the key points to keep in mind.

Inflation differential

If the inflation differential from one country to another is growing, it means that the first is losing price competitiveness. As a result, exports World fall and imports rise as they became cheaper. So, the foreign currency would be bought and our own local currency sold. Therefore the local currency would depreciate.

Interest rate differential 

High interest rates, compared to other countries can attract investment of foreign capital, especially in the short term, which would cause the currency to increase in value. If interest rates were lower than in other countries, outflows of funds could lead to the devaluation of the currency.

Political stability

Certain foreign exchange can act as "shelter" at certain times when other countries have an uncertain or unstable situation.

Balance of Trade

The trade deficit implies a higher level of imports than exports, unlike the trade surplus. Therefore, a strong trade deficit will affect the local currency adversely while a trade surplus Hill do the opposite.

Public Deficit

Excessive public deficit, which may affect the growth of the country, will have negative consequences for its currency.

Gross Domestic Product growth 

In principle, higher GDP growth in one country with respect to another, would mean an increase in value of its currency since it would imply higher consumption and investment. However, we would also have to weigh up how this growth would affect other variables such as inflation.