Repercussions of Settlement Failure
Although the party that causes the failure typically has to compensate the other counterparty for any interest income lost due to the non-receipt of currency, this failure can have serious repercussions.
Apart from the (cost of) time wasted trying to resolve the issue, such failures can erode a bank’s reputation quite quickly. Also, the party causing the failure will typically have to compensate the other counterparty for any interest income lost due to the non-receipt of currency. A settlement failure may also have a snowball effect in that the receiving bank may have needed the funds to pay another obligation. Additionally, market regulators often apply fines and sanctions to banks that cause settlement failure.
One method to prevent failure in FX market settlement is netting. See in detail here.
Showing posts with label Foreign Exchange / FX. Show all posts
Showing posts with label Foreign Exchange / FX. Show all posts
Sunday, 25 July 2010
Netting
Netting is one of the most effective ways of reducing settlement risk in FX trades. Payment (or settlement) netting is defined as an arrangement between two or more counterparties to net all payments in a single currency owed between them on a given value date.
Regulatory authorities encourage netting arrangements because they reduce the amount of payments that have to be made.The lower the number of payments, the lower the probability that there will be a default. In addition, because netting reduces the number of payments, both the opportunity for human error and the charges levied per payment are reduced.
Ideally, the process of payment netting should be supported by a legal agreement. This can take the form of a brief document that only supports netting, or it can be a settlement netting provision that is included in a master agreement.
Calculating netted amounts correctly is important to ensure accurate settlement monies. Market participants should automate the actual netting calculation, if possible, so that errors introduced by manual calculations are reduced. Counterparties should confirm the net payment amount with each other at a predetermined cut-off time prior to settlement.
Types of Netting
Netting of payments between counterparties take place through different methods.
Bilateral Netting
The netting of payments between two counterparties is known as bilateral settlement netting.
Example
Invest Bank is due to make five payments to Finance Bank for a total of GBP 100 million. However, Finance Bank is due to make three payments to Invest Bank for a total of GBP 95 million.
If the two banks use bilateral settlement netting then they need not make eight separate payments totaling GBP 195 million. Instead, Invest Bank can simply make one payment to Finance Bank for GBP 5 million.
The one drawback with bilateral netting is that although it reduces the number of payments a bank has to make, the actual reduction is often rather small in practice. The reason for this is that a bank may not have reciprocal deals with all the banks that it deals with. In such situations, bilateral netting cannot bring the maximum benefit of netting.
Multilateral Netting
Netting by Novation
Payment netting reduces the number of settlement payments flowing between counterparties and therefore reduces settlement risk. However, it does not reduce credit risk as the contracts giving rise to the obligations being netted remain in effect, and both counterparties remain legally obliged to settle for the gross amount of their obligations.
Netting by novation is the process whereby a number of contracts are canceled and replaced by one single contract. This new contract is legally binding and aggregates and nets all of the payment obligations of the previous contracts.
Novation netting, unlike payment netting, refers not only to the payments due under transactions, but also to the transactions themselves – it is arranged not at settlement but when a contract is entered into, and it has the effect of lowering counterparty credit risk.
Close-Out Netting
In addition to payment netting, master agreements may also provide for close-out netting. This is an agreement to settle all contracted claims and obligations by one single payment, upon the occurrence of default by one party (or if some other termination event occurs).
Close-out netting differs from netting by novation in that the latter is accomplished prior to a default or bankruptcy occurring (when the transaction takes place), whereas the former type of agreement occurs in the event of default (that is, a contract is signed but only retrieved in the event of default).
Regulatory authorities encourage netting arrangements because they reduce the amount of payments that have to be made.The lower the number of payments, the lower the probability that there will be a default. In addition, because netting reduces the number of payments, both the opportunity for human error and the charges levied per payment are reduced.
Ideally, the process of payment netting should be supported by a legal agreement. This can take the form of a brief document that only supports netting, or it can be a settlement netting provision that is included in a master agreement.
Calculating netted amounts correctly is important to ensure accurate settlement monies. Market participants should automate the actual netting calculation, if possible, so that errors introduced by manual calculations are reduced. Counterparties should confirm the net payment amount with each other at a predetermined cut-off time prior to settlement.
Types of Netting
Netting of payments between counterparties take place through different methods.
- Bilateral netting
- Multilateral netting
- Netting by novation
- Close-out netting
Bilateral Netting
The netting of payments between two counterparties is known as bilateral settlement netting.
Example
Invest Bank is due to make five payments to Finance Bank for a total of GBP 100 million. However, Finance Bank is due to make three payments to Invest Bank for a total of GBP 95 million.
If the two banks use bilateral settlement netting then they need not make eight separate payments totaling GBP 195 million. Instead, Invest Bank can simply make one payment to Finance Bank for GBP 5 million.
The one drawback with bilateral netting is that although it reduces the number of payments a bank has to make, the actual reduction is often rather small in practice. The reason for this is that a bank may not have reciprocal deals with all the banks that it deals with. In such situations, bilateral netting cannot bring the maximum benefit of netting.
Multilateral Netting
Netting by Novation
Payment netting reduces the number of settlement payments flowing between counterparties and therefore reduces settlement risk. However, it does not reduce credit risk as the contracts giving rise to the obligations being netted remain in effect, and both counterparties remain legally obliged to settle for the gross amount of their obligations.
Netting by novation is the process whereby a number of contracts are canceled and replaced by one single contract. This new contract is legally binding and aggregates and nets all of the payment obligations of the previous contracts.
Novation netting, unlike payment netting, refers not only to the payments due under transactions, but also to the transactions themselves – it is arranged not at settlement but when a contract is entered into, and it has the effect of lowering counterparty credit risk.
Close-Out Netting
In addition to payment netting, master agreements may also provide for close-out netting. This is an agreement to settle all contracted claims and obligations by one single payment, upon the occurrence of default by one party (or if some other termination event occurs).
Close-out netting differs from netting by novation in that the latter is accomplished prior to a default or bankruptcy occurring (when the transaction takes place), whereas the former type of agreement occurs in the event of default (that is, a contract is signed but only retrieved in the event of default).
Settlement and payment systems in FX markets
Settlement of FX transactions usually involves the use of secure international and domestic payment system networks. Let us study three of these networks in detail.
Con
Con
Continuous Linked Settlement (CLS)
Continuous Linked Settlement is a real-time system that by which a number of the world's largest banks manage settlement of foreign exchange amongst themselves (and their customers and other third-parties), irrespective of time zones.
It has 17 eligible currencies under it right now. These are:
The process is managed by CLS Group Holdings AG and its subsidiary companies and include a settlement bank regulated by the Federal Reserve Bank of New York. The Group was formed in 1997 and the settlement system has been operational since 2002. As of February 2009, there were 73 shareholders and 62 settlement members as well as 4,576 Third Party participants (411 banks, corporates and non-bank financial institutions and 4,165 investment funds) that participate in the system.
CLS settles transactions on a payment versus payment basis, also known as PVP. When a foreign exchange trade is settled, each of the two parties to the trade pays out (sells) one currency and receives (buys) a different currency; PVP ensures that these payments and receipts happen simultaneously. Without PVP there is a (small, but with potentially devastating financial consequences) chance that one or more parties could pay away funds to another institution but not receive any reciprocal funds due (generally for reasons of credit-related default)—this is known as settlement risk, or Herstatt risk.
An additional benefit of the CLS system is the increased straight through processing capabilities.
Other services like CLS , there is TARGET and EBA.
It has 17 eligible currencies under it right now. These are:
- Australian Dollar
- Canadian Dollar
- Danish Krone
- EUR Euro
- Hong Kong Dollar
- Israeli new shekel
- Japanese Yen
- Mexican Peso
- New Zealand Dollar
- Norwegian Krone
- Singapore Dollar
- South African Rand
- South Korean Won
- Swedish Krona
- Swiss Franc
- Pound Sterling
- United States Dollar
The process is managed by CLS Group Holdings AG and its subsidiary companies and include a settlement bank regulated by the Federal Reserve Bank of New York. The Group was formed in 1997 and the settlement system has been operational since 2002. As of February 2009, there were 73 shareholders and 62 settlement members as well as 4,576 Third Party participants (411 banks, corporates and non-bank financial institutions and 4,165 investment funds) that participate in the system.
CLS settles transactions on a payment versus payment basis, also known as PVP. When a foreign exchange trade is settled, each of the two parties to the trade pays out (sells) one currency and receives (buys) a different currency; PVP ensures that these payments and receipts happen simultaneously. Without PVP there is a (small, but with potentially devastating financial consequences) chance that one or more parties could pay away funds to another institution but not receive any reciprocal funds due (generally for reasons of credit-related default)—this is known as settlement risk, or Herstatt risk.
An additional benefit of the CLS system is the increased straight through processing capabilities.
Other services like CLS , there is TARGET and EBA.
TARGET
TARGET( Trans-European Automated Real-time Gross Settlement Express Transfer System) was an interbank payment system for the real-time gross settlement (RTGS) of cross-border transfers throughout the European Union. It included 17 national real-time gross settlement (RTGS) systems and the ECB payment mechanism (EPM). TARGET provided access to more than 1,000 direct participants and more than 48,000 credit institutions (including branches and subsidiaries). In November 2007 it was replaced by TARGET2.
Euro Banking Association (EBA)
The Euro Banking Association (EBA) is an industry forum for the European payments industry with over 200 member banks and organisations from the European Union and across the world aimed at fostering and driving pan-European payment initiatives. Through its EURO1, STEP1 and STEP2 systems, EBA offers clearing and settlement services to wide community of banks in the European Union, and continues to be a key contributor to the creation of a standardised Single Euro Payments Area (SEPA).
3 systems
The 3 systems are run by EBA CLEARING. The EBA Clearing Company was founded in June 1998 by 52 banks.
Euro1
EURO1 is a real-time net clearing and settlement system for individual financial and commercial payments and is owned and operated by EBA CLEARING. It is open to banks that have a registered address or branch in the European Union and fulfill a number of additional requirements.
Step1
It is a payment system for commercial transactions in EURO.
Step2
It the first and so far only pan-European Automated Clearing House (PE-ACH) , which processes mass or bulk euro payments ( upto EUR 50,000 per transaction ) for banks from 32 European countries.
Those payment are processed that bears an International Bank Account Number, IBAN, and a Bank Identifier Code (BIC)) as well as payments that comply with the Scheme Rulebooks and Implementation Guidelines for the Single Euro Payments Area (SEPA) as they have been issued by the European Payments Council.
Once a year, the EBA brings together its member banks and organisations as well as other stakeholders in the market for a pan-European payments conference entitled EBAday. The EBA also runs a payments portal providing news and information on ongoing topics in the market.
3 systems
The 3 systems are run by EBA CLEARING. The EBA Clearing Company was founded in June 1998 by 52 banks.
Euro1
EURO1 is a real-time net clearing and settlement system for individual financial and commercial payments and is owned and operated by EBA CLEARING. It is open to banks that have a registered address or branch in the European Union and fulfill a number of additional requirements.
Step1
It is a payment system for commercial transactions in EURO.
Step2
It the first and so far only pan-European Automated Clearing House (PE-ACH) , which processes mass or bulk euro payments ( upto EUR 50,000 per transaction ) for banks from 32 European countries.
Those payment are processed that bears an International Bank Account Number, IBAN, and a Bank Identifier Code (BIC)) as well as payments that comply with the Scheme Rulebooks and Implementation Guidelines for the Single Euro Payments Area (SEPA) as they have been issued by the European Payments Council.
Once a year, the EBA brings together its member banks and organisations as well as other stakeholders in the market for a pan-European payments conference entitled EBAday. The EBA also runs a payments portal providing news and information on ongoing topics in the market.
Foreign exchange transactions
Spot deal
A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction.
Notes:
Most spot deals take T+2 days
For Canadian dollar and Mexican peso settle on T+1 days,
South African rand, Thai baht with T+3 days
Saudi riyal (SAR) cannot be settled on friday due to religious reasons. So if you have USD/SAR trade on wednesday it will be settled on monday.
Forward
One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a one day, a few days, months or years. Usually the date is decided by both parties. and foreward contract is a negotiated and agreement between two parties.
FX swap
In finance, a forex swap (or FX swap) is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward).So 1st transaction is spot deal where where 2 parties agree to exchange 2 currencies on spot date. 2nd transaction is forward transaction where currencies are re-exchanged at an agreed forward rate.
Non-deliverable Forward
A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction.
Notes:
Most spot deals take T+2 days
For Canadian dollar and Mexican peso settle on T+1 days,
South African rand, Thai baht with T+3 days
Saudi riyal (SAR) cannot be settled on friday due to religious reasons. So if you have USD/SAR trade on wednesday it will be settled on monday.
Forward
One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a one day, a few days, months or years. Usually the date is decided by both parties. and foreward contract is a negotiated and agreement between two parties.
FX swap
In finance, a forex swap (or FX swap) is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward).So 1st transaction is spot deal where where 2 parties agree to exchange 2 currencies on spot date. 2nd transaction is forward transaction where currencies are re-exchanged at an agreed forward rate.
Non-deliverable Forward
Trade settlement in FX market
Standard settlement instructions (SSIs) need to be exchanged where possible as they minimize the chances of incorrect/incomplete instructions being exchanged.
One day prior to settlement or on the settlement date (up to a cut-off time), payment instructions are sent to the nostro bank for all the amounts owed. These instructions advise the nostro bank of the counterparty’s nostro agent’s name, SWIFT address, and account numbers if applicable.
Settlement and payment systems in FX markets
Settlement Failures in FX markets
One day prior to settlement or on the settlement date (up to a cut-off time), payment instructions are sent to the nostro bank for all the amounts owed. These instructions advise the nostro bank of the counterparty’s nostro agent’s name, SWIFT address, and account numbers if applicable.
Settlement and payment systems in FX markets
Settlement Failures in FX markets
Nostro Account
Every bank has accounts for each currency held in correspondent banks in the country of origin of the currency. These accounts are known as nostro accounts. For example, a bank located in New York will have a nostro account in a correspondent bank in Japan to receive yen. It will also have a nostro account in a correspondent bank in the UK to receive sterling.
Since euro can be received in any country within the euro area, banks can have euro-denominated nostro accounts in correspondent banks in Paris, Frankfurt, and so on.
A nostro account to one bank must simultaneously be a vostro account to another bank.
For example, if UK Bank maintains a dollar account with USA Bank in New York, the account would be a USD-denominated nostro account to UK Bank, but a vostro account in its home currency to USA Bank.
Similarly, if USA Bank maintains a GBP account with UK Bank in London, this would be a vostro account to UK Bank, but a nostro account to USA Bank.
Since euro can be received in any country within the euro area, banks can have euro-denominated nostro accounts in correspondent banks in Paris, Frankfurt, and so on.
A nostro account to one bank must simultaneously be a vostro account to another bank.
For example, if UK Bank maintains a dollar account with USA Bank in New York, the account would be a USD-denominated nostro account to UK Bank, but a vostro account in its home currency to USA Bank.
Similarly, if USA Bank maintains a GBP account with UK Bank in London, this would be a vostro account to UK Bank, but a nostro account to USA Bank.
Standard settlement instructions (SSIs)
Standard settlement instructions (SSIs) need to be exchanged where possible as they minimize the chances of incorrect/incomplete instructions being exchanged. If SSIs are not used, then the settlement instructions may be recorded at the time of trade execution.
Eg. in case of FX markets, such instructions should be sent by the close of business on the trade date (for a spot deal) or at least one day before settlement (for a forward deal).
Eg. in case of FX markets, such instructions should be sent by the close of business on the trade date (for a spot deal) or at least one day before settlement (for a forward deal).
Some ISO Currency Codes
USD (US dollar)
EUR (euro)
GBP (sterling)
JPY (Japanese yen)
CHF (Swiss franc)
CAD (Canadian dollar)
AUD (Australian dollar)
HKD (Hong Kong dollar)
INR (Indian Rupee)
EUR (euro)
GBP (sterling)
JPY (Japanese yen)
CHF (Swiss franc)
CAD (Canadian dollar)
AUD (Australian dollar)
HKD (Hong Kong dollar)
INR (Indian Rupee)
Trading systems in FX
The most commonly used trading systems are Reuters and EBS ( Electronic broking system ).
Markets Trading system
spot market Reuters Dealing 3000 Spot matching service , EBS
forward market Reuters Dealing 3000 Forward matching service
Hybrid Tullet-Prebon
Reuters and EBS provide anonymity.
EBS is screen-based working 24X7 throughout weeks.
Markets Trading system
spot market Reuters Dealing 3000 Spot matching service , EBS
forward market Reuters Dealing 3000 Forward matching service
Hybrid Tullet-Prebon
Reuters and EBS provide anonymity.
EBS is screen-based working 24X7 throughout weeks.
Foreign exchange transactions
Spot deal
A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction.
Notes:
Most spot deals take T+2 days
For Canadian dollar and Mexican peso settle on T+1 days,
South African rand, Thai baht with T+3 days
Saudi riyal (SAR) cannot be settled on friday due to religious reasons. So if you have USD/SAR trade on wednesday it will be settled on monday.
Forward
One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a one day, a few days, months or years. Usually the date is decided by both parties. and foreward contract is a negotiated and agreement between two parties.
FX swap
In finance, a forex swap (or FX swap) is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward).
Transaction 1 : Spot deal on 2 currencies where 2 parties agree to exchange on spot date
Transaction 2 : A forward transaction where teh currencies are re-exchanged at a forward date and at an agreed forward rate.
NDF (Non-deliverable funds )
A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction.
Notes:
Most spot deals take T+2 days
For Canadian dollar and Mexican peso settle on T+1 days,
South African rand, Thai baht with T+3 days
Saudi riyal (SAR) cannot be settled on friday due to religious reasons. So if you have USD/SAR trade on wednesday it will be settled on monday.
Forward
One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a one day, a few days, months or years. Usually the date is decided by both parties. and foreward contract is a negotiated and agreement between two parties.
FX swap
In finance, a forex swap (or FX swap) is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward).
Transaction 1 : Spot deal on 2 currencies where 2 parties agree to exchange on spot date
Transaction 2 : A forward transaction where teh currencies are re-exchanged at a forward date and at an agreed forward rate.
NDF (Non-deliverable funds )
Saturday, 24 July 2010
Settlement
Settlement (of securities/bonds or in FX market) is a business process whereby securities or interests in securities are delivered, usually against (in simultaneous exchange for) payment of money, to fulfill contractual obligations, such as those arising under securities trades.
Nature of Settlement -
There are 2 ways of payment in case of settlement.
1. Delivery versus payment(DVP) in which transfer of security takes place for payment or any other financial asset.
2. Free of payment (FOP) - Here first delivery of securities takes place and later on payment is done. Here 1 party takes risk of not getting anything at all.
Settlement cycles
US and UK have T+3 days for Equities but for bonds they have T+1 days for bonds.
Japan has T+3 days for both bonds and Equities.
Germany T+2 days
Greater the number of business days, greater the risk.
In case of FX market it takes T+2 day mainly.
Settlement date
Settlement date
Transfer of legal ownership of a bond/shares move from the seller to the buyer on the intended settlement date. This should be before value date.
Trade settlement process
Step 1: Settlement instructions
Although agreement may have been confirmed on a trade with the client, the actual process of exchanging bonds/cash cannot take place until a settlement instruction has been issued to the custodian. Its better if standard settlement instructions (SSIs) are used. The settlement instructions are generally transmitted from bank's settlement system via a secure method such as SWIFT.
Step 2: Settlement process
Upon receipt or ack of settlement instructions, the custodian tries to match the instruction sent by the counterparty to its custodian. It then returns the settlement status.
Step 3 : Settlement status
Depending on the settlement status, either the settlement is done or there is settlement failure.
In case some problem occurs there is settlement failure due to settlement not done till value date. See here for more on settlement failure.
Wednesday, 14 July 2010
Market Participants in Foreign Exchange
The main participants in the FX market are:
- market makers
- brokers
- central authorities
- international corporations
- fund managers
- leveraged accounts
Market Makers
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Brokers
Brokers do not quote their own exchange rates; they are not market makers. Rather, they act as intermediaries for the market makers, relaying the best prices and trying to match buy and sell orders.
The broker will not reveal the name of the counterparty making the quote until a positive commitment has been made by another counterparty. The broker makes a commission, charged to both counterparties to a transaction.
Brokers do not take positions in the FX market, nor do they take on the risk associated with holding an inventory of currencies subject to fluctuations in exchange rates. They are intermediaries between buyers and sellers, not market makers.
In the past, brokers were particularly useful to smaller market makers who might otherwise have found it difficult to obtain a competitive market rate given the average size of their deals. However, electronic broking and a single currency in the euro area (EUR) have greatly diminished the role of the voice broker in recent years.
The broker will not reveal the name of the counterparty making the quote until a positive commitment has been made by another counterparty. The broker makes a commission, charged to both counterparties to a transaction.
Brokers do not take positions in the FX market, nor do they take on the risk associated with holding an inventory of currencies subject to fluctuations in exchange rates. They are intermediaries between buyers and sellers, not market makers.
In the past, brokers were particularly useful to smaller market makers who might otherwise have found it difficult to obtain a competitive market rate given the average size of their deals. However, electronic broking and a single currency in the euro area (EUR) have greatly diminished the role of the voice broker in recent years.
Central authorities
Central authorities or central banks enter the FX market for several reasons:
to strengthen or weaken their own currency or to assist another central bank to do the same
to switch reserves from one currency to another
to smooth out any undesirable fluctuations in an exchange rate
When active in the FX market, the central authorities will transact deals with the market makers. In such situations, the central banks are said to be intervening in the market.
Central authorities include such banks as the European Central Bank (ECB), the US Federal Reserve Bank, the Bank of England, the Swiss National Bank, and the Bank of Japan.
International corporations
Fund Managers
Fund managers are institutions or individuals that manage investment portfolios either on their own account or on behalf of their customers. When they invest in the international stock and bond markets, they will have a natural need to convert from one currency to another in moving from one stock/bond market to another.
Leveraged Account
Leveraged accounts are high net worth individuals (private customers), as well as institutions, that are involved in margin trading. This allows them to speculate in amounts that are far larger than their available capital. They would need to post collateral (for example, treasury securities) with the bank in a blocked account. The bank would then propose a leverage multiple that both sides find acceptable.
For example, if the leverage multiple is ten times, then the investor can post collateral of USD 10 million and can subsequently trade up to USD 100 million in the FX market.
Tuesday, 13 July 2010
Foreign Exchange (FX)
The foreign exchange (FX) market is where world currencies are bought and sold against one another.
Unlike the commodity and stock markets, it is not a physical market based in one building or location. Rather, it is an organizational framework within which participants linked by telephone and computers buy and sell currencies.
The market runs 24 hours a day in the major financial centers around the world. Actual currencies are not physically traded; instead, they are transferred electronically from one bank account to another. The FX market is an over-the-counter (OTC) market. This means that all of the following are negotiable between the two counterparties in the market:
If an agent has the wrong currency; the agent may wish to buy goods in Europe, but unfortunately only possesses US dollars. A foreign exchange transaction would be necessary, whereby the party would sell US dollars in exchange for the euro that it would need to buy the relevant goods.
In addition to FX transactions that are conducted for immediate delivery, there is also a large market in forward FX. These transactions commit a party to buying a certain amount of one currency in exchange for another at a predetermined rate at a specified date in the future. This allows agents who have known future cash flows payable/receivable in different currencies to fix the rate now for future transactions.
Unlike the commodity and stock markets, it is not a physical market based in one building or location. Rather, it is an organizational framework within which participants linked by telephone and computers buy and sell currencies.
The market runs 24 hours a day in the major financial centers around the world. Actual currencies are not physically traded; instead, they are transferred electronically from one bank account to another. The FX market is an over-the-counter (OTC) market. This means that all of the following are negotiable between the two counterparties in the market:
- the size of the deal
- the settlement date
- the price
If an agent has the wrong currency; the agent may wish to buy goods in Europe, but unfortunately only possesses US dollars. A foreign exchange transaction would be necessary, whereby the party would sell US dollars in exchange for the euro that it would need to buy the relevant goods.
In addition to FX transactions that are conducted for immediate delivery, there is also a large market in forward FX. These transactions commit a party to buying a certain amount of one currency in exchange for another at a predetermined rate at a specified date in the future. This allows agents who have known future cash flows payable/receivable in different currencies to fix the rate now for future transactions.
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