Forex: The basic theories underlying the dollar to euro exchange rate

Law of One Price: In competitive markets free of transportation cost barriers to trade, identical products sold in different countries must sell at the same price when the prices are stated in terms of the same currency.

Interest rate effects: If capital is allowed to flow freely, exchange rates become stable at a point where equality of interest is established.

The dual forces of supply and demand determine euro vs. dollar exchange rates. Various factors affect these two forces, which in turn affect the exchange rates:

The business environment: Positive indications (in terms of government policy, competitive advantages, market size, etc.) increase the demand for the currency, as more and more enterprises want to invest there.

Stock market: The major stock indices also have a correlation with the currency rates.

Political factors: All exchange rates are susceptible to political instability and anticipations about the new government. For example, political or financial instability in Russia is also a flag for the euro to US dollar exchange because of the substantial amount of German investments directed to Russia.

Economic data: Economic data such as labor reports (payrolls, unemployment rate and average hourly earnings), consumer price indices (CPI), producer price indices (PPI), gross domestic product (GDP), international trade, productivity, industrial production, consumer confidence etc., also affect fluctuations in currency exchange rates.

Confidence in a currency is the greatest determinant of the real euro-dollar exchange rate. Decisions are made based on expected future developments that may affect the currency. A EUR/USD exchange can operate under one of four main types of exchange rate systems:

Fully fixed exchange rates
In a fixed exchange rate system, the government (or the central bank acting on its behalf) intervenes in the currency market in order to keep the exchange rate close to a fixed target. It is committed to a single fixed exchange rate and does not allow major fluctuations from this central rate.

Semi-fixed exchange rates
Currency can move inside permitted ranges of fluctuation. The exchange rate is the dominant target of economic policy-making, interest rates are set to meet the target and the exchange rate is given a specific target.

Free floating
The value of the currency is determined solely by market supply and demand forces in the foreign exchange market. Trade flows and capital flows are the main factors affecting the exchange rate. A floating exchange rate system: Monetary system in which exchange rates are allowed to move due to market forces without intervention by national governments. For example, the Bank of England does not actively intervene in the currency markets to achieve a desired exchange rate level. With floating exchange rates, changes in market demand and supply cause a currency to change in value. Pure free floating exchange rates are rare - most governments at one time or another seek to "manage" the value of their currency through changes in interest rates and other controls.

Managed floating exchange rates
Governments normally engage in managed floating if not part of a fixed exchange rate system.

The advantages of fixed exchange rates are the disadvantages of floating rates:
Fixed rates provide greater certainty for exporters and importers and, under normal circumstances, there is less speculative activity - although this depends on whether the dealers in the foreign exchange markets regard a given fixed exchange rate as appropriate and credible.

Advantages of floating exchange rates
Fluctuations in the exchange rate can provide an automatic adjustment for countries with a large balance of payments deficit. A second key advantage of floating exchange rates is that it gives the government/monetary authorities flexibility in determining interest rates.

Forex: Dollar-euro currency exchange

This article provides an overview of the factors affecting the leading currency pair: Euro-dollar exchange, commonly expressed as EUR/USD.
The euro to dollar exchange rate is the price at which the world demand for US dollars equals the world supply of euros. Regardless of geographical origin, a rise in the world demand for euros leads to an appreciation of the euro.

Factors affecting exchange rates
Four factors are identified as fundamental determinants of the real euro to dollar exchange rate:


.The international real interest rate differential
.Relative prices in the traded and non-traded goods sectors
.The real oil price
.The relative fiscal position

The nominal bilateral dollar to euro exchange is the exchange rate that attracts the most attention. Notwithstanding the comparative importance of euro to US dollar bilateral trade links, trade with the UK is, to some extent, more important for the Euro zone than is trade with the US. The dollar and the euro have a strong predisposition to run together in the very short run, but sometimes there can be significant discrepancies. The very strong appreciation of the dollar against the euro in 2003 is one example of these discrepancies.
In the long run, the correlation between the bilateral dollar to euro exchange rate, and different measures of the effective exchange rate of Euroland, has been rather high, especially if one looks at the effective real exchange rate. As inflation is at very similar levels in the US and the Euro area, there is no need to adjust the dollar to euro rate for inflation differentials, but because the Euro zone also trades intensively with countries that have relatively high inflation rates (e.g. some countries in Central and Eastern Europe, Turkey, etc.), it is more important to downplay nominal exchange rate measures by looking at relative price and cost developments.

The fall of the dollar
The steady and orderly decline of the dollar from early 2002 to early 2004 against the euro, Australian dollar, Canadian dollar and a few other currencies (i.e., its trade-weighted average, which is what counts for purposes of trade adjustment), while significant, has still only amounted to about 10 percent.

There are two reasons why concerns about a free fall of the dollar should not be worth consideration. The first is that the US external deficit will stay high only if US growth remains vigorous. But if the US continues to grow strongly, it will also retain a strong attraction for foreign capital, which should support the dollar. The second reason is that the attempts by the monetary authorities in Asia to keep their currencies weak will probably not work.

Forex: Risks

Although Forex trading can lead to very profitable results, there are risks involved: exchange rate risks, interest rate risks, credit risks, and country risks. Approximately 80% of all currency transactions last a period of seven days or less, while more than 40% last fewer than two days. Given the extremely short lifespan of the typical trade, technical indicators heavily influence entry, exit and order placement decisions.

Forex: Forwards and Futures

Forwards make up about 46% of currency trading. A forward transaction is an agreement between two parties whereby one party buys a currency at a particular price by a certain date that is greater than two business days (a spot transaction).
A future contract is a forward contract with fixed currency amounts and maturity dates. They are traded on future exchanges and not through the interbank foreign exchange market.

Forex: A spot Transaction

A spot transaction is a straightforward exchange of one currency for another. The spot rate is the current market price, also called the benchmark price. Spot transactions do not require immediate settlement, or payment "on the spot." The settlement date, or "value date," is the second business day after the "deal date" (or "trade date") on which the transaction is agreed to by the two traders. The two-day period provides time to confirm the agreement and arrange the clearing and necessary debiting and crediting of bank accounts in various international locations

Forex: Exchange Rates

Because currencies are traded in pairs and exchanged one against the other when traded, the rate at which they are exchanged is called the exchange rate. The majority of the currencies are traded against the US dollar (USD). The four next-most traded currencies are the Euro (EUR), the Japanese yen (JPY), the British pound sterling (GBP) and the Swiss franc (CHF). These five currencies make up the majority of the market and are called the major currencies or "the Majors". Some sources also include the Australian dollar (AUD) within the group of major currencies.

The first currency in the exchange pair is referred to as the base currency and the second currency as the counter term or quote currency. The counter term or quote currency is thus the numerator in the ratio, and the base currency is the denominator. The value of the base currency (denominator) is always 1. Therefore, the exchange rate tells a buyer how much of the counter term or quote currency must be paid to obtain one unit of the base currency. The exchange rate also tells a seller how much is received in the counter term or quote currency when selling one unit of the base currency. For example, an exchange rate for EUR/USD of 1.2083 specifies to the buyer of euros that 1.2083 USD must be paid to obtain 1 euro.

At any given point, time and place, if an investor buys any currency and immediately sells it - and no change in the exchange rate has occurred - the investor will lose money. The reason for this is that the bid price, which represents how much will be received in the counter or quote currency when selling one unit of the base currency, is always lower than the ask price, which represents how much must be paid in the counter or quote currency when buying one unit of the base currency. For instance, the EUR/USD bid/ask currency rates at your bank may be 1.2015/1.3015, representing a spread of 1000 pips (also called points, one pip = 0.0001), which is very high in comparison to the bid/ask currency rates that online Forex investors commonly encounter, such as 1.2015/1.2020, with a spread of 5 pips. In general, smaller spreads are better for Forex investors since even they require a smaller movement in exchange rates in order to profit from a trade.

Margin
Banks and/or online trading providers need collateral to ensure that the investor can pay in case of a loss. The collateral is called the margin and is also known as minimum security in Forex markets. In practice, it is a deposit to the trader's account that is intended to cover any currency trading losses in the future.
Margin enables private investors to trade in markets that have high minimum units of trading by allowing traders to hold a much larger position than their account value. Margin trading also enhances the rate of profit, but can also enhance the rate of loss if the investor makes the wrong decision.

Leveraged financing
Leveraged financing, i.e., the use of credit, such as a trade purchased on a margin, is very common in Forex. The loan/leveraged in the margined account is collateralized by your initial deposit. This may result in being able to control USD 100,000 for as little as USD 1,000.
There are three ways private investors can trade in Forex directly or indirectly:

.The spot market
.Forwards and futures
.Options

Forex: What is Forex Trading?

The investor's goal in Forex trading is to profit from foreign currency movements. Forex trading or currency trading is always done in currency pairs. For example, the exchange rate of EUR/USD on Aug 26th, 2003 was 1.0857. This number is also referred to as a "Forex rate" or just "rate" for short. If the investor had bought 1000 euros on that date, he would have paid 1085.70 U.S. dollars. One year later, the Forex rate was 1.2083, which means that the value of the euro (the numerator of the EUR/USD ratio) increased in relation to the U.S. dollar. The investor could now sell the 1000 euros in order to receive 1208.30 dollars. Therefore, the investor would have USD 122.60 more than what he had started one year earlier. However, to know if the investor made a good investment, one needs to compare this investment option to alternative investments. At the very minimum, the return on investment (ROI) should be compared to the return on a "risk-free" investment. One example of a risk-free investment is long-term U.S. government bonds since there is practically no chance for a default, i.e. the U.S. government going bankrupt or being unable or unwilling to pay its debt obligation.
When trading currencies, trade only when you expect the currency you are buying to increase in value relative to the currency you are selling. If the currency you are buying does increase in value, you must sell back the other currency in order to lock in a profit. An open trade (also called an open position) is a trade in which a trader has bought or sold a particular currency pair and has not yet sold or bought back the equivalent amount to close the position.

However, it is estimated that anywhere from 70%-90% of the FX market is speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency.

Forex: Overview of the Forex market

An overview of the Forex market
Foreign Exchange (FOREX) is the arena where a nation's currency is exchanged for that of another. The foreign exchange market is the largest financial market in the world, with the equivalent of over $1.9 trillion changing hands daily; more than three times the aggregate amount of the US Equity and Treasury markets combined. Unlike other financial markets, the Forex market has no physical location and no central exchange (off-exchange). It operates through a global network of banks, corporations and individuals trading one currency for another. The lack of a physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one zone to another in all the major financial centers.

Traditionally, retail investors' only means of gaining access to the foreign exchange market was through banks that transacted large amounts of currencies for commercial and investment purposes. Trading volume has increased rapidly over time, especially after exchange rates were allowed to float freely in 1971. Today, importers and exporters, international portfolio managers, multinational corporations, speculators, day traders, long-term holders and hedge funds all use the FOREX market to pay for goods and services, transact in financial assets or to reduce the risk of currency movements by hedging their exposure in other markets.

Forex: History(continued)

The Explosion of the Euromarket
A major catalyst to the acceleration of Forex trading was the rapid development of the eurodollar market; where US dollars are deposited in banks outside the US. Similarly, Euromarkets are those where assets are deposited outside the currency of origin. The Eurodollar market first came into being in the 1950s when Russia’s oil revenue-- all in dollars -- was deposited outside the US in fear of being frozen by US regulators. That gave rise to a vast offshore pool of dollars outside the control of US authorities. The US government imposed laws to restrict dollar lending to foreigners. Euromarkets were particularly attractive because they had far less regulations and offered higher yields. From the late 1980s onwards, US companies began to borrow offshore, finding Euromarkets a beneficial center for holding excess liquidity, providing short-term loans and financing imports and exports.

London was, and remains the principal offshore market. In the 1980s, it became the key center in the Eurodollar market when British banks began lending dollars as an alternative to pounds in order to maintain their leading position in global finance. London’s convenient geographical location (operating during Asian and American markets) is also instrumental in preserving its dominance in the Euromarket.

Forex: History

The Evolution of Forex Market

The Gold Exchange and the Bretton Woods Agreement

In 1967, a Chicago bank refused a college professor by the name of Milton Friedman a loan in pound sterling because he had intended to use the funds to short the British currency. Friedman, who had perceived sterling to be priced too high against the dollar, wanted to sell the currency, then later buy it back to repay the bank after the currency declined, thus pocketing a quick profit. The bank’s refusal to grant the loan was due to the Bretton Woods Agreement, established twenty years earlier, which fixed national currencies against the dollar, and set the dollar at a rate of $35 per ounce of gold.

The Bretton Woods Agreement, set up in 1944, aimed at installing international monetary stability by preventing money from fleeing across nations, and restricting speculation in the world currencies. Prior to the Agreement, the gold exchange standard--prevailing between 1876 and World War I--dominated the international economic system. Under the gold exchange, currencies gained a new phase of stability as they were backed by the price of gold. It abolished the age-old practice used by kings and rulers of arbitrarily debasing money and triggering inflation.

But the gold exchange standard didn’t lack faults. As an economy strengthened, it would import heavily from abroad until it ran down its gold reserves required to back its money; consequently, the money supply would shrink, interest rates rose and economic activity slowed to the extent of recession. Ultimately, prices of goods had hit bottom, appearing attractive to other nations, who would rush into buying sprees that injected the economy with gold until it increased its money supply, and drive down interest rates and recreate wealth into the economy. Such boom-bust patterns prevailed throughout the gold standard until the outbreak of World War I interrupted trade flows and the free movement of gold.

After the Wars, the Bretton Woods Agreement was founded, where participating countries agreed to try and maintain the value of their currency with a narrow margin against the dollar and a corresponding rate of gold as needed. Countries were prohibited from devaluing their currencies to their trade advantage and were only allowed to do so for devaluations of less than 10%. Into the 1950s, the ever-expanding volume of international trade led to massive movements of capital generated by post-war construction. That destabilized foreign exchange rates as setup in Bretton Woods.

The Agreement was finally abandoned in 1971, and the US dollar would no longer be convertible into gold. By 1973, currencies of major industrialized nations floated more freely, as they were controlled mainly by the forces of supply and demand. Prices were floated daily, with volumes, speed and price volatility all increasing throughout the 1970s, giving rise to new financial instruments, market deregulation and trade liberalization.

In the 1980s, cross-border capital movements accelerated with the advent of computers and technology, extending market continuum through Asian, European and American time zones. Transactions in foreign exchange rocketed from about $70 billion a day in the 1980s, to more than $1.5 trillion a day two decades later.

Forex: What is Forex Trading?

An overview of Forex Market
The Forex market is a non-stop cash market where currencies of nations are traded, typically via brokers. Foreign currencies are constantly and simultaneously bought and sold across local and global markets and traders' investments increase or decrease in value based upon currency movements. Foreign exchange market conditions can change at any time in response to real-time events.

The main enticements of currency dealing to private investors and attractions for short-term Forex trading are:

Microsoft Excel 2003: More Cell Formatting

We want our numbers to look better. To do this we'll include dollar signs and decimal points in our numbers. This is done by using the mouse. Point to cell C6, hold down the left mouse button and drag down slowly to highlight cells C6 through C19. Your screen should look like



Now point anywhere in the highlighted area and click the RIGHT mouse button. A pop-up menu will appear. Click-on Format Cells (like you have done before).


Click-on the Number “Tab” at the top of the Format Cells menu screen. Point to Currency and click-on Currency.



Notice several things. The right side shows the number of decimal places. The 2 is the default for cents. We'll use 2. Notice above the Decimal Places that there is a sample of what our number will look like. At the lower right it shows how negative numbers can appear, depending on your choice. When a negative number is calculated, it will appear with your choice. Now click-on OK. All the numbers now have $. If you have large numbers that are "too wide" for the current column width you will see some ######## in the cells where these numbers are located. If this occurs in your spreadsheet, go ahead and widen the columns as you did previously.



Your spreadsheet numbers should now look like the one above.

Microsoft Excel 2003: Subtraction

In cell A19 type-in Net Income. Next, adjust the width of column A.

Click-on cell C19.

In cell C19 we want to subtract ( - )the amount in for Expenses in cell C17 from the amount for Income in cell C9. This can be accomplished by using either the Type-In Method or Point Method. Go ahead and do this. Don’t forget to tap the Enter key to confirm your formula.

The formula should look like =C9 C17

Microsoft Excel 2003: AutoSum METHOD - ∑

Since we add numbers more than any other operation in spreadsheets, Excel spreadsheet has an additional feature - Auto Sum. Move to cell C9 again and tap the delete key to erase your last formula. Now look at the upper area of the screen, just below the menu bar, for a ∑ (summation) symbol button. Point to it and click with the left mouse button. WOW !! Automatic addition!! Notice that the cells, you’d logically desire to add, have a marquee around them and that the SUM function is displayed in cell C9. You’ll need to confirm that this is the correct formula. So, tap the Enter key and the SUM function will now be set in cell C9. Any time you want to add using this method just click-on the cell where you desire the total to be and click-on the ∑.

This would be a good time to save your work.

PERIODICALLY SAVE AND REPLACE YOUR WORK IN CASE YOU LOOSE POWER TO YOUR COMPUTER

Now move to cell C17 and add the total Expenses in cells C13 to C16 - using each of the four methods.
While you are in cell C17, go ahead and place a line at the top of cell C17 using the format cells – border method that you learned

Microsoft Excel 2003: Functions (Continued)

One of the really neat things about these Help windows is that there are examples for each function. We moved down the SUM help screen using the elevator bar on the right of the help screen. The bottom of the screen looks like the image at the top of the next page. Spend a few minutes looking at the SUM Help window and notice all of the features.


The bottom of the SUM help screen looks like the image on the left. Notice that it gives you examples from a small spreadsheet that has data in cells A1 through A6. It uses these numbers in the examples at the bottom of the help screen.

When you have reviewed all of the help you care to see, carefully click-on the X at the upper right corner of the Microsoft Office Excel Help blue bar to close the Microsoft Excel Help window.


The Function Arguments menu screen will still be on the screen.


If the Office Assistant is still on the screen simply point to it and click the RIGHT mouse button. A pop-up menu will appear. Click-on Hide. This will put the Assistant away until we need it again



As you can see, in the area to the right of Number 1, the “Wizard” has “guessed” that you want to add the numbers in the range C6 to C8. Now that you are becoming proficient with Excel, we’ll try something special. Carefully, point to some “plain part,” in the gray area above. Click and hold down the left mouse button, and drag the above SUM box “away” so that you can see your numbers in C column cells. When you have done this, release the mouse button. Now click-on the “small box” on the right edge of the Number 1 area (see arrow above). It has a little red arrow in it.

The below Function Arguments window will appear.


Highlight cells C6 to C8 in the spreadsheet (click-on C6, hold down the left mouse button, and drag until the three cells are highlighted). A “marquee” will begin to flash around the cells, indicating they are highlighted (left arrow above). The Function Arguments area will appear as above. Now click-on the small button on the right of the cell (see right arrow above). The numbers will show in the area to the right of Number 1. Now, click-on OK at the bottom of the Function Arguments menu screen. You’ll see that the SUM formula [=SUM(C6:C8)] shows in the formula area at the top of the screen. This is a really handy method to highlight a “group” of numbers you want to add.

Microsoft Excel 2003: Functions

There are a number of formulas built into Excel, like Sum. These formulas are called Functions. Below the Menu Bar (see right) you will see a “sigma” ∑ with a small down triangle to the right of the sigma (see arrow on diagram to the right). Click on the down triangle. The drop down menu that you see on the right will appear. Move down to More Functions and click-on More Functions.

Two menu screens will now appear at the same time. An “Office Assistant” will appear (see image on left of next page) and you can ask it questions (the little assistant may be a paper clip or just about anything). The Insert Function menu screen will also appear (see image on right of next page). The two menu screens work together to assist you when you are using functions.





Let’s work with the Insert Function menu screen. Click-on the small down arrow to the right of Or select a category: (see arrow at left).

In the drop down menu that appears you can see that there are all kinds of formulas (functions) that come with Excel spreadsheet (e.g. statistical, mathematical, financial, etc.). Instead of having to go to math, financial, or statistical tables in a book, you can enter data from your spreadsheet into the formulas and receive answers.


This is a really great, timesaving feature. We’ll now show you how to use the Help features of Excel 2003 to work with and understand these functions.



Click-on All in the drop down menu.



Look at all the functions (formulas)! We’ll just go through how to use the addition formula (SUM) in this tutorial. If you need these formulas in the future, you’ll know they’re here.


Use the elevator bar on the right side of the Select a function menu screen to move down the list until you see SUM. Click-on SUM.



Then click-on OK.

Remember, you clicked-on Cell C9 – which was “empty” because you deleted the formula in that cell.


When you click-on OK, the Function Arguments menu screen (above) will appear. If you look at the top of the screen in the SUM area, you’ll see that Excel 2003 has “guessed” that you desire to add the numbers above cell C9 – where you clicked in your spreadsheet. Smart Excel! Notice that it indicates that cells C6:C8 will be added (sum cells C6 through C8 – the colon (:) means “through.” It also indicates the numbers in cells C6, C7 and C8 and give you the sum {300;50;150} = 500 (right arrow above).

But it’s a little unclear how Excel did this. The Help in Excel Functions is excellent. So, to see how this SUM equation works, we’ll go to Help. To do this, click-on Help on this function in the lower left corner of the screen (see lower left arrow above).



On the right side of your screen you will see a Microsoft Office Excel Help window appear (similar to the one above) that will show you how to use this SUM function (or any function).

Excel 2003:Subtraction, Multiplication, and Division(Function Methd)

Function Method:
Move again to cell C9. Delete the formula by tapping the Delete key again.


Now type in the following: =SUM(


[This tells Excel that we are going to sum some numbers in a RANGE which will follow the =SUM(.]

There are two ways to put in this range:



Arrow Key and Anchor Method:

With the keyboard arrow keys, move the cursor to cell C6. As you move you will notice that the cell where the cursor is located appears after the =SUM(. When you get to C6 tap the . (Period) Key. This is called an ANCHOR and holds one end of the RANGE in place. You will notice that a C6:C6 appears in the formula area under the button bar. This is a one cell range. Now move, with the arrow keys, to cell C8. See how cells C6, C7 and C8 are highlighted. This indicates the Range is C6:C8. Excel assumes, logically, that these are the numbers you want to add. Now tap Enter. The numbers still add, but now the formula reads =SUM(C6:C8) instead of =C6+C7+C8 like it did before.


Mouse Method:

Move again to cell C9. Delete the formula in cell C9 by tapping the Delete key. Type in =SUM( as you did before. Point to Cell C6 – with your mouse cursor. Click and hold down the left mouse button and move/drag the cursor down to cell C8. (Cells C6, C7 and C8 should be highlighted.) Now tap Enter.

This =SUM Function is a great way to add a lot of numbers, or a block/range of numbers. By simply anchoring, and using page downs, or using the mouse, you can highlight lots and lots of numbers to add quickly. However, since it only sums you can't do subtraction, etc.


Point to cell C9 again. Tap the Delete key to remove the formula currently in cell C9. This is a really important DELETE, since what we’ll explain below won’t work correctly if you do not delete the formula in cell C9.

Excel 2003:Subtraction, Multiplication, and Division(Point Method)

You can put in a (minus) for subtraction, (asterisk) * for multiplication, and (slash) / for division. As you become more capable we'll, build some nifty formulas – using these features.

Point Method:

Move to cell C9 again and click-on it. We'll now add the numbers a second way. Tap the Delete key on the keyboard to delete the current formula.
First, tap the = and then POINT (move) the cursor over cell C6 using the mouse, tap the left mouse button on cell C6 (you will see a marquee box go around the cell).


Now tap a + and move cursor to C7, tap the left mouse button, and tap another + and move the cursor to C8 and tap the left mouse button (notice how as you " + and point " the addition formula is being built in cell C9), now tap Enter. The same formula can be built using the arrow movement keys on the keyboard (except that you don’t have to click-on each cell as the cell is marked - as you move the arrows). Notice, as you are entering the cell addresses, that as you place another + in the formula, that the cursor “returns” to cell C9. Also notice, as you point to each cell that it is highlighted by a “marquee box.” This “tells” you what cell you’ve pointed to. Pretty neat!

This method is good when you need to move to numbers that are spread out all over the place. Some people like it best and use it all the time it's your choice.