Forex market attractive because it consists of millions of participants. Buyers and sellers who constantly do the participants have added liquidity that can only be found in the forex market. This chapter focuses on the six largest players in the foreign exchange market. They are:
1. The central bank
2. Private banks and investment
3. Multinationals Company
4. Institutional Traders
5. Broker retail forex
6. Retail trader
We start with the central bank, and three ways they use to manage inflation. We then quotes the banking, proprietary trading, and understand the Volcker rule.
We also met with three of history's greatest thief trader. Segments of multinational companies present two examples of how importers and exporters to implement hedging in the forex market to secure price. Finally, a review of the retail community groups to show us why the foreign exchange brokers and high frequency trading is growing rapidly worldwide.
Central Bank
The main objective of central banks is to stabilize the country's economy. They do so by watching one of the most important benchmarks in the economy: inflation.
Inflation is generally defined as the rate of increase in prices of goods and services. If the central bank does not cope with rapid inflation, the purchasing power will decline.
In most countries, inflation measured by the consumer price index (consumer price index / CPI). CPI is the average price of consumer goods and services. Consumer goods and services typically include but are not limited to housing, food, transportation, recreation, education, and health care. A central bank to control inflation in three ways:
1. Regulating interest rates;
2. Intervene by buying or selling currencies;
3. Regulate the mandatory reserve ratio.
I'll go one by one:
Regulating Interest Rates - Up
Central banks typically raise interest rates due to high inflation. In simple terms defined inflation is too much money in circulation, so a little bit of a good. This causes the prices of goods rise. If no measures are taken, the possibility of impact will weaken the currency. When this happens, the central bank raised interest rates to dampen inflation expectations and strengthen its currency back.
How to hike interest rates to help this process? When the central bank to raise interest rates, deposit and lending private banks also increased. It affects two groups: savers and borrowers. Higher interest on loans to make money becomes "more expensive" to borrow, so that prevent people and businesses to borrow money. The opposite is also true, higher deposit rates encourage people and businesses to save even more than usual.
The combined effects caused a decline in the supply of money in the system, thus offset the effects of inflation.
See the following example:
People's Bank of China Raising Interest Rates
China's central bank Increased interest rates for the third time this year on Wednesday, making clear that Taming inflation is a top priority even when as the economy slows Gently.The benchmark one-year lending rates will be raised 25 basis points to 6:56 percent, and benchmark one-year deposit rates will be raised 25 basis points to 3.5 percent, the central bank said in a short statement on its website.
Officials of the Federal Reserve Raised Interest rates
Officials of the Federal Reserve raised interest rates for the first time this year and forecast a steeper path for borrowing costs in 2017, saying Increased inflation expectations have "considerably" and suggesting the labor market is tightening.The Federal Open Market Committee cited "Tirrenus and expected labor market conditions and inflation" in increasing its benchmark rate a quarter percentage point, According to a statement Wednesday following a two-day meeting in Washington. New projections show central bankers expect a three-quarter-point rate increases in 2017, up from the two seen in the previous forecasts in September, based on median estimates.
Regulating Interest Rates - Down
Central Bank cut interest rates to weaken its currency. This usually occurs when the inflation rate is low. A weak currency encourages borrowing and thus stimulate growth. When the central bank lowered interest rates, deposit and lending private banks will fall. It affects two groups of people: savers and borrowers.
Lower interest on loans to make money become "cheaper" to borrow, so that people and businesses are encouraged to apply for a loan. The opposite effect is also true. Deposit rates lower to prevent people and businesses to save more than usual. Therefore, the combined effect of this will lead to increased supply of money in the system, thus stimulating growth.
See the following example:
Indonesia Cuts Interest Rate for Sixth Time Before Fed Move
Indonesia's central bank cut its benchmark interest rate for a second month in a row, injecting stimulus into the economy before the U.S. Federal Reserve moves to tighten policy.Governor Agus Martowardojo and his board lowered the seven-day reverse repurchase rate to 4.75 percent from 5 percent on Thursday, as forecast by 12 of 26 economists surveyed by Bloomberg. The rest had predicted the benchmark rate unchanged would Werner.
Australia's Central Bank Cuts Interest Rates to Record Low
Australia's central bank cut interest rates Tuesday, responding to record-low inflation and a slowing jobs market, while playing down the risks of fanning house-price growthThe Reserve Bank of Australia reduced its cash rate by a quarter of a percentage point to 1.5%, the first cut since May. The result was expected, with financial markets pricing in a roughly 66% chance of a cut before the decision."The board judged that prospects for sustainable growth in the economy, with inflation returning to the target over time, would be improved by easing monetary policy at this meeting," central bank Gov. Glenn Stevens said in an Accompanying statement
Central banks sometimes intervene the currency to strengthen or weaken the country's currency.
See the following example:
Bank of Japan to Help Tokyo in Yen Intervention
Japan's central bank will provide funds to the government for currency intervention if needed, as Tokyo continues its campaign to keep down the yen, the Bank of Japan and the Finance Ministry said.The central bank will be ready to lend as much as & yen; 10 trillion ($ 93.03 billion) in funds by buying U.S. Treasury bonds from the ministry on repurchase agreements, the two agencies said.
Swiss National Bank Ramps up Currency Intervention After Brexit
The Swiss National Bank (SNB) went on its biggest foreign-currency buying spree since January 2015 in the wake of Britain's vote to leave the European Union, the data Showed on Monday.Commercial and other deposits with the SNB rose to 507 514 billion Swiss francs ($ 520.69 billion) from 501 231 billion the previous week, Indicating the bank had bought foreign exchange on the market and then credited depositors' accounts.
The reserve requirement ratio (RRR) is defined as the amount of liquid assets that is mandated by the central bank in a bank to be maintained at all times. The ratio is expressed as a percentage of total bank deposits, RRR ensure that the bank is able to pay in the event of the withdrawal of large amounts. It also helps ensure that the banks do not perform excessive leverage. Raising or lowering the RRR has the effect of controlling the money, thus reducing inflation.
Raising RRR
On May 11, 2011, China 5.4%, also announce inflation figures for April 2011, higher than the estimate of 5.2% expected by economists. A day later, China announced a rise in RRR by 50 basis points from 20.5% to 21%. Raising RRR basically limits the supply of money in the system. This has effect of reducing inflationary pressures.
As the data from Reuters.com following:
Lowering/Cut RRR
Here's an example of China in lowering RRR:
Facilitating Transactions for Clients
Bank offers a range of foreign exchange services to their clients. This includes but is not limited to cash transactions, transactions off, options, and international money transfers. Their clients include small banks, corporations, financial institutions and wealthy individuals.
These clients move in currency markets to prevent currency risk or speculate on price movements in order to make a profit. A common transaction between the bank and the client follows a simple three-step process:
1. Contact
This is the first initiation is done by the bank. Telephone calls are usually made through direct telephone or electronic dealing phones, such as Reuters Dealing 3000 can call to make a reservation or simply to request market information and ask the opinion of the sales force about the market direction.
2. Agreement
If there is a need to transact, the client will state the amount and the currency pairs involved. The salesperson then be directly submitted to the client a price quote or contact the dealing desk and get the price directly. Generally, clients who already have a relationship with a bank or transacting in large quantities usually enjoy a more competitive price than other clients.
3. Execution
When the client receives the offer price from the bank, the deal is executed.
By facilitating these transactions for its clients, sales reps gain margin of the bank. Margins are the amounts listed in the offer price the client that can be changed by the sales force to benefit the bank.
Counter Transactions Ownership
Bank runs counter transactions ownership for one reason only: to make a profit. However, the speculative activity like this has long been in the spotlight because it involves less risk management. Investment banks such as Goldman and Deutsche Bank Sacsh known to produce most of the profits from their annual quarter and through the transaction of ownership.
The transaction table is usually separated from the flow of customers. In 2008, chaotic global financial crisis revealed the risks taken by large banks in the ownership transaction activity.
Bear Stearns, the fifth largest investment bank in the United States is the first victim got hit. In March 2008, the Federal Reserve Bank of New York gave emergency loans to banks to avoid sudden bankruptcy. However, losses company of asset-backed securities issuance proved to be the death knell for the company.
In September 2008, Bear Stearns was sold to JP Morgan Chase at a price of USD 10 per share, a price far below pre-crisis highs of USD 133.2 per share for 52 weeks. Sales were higher than the initial price agreed upon, namely USD 2 per share, causing stockholders to lose about 90% of their investment.
Lehman Brothers, the fourth largest investment bank in the United States, is the next bank that went bankrupt on September 15, 2008. When it went bankrupt, the bank has more than 26000 employees are an asset of USD 639 billion, making it the largest bankruptcy in US history.
On the same day, Merrill Lynch was sold to Bank of America in a deal worth USD 50 billion. Three other proprietary trading turmoil in recent years are as follows:
1. Jerome Kerviel, Société Générale.
In 2008, Jerome Kerviel made the whole world was in shock when he inflicted the biggest loss for a large bank in financial history. In 2000, Kerviel joined the compliance department of Société Générale, France's second biggest bank. In 2005, he was promoted to the Delta One trading team belongs to the bank, which specializes in the futures market.
In the course of its trading career, Kerviel's unauthorized trades worth 30 billion euros, generating 1.4 billion euros at the end of the year. After the disguise of its revenue from trade with counterfeit trade, he began 2008 with a bigger appetite, and certainly more risky.
With computing skills and knowledge, Kerviel hide 50 billion euros in trade outside authority. On January 19, 2008, superiors expose his evil plan, and began to close the position for three days starting January 21.
The losses due to trade beyond the authority which made Kerviel reached 4.9 billion euros. Losses incurred Kerviel is regarded as the second largest fraud in banking history after a Ponzi scheme that made Bernie Madoff.
In May 2010, Kerviel published a book entitled L'engrenage: Memories d'un Trader (Downward Spiral: Memoirs of a Trader), in which he accused his superiors aware of its activities from the beginning.
In October 2012, a Paris court sentenced him to three years in prison on Kerviel and the obligation to pay damages of 4.9 billion euros in the company where he worked, Société Générale.
2. Kweku Adoboli, UBS
In September 2011, the giant Swiss bank, UBS, announced a loss of more than USD 2 billion due to fraudulent trading activities conducted Kweku Adoboli, 31-year-old man. Adoboli joined UBS as an intern in March 2006 and eventually worked on the Delta One trading business of the bank, handles trading funds. When news of the trading activity beyond the authority which he did outstanding, UBS shares plummeted, wiping out more than 3.3 billion euros of the bank's market value.
In September 2011, Oswald Gruebel, UBS CEO, resigned as accountable for Adoboli actions. Later revealed that UBS failed to act on warnings issued their computer systems on commercial activities Adoboli. On January 30, 2012, Adoboli declared themselves not guilty to two charges, namely fraud and irregularities in the bookkeeping. On 20 November 2012, he was found guilty after a two-month trial. He was sentenced to 7 years in prison for fraud, and expressed as offenders who cause harm trade outside the purview of the largest in British history..
3. Bruno Iksil, JP Morgan Chase & Co.
In May 2012, the CEO of JP Morgan Chase & Co. Jamie Dimon hit the world when he announced to investors that bad trafficking is happening in London will result in loss of 2 USD billion. This announcement led to the drop in the price of the bank's shares by 10% in a day, remove the value of USD 14 billion. The person responsible for the huge loss this is a French trader named Bruno Iksil, dubbed the "London whale" or "Voldemort", a character in the Harry Potter books.
Apparently Iksil doing bet so big on a credit derivative index so that the deviation (a measure of where the index should transact based components and where the index of actual transactions) becomes too large. At that time, the hedge fund manager bet against Iksil, and position Iksil made it come up short when the economic outlook worsened dramatically. In June 2012, Kate Kelly of CNBC reported that JP Morgan Chase & Co. Chief Investment Office to sell as much as 65% to 70% of their London whale positions are the losers in the index CDX IG-9 10 years.
In July 2012, JP Morgan announced that loss of trade reached USD 4.4 billion. More than double the original estimate. In the same month, Iksil and two other employees, Achilles Marcris and Javier Martin - Artajo, removed from the company's internal job placement database.
After the number of actual trading loss was revealed, Dimon admitted that he was wrong to ignore the concerns expressed in April 2012 about the trade as a sophist.
Volcker Rule
Since 2008, the disclosure for repeated failure to push proprietary trading activities chairman of the US Federal Reserve, Paul Volcker to design what is now known as the Volcker Rule. When filing this rule, Volcker stated that the speculative activities of the bank, especially derivatives, has a key role in the ongoing global financial crisis in 2008 to 2010.
Derivatives originally designed to reduce risk in the financial system, but in its use even cause the opposite effect. Volcker also argued that the Wall Street banks taking excessive risks and carrying out unfair business practices because the regulators are not able to monitor the complexity of the instruments and activities of banks correctly.
Basically, the Volcker Rule is a special part of the Dodd Frank Wall Street Reform and Consumer Protection Act, which restricts US banks trading speculative investments that do not benefit their customers.
This rule states that banks should not be jointly act as advisors and creditors for the client, as well as private equity firms. Volcker Rule aims to minimize conflicts of interest between banks and their clients to separate different types of business practices implemented financial institutions. This rule also aims to protect individuals by creating a more transparent financial framework that can be regulated more easily.
On January 21, 2010, President Barack Obama publicly supports the Volcker Rule. A month later, on February 22, 2010, five former US treasury secretary, W. Michael Blumenthal, Nicholas Brady, and Paul O'Neill, George Shultz, and John Snow, also gave support to the Volcker Rule by sending a letter to the Wall Street Journal.
Volcker rule is not without criticism. On 10 April 2012, Peter J. Wallison, a senior fellow at the American Enterprise Institute, sent a letter to the Wall Street Journal, Wallison urged repeal of the rule.
Multinationals Corporations
Multinational corporations (MNC) participated in the foreign exchange market mainly for hedging purposes. Hedging is basically a type of activity that offset the risks related to currency movements. Hedging represents approximately 5% of all global foreign exchange transactions.
Some companies even have adequate own trading floor, with traders speculating to generate profits and reduce risks related to exchange rate fluctuations. Daily movement of currency can have a significant impact on the final report.
In July 2011, Swatch CEO Nick Hayek Reported that the strength of the Swiss franc could cost the company upwards of USD 1 billion.
As shown in this report:
Japan is an export-oriented country, and a strong yen can wipe billionsof dollars off corporate balance sheets in the country. In February 2012,Nissan Reported that for every 1 yen that Strengthens against the U.S.dollar (e.g., if USD / JPY falls from 80 to 79), the company loses 20 billionyen in annual operating proft.
As shown in this report:
To protect itself against such currency fluctuations, Company A can hedge this risk by going "long" on EUR / USD on the futures market. A long position is a bet that the EUR / USD currency pair will rise. this position is taken on the day the deal is done, the which is June 1, 2012. On September1, 2012, the day of the cash transactions between the two companies, two scenarios can happen.
Scenario 1: Euro Strengthens Against the U.S. Dollar Saythe euro strengthens against the U.S. dollar between June 1, 2012, andSeptember 1, 2012. With a stronger euro, Company A will receive fewer
euros once the USD100,000 is converted to euros. However, it will net aprofit on the futures market because of its long position.
The lesser cash received for the goods will be offset by the profitreceived on the futures market. This sum total will be almost equivalent to the sum paid by Company B had the transaction been done on June 1, 2012.
Scenario 2: Euro Weakens Against the U.S. Dollar In contrast, say the euro weakens against the U.S. dollar between June 1, 2012, and September 1, 2012. With a weaker euro, Company A will receive more cash once the USD100,000 is converted to euros. However, it will net a loss on the futures market because of its long position (which is essentially a bet that the euro will strengthen against the U.S. dollar). The more cash received for the goods will offset the loss incurred onthe futures market. This sum total will be almost equivalent to the sum paid by Company B had the transaction been done on June 1, 2012.
Let ’s take a look at the next sample transaction.
Futures exchange: Singapore Mercantile Exchange
1 lot 5 € 25,000
1 pip 5 USD2.50
EUR/USD exchange rate on June 1, 2012 5 1.3000Note: Had the transaction been done on June 1, 2012, the exporterwould have received €76,923 (100,000/1.3000). Hence, the exporterneeds to hedge an amount close to €76,923.
Raising RRR
On May 11, 2011, China 5.4%, also announce inflation figures for April 2011, higher than the estimate of 5.2% expected by economists. A day later, China announced a rise in RRR by 50 basis points from 20.5% to 21%. Raising RRR basically limits the supply of money in the system. This has effect of reducing inflationary pressures.
As the data from Reuters.com following:
China raises bank reserves again to tame inflation
China lifted bank reserve requirements by 50 basis points on Thursday, signaling that containing inflation and soaking up excess cash Remained its top priority even after signs the economy was slowing down.The announcement of more tightening Came as a surprise to some analysts who had expected the People's Bank of China to tap the monetary brakes more Gently after a host of the data from industrial output to imports were Weaker than expected in April.
Lowering/Cut RRR
Here's an example of China in lowering RRR:
China makes big cut in bank reserve requirements to fight slowdown
China's central bank on Sunday cut the amount of cash that banks must hold as reserves, the second industry-wide cut in two months, adding more liquidity to the world's second-biggest economy to help spur bank lending and combat slowing growth.The People's Bank of China (PBOC) lowered the reserve requirement ratio (RRR) for all banks by 100 basis points to 18.5 percent, effective from April 20, the central bank said in a statement on its website www.pbc.gov.cn.
Private Bank and Investment Bank
Private banks are the largest currency trader currency in the world. These banks are connected to the interbank market, mutual trade currencies through electronic networks. The difference or the difference between the price of supply and demand is very thin in the interbank market.
This narrow margin allowed banks to trade currencies in large quantities at very low cost. On the interbank market rate covers about 55% of all foreign exchange transactions in the world. According to Euromoney 2012 survey of foreign exchange, Deutsche Bank maintained its position as the largest foreign exchange trading bank in the world for eight consecutive years.
Another player who occupy the top 10:
Ranked
|
Name
|
Market share (%)
|
1
|
Deutsche Bank
|
14.57
|
2
|
Citi
|
12.26
|
3
|
Barclyas Investment Bank
|
10.95
|
4
|
UBS AG
|
10.48
|
5
|
HSBC
|
6.72
|
6
|
JP Morgan
|
6.60
|
7
|
Royal Bank of Scotland
|
5.86
|
8
|
Credit Suisse
|
4.68
|
9
|
Morgan Stanley
|
3.52
|
10
|
Goldman Sachs
|
3.12
|
Basically, there are two reasons why private banks participate in the foreign exchange market: First, to facilitate transactions for clients and to execute the counter transactions ownership
Bank offers a range of foreign exchange services to their clients. This includes but is not limited to cash transactions, transactions off, options, and international money transfers. Their clients include small banks, corporations, financial institutions and wealthy individuals.
These clients move in currency markets to prevent currency risk or speculate on price movements in order to make a profit. A common transaction between the bank and the client follows a simple three-step process:
1. Contact
This is the first initiation is done by the bank. Telephone calls are usually made through direct telephone or electronic dealing phones, such as Reuters Dealing 3000 can call to make a reservation or simply to request market information and ask the opinion of the sales force about the market direction.
2. Agreement
If there is a need to transact, the client will state the amount and the currency pairs involved. The salesperson then be directly submitted to the client a price quote or contact the dealing desk and get the price directly. Generally, clients who already have a relationship with a bank or transacting in large quantities usually enjoy a more competitive price than other clients.
3. Execution
When the client receives the offer price from the bank, the deal is executed.
By facilitating these transactions for its clients, sales reps gain margin of the bank. Margins are the amounts listed in the offer price the client that can be changed by the sales force to benefit the bank.
Counter Transactions Ownership
Bank runs counter transactions ownership for one reason only: to make a profit. However, the speculative activity like this has long been in the spotlight because it involves less risk management. Investment banks such as Goldman and Deutsche Bank Sacsh known to produce most of the profits from their annual quarter and through the transaction of ownership.
The transaction table is usually separated from the flow of customers. In 2008, chaotic global financial crisis revealed the risks taken by large banks in the ownership transaction activity.
Bear Stearns, the fifth largest investment bank in the United States is the first victim got hit. In March 2008, the Federal Reserve Bank of New York gave emergency loans to banks to avoid sudden bankruptcy. However, losses company of asset-backed securities issuance proved to be the death knell for the company.
In September 2008, Bear Stearns was sold to JP Morgan Chase at a price of USD 10 per share, a price far below pre-crisis highs of USD 133.2 per share for 52 weeks. Sales were higher than the initial price agreed upon, namely USD 2 per share, causing stockholders to lose about 90% of their investment.
Lehman Brothers, the fourth largest investment bank in the United States, is the next bank that went bankrupt on September 15, 2008. When it went bankrupt, the bank has more than 26000 employees are an asset of USD 639 billion, making it the largest bankruptcy in US history.
On the same day, Merrill Lynch was sold to Bank of America in a deal worth USD 50 billion. Three other proprietary trading turmoil in recent years are as follows:
1. Jerome Kerviel, Société Générale.
In 2008, Jerome Kerviel made the whole world was in shock when he inflicted the biggest loss for a large bank in financial history. In 2000, Kerviel joined the compliance department of Société Générale, France's second biggest bank. In 2005, he was promoted to the Delta One trading team belongs to the bank, which specializes in the futures market.
In the course of its trading career, Kerviel's unauthorized trades worth 30 billion euros, generating 1.4 billion euros at the end of the year. After the disguise of its revenue from trade with counterfeit trade, he began 2008 with a bigger appetite, and certainly more risky.
With computing skills and knowledge, Kerviel hide 50 billion euros in trade outside authority. On January 19, 2008, superiors expose his evil plan, and began to close the position for three days starting January 21.
The losses due to trade beyond the authority which made Kerviel reached 4.9 billion euros. Losses incurred Kerviel is regarded as the second largest fraud in banking history after a Ponzi scheme that made Bernie Madoff.
In May 2010, Kerviel published a book entitled L'engrenage: Memories d'un Trader (Downward Spiral: Memoirs of a Trader), in which he accused his superiors aware of its activities from the beginning.
In October 2012, a Paris court sentenced him to three years in prison on Kerviel and the obligation to pay damages of 4.9 billion euros in the company where he worked, Société Générale.
2. Kweku Adoboli, UBS
In September 2011, the giant Swiss bank, UBS, announced a loss of more than USD 2 billion due to fraudulent trading activities conducted Kweku Adoboli, 31-year-old man. Adoboli joined UBS as an intern in March 2006 and eventually worked on the Delta One trading business of the bank, handles trading funds. When news of the trading activity beyond the authority which he did outstanding, UBS shares plummeted, wiping out more than 3.3 billion euros of the bank's market value.
In September 2011, Oswald Gruebel, UBS CEO, resigned as accountable for Adoboli actions. Later revealed that UBS failed to act on warnings issued their computer systems on commercial activities Adoboli. On January 30, 2012, Adoboli declared themselves not guilty to two charges, namely fraud and irregularities in the bookkeeping. On 20 November 2012, he was found guilty after a two-month trial. He was sentenced to 7 years in prison for fraud, and expressed as offenders who cause harm trade outside the purview of the largest in British history..
3. Bruno Iksil, JP Morgan Chase & Co.
In May 2012, the CEO of JP Morgan Chase & Co. Jamie Dimon hit the world when he announced to investors that bad trafficking is happening in London will result in loss of 2 USD billion. This announcement led to the drop in the price of the bank's shares by 10% in a day, remove the value of USD 14 billion. The person responsible for the huge loss this is a French trader named Bruno Iksil, dubbed the "London whale" or "Voldemort", a character in the Harry Potter books.
Apparently Iksil doing bet so big on a credit derivative index so that the deviation (a measure of where the index should transact based components and where the index of actual transactions) becomes too large. At that time, the hedge fund manager bet against Iksil, and position Iksil made it come up short when the economic outlook worsened dramatically. In June 2012, Kate Kelly of CNBC reported that JP Morgan Chase & Co. Chief Investment Office to sell as much as 65% to 70% of their London whale positions are the losers in the index CDX IG-9 10 years.
In July 2012, JP Morgan announced that loss of trade reached USD 4.4 billion. More than double the original estimate. In the same month, Iksil and two other employees, Achilles Marcris and Javier Martin - Artajo, removed from the company's internal job placement database.
After the number of actual trading loss was revealed, Dimon admitted that he was wrong to ignore the concerns expressed in April 2012 about the trade as a sophist.
Volcker Rule
Since 2008, the disclosure for repeated failure to push proprietary trading activities chairman of the US Federal Reserve, Paul Volcker to design what is now known as the Volcker Rule. When filing this rule, Volcker stated that the speculative activities of the bank, especially derivatives, has a key role in the ongoing global financial crisis in 2008 to 2010.
Derivatives originally designed to reduce risk in the financial system, but in its use even cause the opposite effect. Volcker also argued that the Wall Street banks taking excessive risks and carrying out unfair business practices because the regulators are not able to monitor the complexity of the instruments and activities of banks correctly.
Basically, the Volcker Rule is a special part of the Dodd Frank Wall Street Reform and Consumer Protection Act, which restricts US banks trading speculative investments that do not benefit their customers.
This rule states that banks should not be jointly act as advisors and creditors for the client, as well as private equity firms. Volcker Rule aims to minimize conflicts of interest between banks and their clients to separate different types of business practices implemented financial institutions. This rule also aims to protect individuals by creating a more transparent financial framework that can be regulated more easily.
On January 21, 2010, President Barack Obama publicly supports the Volcker Rule. A month later, on February 22, 2010, five former US treasury secretary, W. Michael Blumenthal, Nicholas Brady, and Paul O'Neill, George Shultz, and John Snow, also gave support to the Volcker Rule by sending a letter to the Wall Street Journal.
Volcker rule is not without criticism. On 10 April 2012, Peter J. Wallison, a senior fellow at the American Enterprise Institute, sent a letter to the Wall Street Journal, Wallison urged repeal of the rule.
Multinationals Corporations
Multinational corporations (MNC) participated in the foreign exchange market mainly for hedging purposes. Hedging is basically a type of activity that offset the risks related to currency movements. Hedging represents approximately 5% of all global foreign exchange transactions.
Some companies even have adequate own trading floor, with traders speculating to generate profits and reduce risks related to exchange rate fluctuations. Daily movement of currency can have a significant impact on the final report.
In July 2011, Swatch CEO Nick Hayek Reported that the strength of the Swiss franc could cost the company upwards of USD 1 billion.
As shown in this report:
Swatch Chief Executive Nick Hayek said: "I think 2011 will be a recordyear, but the franc is a real concern." He added: "If the situation stays like it is now, sales could be hit by as much as one billion Swiss francs , or $ 1.25 billion, due to the impact of the strong franc. "
Wall Street Journal, July 28, 2011
Japan is an export-oriented country, and a strong yen can wipe billionsof dollars off corporate balance sheets in the country. In February 2012,Nissan Reported that for every 1 yen that Strengthens against the U.S.dollar (e.g., if USD / JPY falls from 80 to 79), the company loses 20 billionyen in annual operating proft.
As shown in this report:
Chief executive Carlos Ghosn said "the yen's recent weakening trenddoes not go far enough. We need more [weakening] to reestablish thecompetitiveness of Japan. The dollar should be between ¥ 90 and¥ 100, "adding that he doesn 't see the yen's recent weakening trendas just a short-term development.
Wall Street Journal, February 27, 2012
Hedging Example for Exporters
Let's take an example of an export company in Germany (called A), which has sold a container of materials worth USD100,000 to an import company in the United States (called B). The deal is done on June 1, 2012, but the payment is settled only once the goods are delivered on September 1, 2012.
The risk to Company A is the Fluctuation of the currency rate of EUR / USD.If the euro Strengthens against the U.S. dollar between June 1, 2012, and September 1, 2012, Company A will receive fewer euros for the USD100,000paid by Company B, thereby affecting Company A 's bottom line.
If, however, the euro weakens against the U.S. dollar in the same period, Company A will receive more euros once the exchange rate is taken into account. There is no currency risk for Company B Because it is based in the United States and the payment is made in U.S. dollars. Company Bis assured that the amount to pay will always be USD100,000 Regardless of when the payment is made.
Scenario 1: Euro Strengthens Against the U.S. Dollar Saythe euro strengthens against the U.S. dollar between June 1, 2012, andSeptember 1, 2012. With a stronger euro, Company A will receive fewer
euros once the USD100,000 is converted to euros. However, it will net aprofit on the futures market because of its long position.
The lesser cash received for the goods will be offset by the profitreceived on the futures market. This sum total will be almost equivalent to the sum paid by Company B had the transaction been done on June 1, 2012.
Scenario 2: Euro Weakens Against the U.S. Dollar In contrast, say the euro weakens against the U.S. dollar between June 1, 2012, and September 1, 2012. With a weaker euro, Company A will receive more cash once the USD100,000 is converted to euros. However, it will net a loss on the futures market because of its long position (which is essentially a bet that the euro will strengthen against the U.S. dollar). The more cash received for the goods will offset the loss incurred onthe futures market. This sum total will be almost equivalent to the sum paid by Company B had the transaction been done on June 1, 2012.
Let ’s take a look at the next sample transaction.
Futures exchange: Singapore Mercantile Exchange
1 lot 5 € 25,000
1 pip 5 USD2.50
EUR/USD exchange rate on June 1, 2012 5 1.3000Note: Had the transaction been done on June 1, 2012, the exporterwould have received €76,923 (100,000/1.3000). Hence, the exporterneeds to hedge an amount close to €76,923.
Since the contract size for 1 lot on the Singapore Mercantile Exchange is € 25,000, the exporter goes long on 3 lots for EUR / USD..
Because of the hedge, Company A gained certainty of price. If the transaction was done on June 1, 2012, the exporter would have received € 76.923. With a simple hedge done on the Singapore Mercantile Exchange, theEUR / USD could have strengthened or weakened 500 pips in three months, and the amount the exporter received would have been almost identical.
Let's have a look at the final summary.
- If goods had been transacted on June 1, 2012, the exporter would havereceived € 76.923.
- On September 1, 2012, if EUR / USD had strengthened to 1:35, theexporter would have received € 76.852.
- On September 1, 2012, if EUR / USD had weakened to 1.25, the exporterwould have received € 77,000.
The hedge executed by the exporter Provided € 100 less than a varianceon either side of the amount of € 76.923. This hedge is important to protect the company's bottom line from wild currency fluctuations. If Company A did not enter into a hedge on the futures position market, it would havereceived either € 74.074 (100.000 / 1.35) or € 80,000 (100.000 / 1.25). It is this uncertainty that causes exporters to hedge on the currency market.
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