I always say that the three most difficult topics in finance to teach are index tranche investing (don’t ask), bond futures and FX swaps.  There is a wonderful adage that comes from the UBS training team that states, “FX is not difficult, it is just very confusing”.

When you look at the statistics for Foreign Exchange Trading it shows quite clearly that this is the dominant product.

Forward FX

First things first.  Within the context of Foreign Exchange Trading, what is forward FX?  This is a transaction that fixes the price for an exchange of cash flows for delivery at a maturity longer than spot – 1 month, 3 months, 12 months.  According to theory the forward FX price should trade at a level that makes an investor indifferent between investments in two different currencies.  Suppose that the EURUSD rate is trading at parity i.e. 1 EUR = 1 USD.  A EUR investor sees that interest rates in the US are 5% while domestic rates are 3% (both actual / actual day basis).

The investor decides to sell her EUR for USD and then invest the proceeds at the higher rate for 12 months before reconverting back into EUR.  How much would she end up receiving?  That would depend on how the spot price evolved over the year.  If the price moves to 1 EUR = 1.10 USD, then she would reconvert her USD105 into EUR95.45.  This is a EUR appreciation / USD depreciation.  A movement in the exchange rate to 1 EUR = USD 0.90 would generate an income of EUR 116.67 (EUR depreciation / USD appreciation). 

No free lunch

Suppose that the investor wanted the enhanced USD return and cash flow certainty.  They approach their bank and ask for a forward FX quote.  Sadly, the market will not grant both conditions as the rate they will be quoted will reflect the ratio of the two interest rates.  That is today’s quote for an exchange of currency in 12 months will be 1EUR = 1.019 USD (USD 105 / EUR 103).  This is the rate of exchange that makes the investor indifferent as to whether they invest in EUR to earn EUR 103) or to invest in USD (to earn USD 105).

Note that the forward rate is a mechanical calculation and is not a forecast of future spot rates. 

What we can offer

If you are interested in understanding more about Foreign Exchange Trading for your team or company here is a flavour of what we can offer. https://www.fmarketstraining.com/what-we-do/foreign-exchange-derivatives-training/

At the moment we do not have the bandwith to offer 1-2-1 training.