Forex.docx

Forex — An Introduction Forex, or foreign exchange, is the buying of 1 currency with that of another. Although it is called foreign exchange, this is just a relative term. The terms domestic and foreign is relative to the person using the term. What is foreign to one person is domestic to another. Currency exchange would be the more proper term. The main reasons to exchange foreign currency for domestic currency is to pay for goods and services in the foreign country, to invest in its financial assets, to hedge against unfavorable rates of exchange in the future, or to profit from those changes. Foreign currency holders need to convert it back to their domestic currency to take profits, so that businesses, governments, and other organizations can use the money at home. Hedging is exchanging currency, either in the spot market or by using forwards or futures contracts, to protect against unfavorable changes in the future. Most hedgers are governments and businesses that need to buy or sell in a foreign country sometime in the future. Speculators are people who are exchanging currency purely for profit. Governments, usually through their central banks, influence the exchange rate to some extent as well, either by buying or selling foreign currency, or by creating or destroying domestic currency. Thus, currency rates fluctuate because demand and supply for each currency fluctuates. The foreign exchange market, often called the FX market, is an over-the-counter (OTC) market. Its consists of a network of dealers—central banks, commercial and investment banks, funds, corporations, and individuals. Transactions are done electronically, usually over the Internet, and traders buy and sell through a broker. Thus, the forex market operates as a spot market. Although there are futures and forward contracts on currencies, most forex transactions use the spot market. There is no central exchange for the spot market, and brokers and dealers are located throughout the world, so the forex market is a 24 hour market during the weekdays. Forex is the largest financial market in the world—

over 4 trillion USD equivalent values of currency are traded daily. Currency rates are listed as pairs, and there are many sites on the Internet that display current quotes. The rate of exchange is the amount of the foreign currency that is equal in value to a unit of domestic currency, or, more generally, it is the amount of currency received for each unit of the currency tendered. Thus, for instance, the Great Britain pound (GBP) has, at 1 time, passed the $2 mark in value. That means that $2 buys £1. Virtually every country, with some small exceptions, has its own currency, and most of them can be traded. However, the currencies of a few countries are the most actively traded, and constitute, by far, the largest volume of trades. The big 5 are the United States dollar (USD), Euro (EUR), Japanese yen (JPY), the British pound (GBP), and the Swiss franc (CHF). Each currency is symbolized using 3-letter ISO (International Organization for Standardization) codes: the 1 2 letters designate the country, the 3 designates the currency. The most famous illustration of this is for the United States dollar—USD. However, sometimes the country name or currency that is symbolized is not the most common name. Thus, the symbol for the Swiss franc is CHF, where CH stands for Confederation Helvetica, which refers to Switzerland, and MXN stands for the Mexican Nuevo Peso, even though the most common name for Mexico's currency is simply the peso. st

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Advantages of Forex Trading There are many advantages to trading currencies for profit. Because there are no organized exchanges for the foreign currency spot market, there are no clearing fees or other exchange fees, and because the forex market is decentralized, there are no government fees. The lack of organized exchanges and its decentralization among worldwide trading centers creates a 24 hour market during the weekdays. The large size of the market provides liquidity and fast transactions. Investing in currencies is also a good way to diversify assets, because it has little correlation with stocks or bonds. You can make money regardless of whether a

currency is rising or falling with respect to another currency. If the target currency is expected to rise, you buy it, then sell it later at a higher price, hopefully; if it is falling, you sell it short, then buy it later at a lower price, if you predicted correctly. Thus, there is no up or down market in the FX market—if one currency is up with respect to another, then the other, obviously, is down, and vice versa. And because of the FX market's huge size and decentralization, there is no possibility that prices will be manipulated by accounting frauds. No Enron's or WorldCom's in this market—not even the possibility. Nor can such a huge market be cornered. And because currency prices are not the result of what any single organization does, there can be no insider trading. Nor can any bubble arise, as has happened to stocks in the late 90's, and to real estate more recently. The size of the market is simply too vast and too interrelated for bubbles to form. FX metals — gold, silver, palladium, platinum — can also be traded in forex accounts. For instance, XAU represents gold. Each XAU/USD pair represents 1 troy ounce of gold. A pip is equal to a penny, 1 lot equals 10 ounces of gold and 10 FX XAU/USD lots is identical to trading 1 lot of the traditional gold futures contract listed on the COMEX exchange. However, the pip spread in FX metals is 2 to 3 times greater than those for the equivalent futures contract. Another disadvantage is that only dealing desk brokers offer FX metals, so the trader would be buying or selling at the broker's price rather than the market price.

Forex Accounts Opening an account to trade currencies requires very little money—in some cases, as little as $200 in socalled mini-accounts. Many firms offer up to 50:1 leverage ratios in mini-accounts, so a trader with $200 in a mini-account can trade up to $10,000 worth of currencies. Leverage greatly amplifies both profits and losses. Before 2010, brokers advertised much higher leverage ratios — as high as 400:1 — but US regulations have capped the leverage ratio to 50:1. Because currencies are naturally range-bound, leverage is necessary to earn a reasonable profit. That currency prices do not change much is what allows brokers to offer such a high leverage ratio.

Is the Forex Market Liquid? Liquidity is the ability to quickly sell an asset for what it is worth. In illiquid markets, assets usually have to be sold for less than what they are worth, especially if the sale must be completed quickly. Forex brokers love to advertise that the forex market is the most liquid market because more than $4 trillion worth of currency is traded daily. However, this is misleading because the currencies are not traded on the same network — there is no centralized exchange for trading currencies, so there is no global price competition for forex orders. Liquidity depends on which currency pairs are traded, whether the trade is with a dealing desk broker or with an electronic communication network (ECN), and, if using an ECN, the number and activity of the participants on that ECN. The largest and most active ECNs have the most liquidity. Some currency pairs are very illiquid. Much of the retail forex trading is done with dealing desk brokers, who set the bid/ask prices on all the currencies that they offer, so there is absolutely no price competition with a dealing desk broker. Although currencies can be bought and sold, the prices will be worse than what could have been gotten on a competitive ECN.

Taxation of Forex Trades Forward contracts on currencies are classified as 1256 contracts by the tax code, but gains and losses in the forex spot market are treated as ordinary income unless the taxpayer opts out. There are 2 methods of reporting gains and losses in forex trading in the spot market. The regular method, which is the default method is governed by IRC §988, which taxes forex trades as ordinary income. However, the trader can opt out of the §988 treatment so that spot forex trades are treated the same as 1256 contracts, where, regardless of the holding period, 60% of the gain or loss is considered long-term and the remaining 40%, short term. This election can be beneficial since longterm capital gains are taxed at a lower rate than ordinary gains. Trades treated as 1256 contracts are reported on Form 6781, Gain and Losses from Section 1256 Contracts and Straddles.

Updated Forex Statistics The Bank for International Settlements (BIS) surveys central banks throughout the world in regards to their currency transactions and reports the results quarterly. In addition to reporting the total volume of spot trades, it also reports statistics on:  

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currency derivatives, which are used to hedge risk or make profits cross currency swaps, where 2 parties agreed to exchange interest payments in different currencies for specified time, and emerging market currencies, which now account for more than 20% of all currency trading. Forex trading continues to grow, due to improving and cheaper technology, with more than $4 trillion of currency values traded daily. Hedge funds and individual investors continue to represent a significant part of the increase. No doubt that this trend will continue for the foreseeable future To buy foreign goods or services, or to invest in other countries, individuals, companies, and other organizations will usually need to exchange their domestic currency for the foreign currency of the country with which they are doing business. Some exporters do, however, accept foreign currencies, especially the United States dollar, which is widely used in the import-export business. For instance, Saudi Arabia accepts payments in U.S. dollars (USD) for its oil, so when Canadians buy their oil, they transact the business in the USD that they receive from trading with the United States, even though the United States is not involved in the oil purchase at all. The foreign exchange rate is simply the price of one currency in terms of another, or how much one currency can be exchanged for another, in the same way that the price of a good is determined by how much money can be exchanged for it. The foreign exchange market – otherwise known as the FX market — consists of financial institutions, mostly banks, that stand ready to exchange one currency for another. Banks often negotiate exchange rates among themselves, but forex dealers that market

their services to the public generally post bid/ask prices on the currency pairs in which they make a market. Most FX transactions take place in the United Kingdom, United States, and Japan with most of the rest of the market centered in Hong Kong, Singapore, Australia, Switzerland, France, and Germany.

Because the FX market is a worldwide market, where most trading takes place on computer networks, the FX market is open as long as any financial institution conducting forex trades is open. Hence, when banks in New Zealand open on Monday morning, it is still Sunday in the rest of the world, and as the day and night progresses, banks in other parts of the world start opening up as it becomes morning there. When some banks close for the day, other banks, farther west, open. San Francisco, in the United States, is the last major trading center to close for the week – Friday afternoon. Hence, the FX market is open 24 hours a day for each of the 5 business days. By contrast, few forex trades occur from late Friday afternoon in San Francisco to Monday morning in New Zealand. Note that because London and New York are the largest forex trading centers, most forex trading occurs between 8 AM and 12 PM Eastern Standard Time.

The International Dateline is where, by tradition and fiat, the new calendar day starts. Since New Zealand is a major financial center, the forex markets open there on Monday morning, while it is still

Sunday in most of the world. United States Naval Observatory.

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The FX market is, by far, the largest market in the world. Some statistics on the foreign exchange market can be found at Bank for International Settlements: International Financial Statistics.

Here are some key statistics released by the Foreign Exchange Committee on January 25, 2018, based on its 27th Survey of North American Foreign Exchange Volume, conducted October 2017.

Source: New York Federal Reserve Bank.

Foreign Exchange Market Participants There are several types of market participants that engage in forex transactions to hedge risk, to speculate for profits, or to facilitate business and other transactions. 1. Banks and other financial institutions are the largest volume traders, where roughly 2/3 of all FX transactions involve banks trading directly with each other. 2. Brokers sometimes act as intermediaries between banks. Brokers with more extensive contacts, can often find better prices for the banks than they could find themselves, and they also offer anonymity to banks seeking to buy or sell large amounts of currency. Brokers profit by charging a commission on the intermediated transactions. 3. Business customers require foreign currency to transact foreign business or to make investments. Businesses with large foreign exchange requirements even have their own trading desks. 4. Institutional investors, such as pension funds, hedge funds, mutual funds, and insurance companies, engage in forex trading to either hedge risk or to speculate for profits.

5. Retail customers need foreign currency to travel abroad or to make online purchases from foreignbased companies. Some retail customers also engage in forex trading, using their own computers or even mobile devices, in the hope of earning profits. 6. And, what are called foreign exchange interventions, central banks, which act either on behalf of their own or foreign governments, sometimes participate in the FX market to offset the influence of short-term shocks that can sometimes cause temporary large movements in the exchange rate of some currencies, such as the rapid appreciation of the yen caused by the 2011 earthquake and tsunami in Japan.

Purposes of Foreign Exchange Trading When currency is exchanged to conduct business, to invest in foreign countries, or to hedge risk, the primary concern of the forex participants is not the short-term movements in exchange rates but to conduct business with a minimal exchange risk. Speculators, on the other hand, hope to profit from short-term movements in the exchange rates by either buying low and selling high or by selling short and buying low, usually over a period of minutes, hours, or sometimes days. However, it is difficult to make profits by speculating in foreign transactions, since short-term movements are governed by the instantaneous supply and demand of any currency, which cannot be predicted by any trader. Traders attempt to forecast currency movements by using either fundamental analysis or technical analysis. Fundamental analysis is used to determine long-term trends in currency prices by examining the economic factors that determine currency rates, such as the relative inflation, interest rates, and the economic strength of the countries being compared. However, fundamental analysis cannot predict short-term prices because it takes time to gather the information – information that is often revised several times over a period of months – and even if the changes in the

fundamentals could be known in real-time, it would not help to predict the instantaneous supply and demand that determines short-term price movements. Instead, most traders have turned to technical analysis, which is the examination of prices and volumes of recent forex transactions in the hope that they can be used to predict future movements. The Efficient Market Hypothesis states that future prices cannot be predicted from past prices, that all market information has already been incorporated into current prices, and, indeed, considering that most forex transactions are independent of each other, there is little reason to believe that future currency movements can be predicted from past forex transactions, even real-time transactions; nonetheless, hope for profits springs eternal. Although technical charts do exhibit patterns, the pattern details and the timing change frequently, making it difficult to profit from small movements in currency prices, even with the 100 to 1 leverage ratio or more that many forex companies offer to retail customers. What technical traders hope for, at best, is that their predictions will have an increased probability of being correct and that they will profit more often than not. Indeed, some technical traders do make a profit over a long time, but are those profits the result of skill? Or is it similar to the proverbial monkeys that pick companies by throwing darts on a list, where if there are enough monkeys throwing darts, some will be successful by sheer chance, by being at the high-end of the statistical distribution. Another thing to consider is whether the profits from technical trading is worth the time invested.

Currency Trading Between Banks Banks, who are the largest forex participants by volume, either trade with each other directly or use the services of a broker. Direct transactions account for 2/3 of forex trades between banks, while brokers mediate the remaining 1/3, charging a commission on the transaction. A bank that wishes to buy or sell currency directly will offer bid/ask prices – bid prices are the prices that the bank is willing to pay for a currency and ask prices are the prices that the bank is

willing to sell. The dealing bank profits by the spread between the bid and the ask price. The size of the spread depends on how frequently the currencies are traded. Hard currencies, such as the US dollar, Euro, Japanese yen, and British pound, constitute about 80% of the FX market, and thus, the spread between these currency pairs is usually quite narrow, often less than 4 pips. (1 pip = 1/10,000th of a currency unit for most currencies.) Soft currencies, such as those of less developed economies, are traded less frequently, resulting in larger spreads.

Types of FX Transactions There are several types of FX transactions: spot transactions, forward transactions, swaps, futures, and options. Other than spot transactions, the remaining types of FX transactions span over time. These types of transactions can help to prevent or hedge FX risks that may result from changes in the exchange rate.

Spot Transactions Spot transactions are an immediate trade in what is called the spot market, where one party agrees to exchange 1 currency for another at an agreed-upon rate. Spot transactions are a major type of FX transaction, consisting of more than 1/3 of all FX transactions. Settlement of spot trades usually occurs in 2 business days, especially for currencies of countries located in different hemispheres. However, some currencies, such as the Canadian-United States dollar, settle in 1 business day. In a trade not involving dealers, one party typically calls another and asks for both the bid and ask prices for a particular currency. Even though the party only wants to buy or sell, he will still ask for both prices, so that the other trader is not alerted yet to his actual intentions, since that would allow her to skew her prices in her favor. A dealer, of course, would post both bid and ask prices. For a business or other organization that must often sign long-term contracts for a stipulated price, using spot prices of currency incurs exchange-rate risk.

Exchange Risks in Spot Transactions Suppose a U.S. company orders machine tools from a company in Japan, which will take 6 months and cost 120 million yen. When the order is placed, the yen is trading at 120 to a dollar. The U.S. company budgets $1 million in Japanese yen to be paid when it receives the tools (120,000,000 yen with 120 yen per dollar = $1,000,000) . However, the yen-dollar exchange rate will almost certainly be different 6 months later. Although the U.S. company could pay when the order is placed, it would lose the opportunity cost of the money during the 6-month period, when it could earn interest, for instance. If, after the 6 months, the exchange rate is 100 yen per dollar, then the cost in U.S. dollars would increase by $200,000 (120,000,000 / 100 = $1,200,000), which would be a profit to the Japanese company but a loss for the American company. But if the rate is 140 yen to a dollar, then the cost in U.S. dollars would decrease by over $142,000 (120,000,000 / 140 = $857,142.86), which would be a profit to the American company and a loss to the Japanese company. Most companies eliminate this foreign exchange risk by using forward contracts.

Forward Transactions FX risks can be prevented by forward transactions. The parties agree to a forward contract where negotiated prices are calculated using a forward exchange rate that depends on the current exchange rate, the difference in interest rates between the 2 countries, and on the settlement date, which is when payment will be made. The settlement date, like all the other contract terms of the forward contract, are negotiable, but the term of the forward contract is usually less than one year. Forward contracts do, however, have counterparty risk, which is the risk that a party will be unable or unwilling to fulfill the contract on the settlement date. There is also business risk to a forward transaction, in that, if the needs of the parties change, the contract cannot be amended or canceled unless both parties agree. Counterparty and business risks increase with the term of the contract.

Currency Swaps Many forward contracts are used in the import/export business, where one party is selling a good or service and the other party is paying for it. A currency swap (aka foreign exchange swap) is a simplified forward contract where the parties exchange currency when

they agree to the contract and reverse the exchange when the contract terminates. Currency swaps are the most common type of forward transaction. Credit risk is limited to the difference in value of the 2 currencies on the settlement date. Because the interest rates of the 2 countries are probably different, there is usually an adjustment made for the different opportunity costs of each currency, which is similar to the adjustment made in forward contracts. Example — Currency Swap Transaction An American company wants to invest €1 million in Germany for one year. It finds a European company in the over-the-counter market that is willing to exchange €1 million for $1.5 million, so the companies exchange the currencies when the agreement is signed. After one year, the American company gets its $1.5 million back and the European company gets its €1 million plus an additional adjustment for the higher interest rate in Europe.

Foreign Currency Futures A foreign currency future (aka forex future) is a forward contract with standardized terms, including quantities and settlement dates, that is traded on organized exchanges. The exchange acts as an intermediary between the buyer and seller and takes on the credit risk of both parties. Hence, credit risk is minimized because the exchange is usually much more creditworthy than the traders and has a greater reputation. Because futures are standardized contracts, there is greater price transparency and liquidity than with forward contracts and, thus, they can be canceled or offset by purchasing or selling an offsetting contract. Indeed, most future contracts are terminated before the settlement date, because speculators have no interest in the actual delivery of currency but are only interested in the profits that they hope to make when they close out their position. Although standardization gives futures contracts most of their advantages over forward contracts, they may not serve the needs of some parties, especially businesses with specialized needs.

Options Forwards and futures require performance at a settlement date. An option gives the owner the right,

but not the obligation, to buy or sell a specified amount of foreign currency at a specified price, called the strike price, at any time up to a specified expiration date. A call option allows the holder to buy currency at the strike price. A put option allows the holder to sell currency at the strike price. Options differ from currency futures because they do not have to be closed out — the option holder can just let the option expire if it is not profitable. In contrast, at the expiration of a futures contract, the futures buyer would have to accept delivery of the currency, and the futures seller would have to actually deliver the currency, unless it is a cashsettled contract, in which case the seller would have to pay to the buyer the equivalent value in a specified currency

Foreign Exchange History Before there was currency, nations traded goods directly, paying for one good by exchanging it for another. It was barter on a national scale. However, barter had major disadvantages: it could not be divided into units of equal amounts, the value of the barter frequently depended on the quality of the goods, and the value of those goods would generally decrease over time. Animals, for instance, were frequently traded, but they age and eventually die, so their value would decline over time, eventually to nothing. Because of its many advantages, money was eventually created to facilitate trading. Money could be divided into equal units that each has the same value, and because its value did not depend on its condition, its nominal value did not change. Thus, money, unlike barter, can serve as a unit of account and as a store of value, the 2 main functions of money. Additionally, it was also a better means of exchange: easier to carry, easier to store, and eliminating the need that one trader had exactly what the other trader wanted, and vice versa. In the beginning, trading partners would use a common form of money to conduct their business, which was usually gold or silver. Then eventually the benefits of paper currency became evident, but since each country issued its own currency, it wasn't very useful for international trading, since the purchasing power of each currency differed considerably and could

differ over time depending on how much currency the countries issued. Hence, foreign exchange history can be viewed as a series of solutions that allowed countries to issue their own currency and to conduct their own monetary policy while also allowing international trade to be conducted by providing a means of exchanging one currency for another according to the exchange rate between them, which was either agreed-upon or set by the market.

Money, Currency, and Foreign Trade One of the qualities that money requires is that it be scarce. If it were not, it would have no value as money. For instance, if ordinary stones were money, then anyone could just pick some up off the ground and pay a merchant for his goods. But why would a merchant accept stones when he could just stoop down to pick up stones, too. He wouldn't need to sell merchandise, or do anything at all, if he could just pick up some stones and use it for money. Everyone else would think similarly. Hence, there would be no economy, and nothing to buy with the stones. Although many different items were used for money in the past, people eventually discovered that gold was the ideal material for money. It could not be manufactured or printed, it was not easily mined, and it was difficult to find new sources of gold. That it was also the most ductile and malleable of metals made it easy to fashion into coins. But gold was heavy, and how much a person could carry is severely limited, since a 10 dollar gold piece would be 10 times heavier than a 1 dollar gold piece. So governments decided that printed currency, usually called bills or notes, was the solution. A 10 dollar bill, for instance, weighs just as much as 1 dollar bill or a 100 dollar bill. This was a good solution, but still had some problems. What would prevent anybody from just printing money? Governments solved that problem by using secret methods of printing and passing harsh laws to punish anyone who would try. But what would prevent the government from just printing more money to pay itself and others? Many governments have done that—Germany, after World

War I, for instance. Consequently, their currency become worthless. It took a wheelbarrow of cash to buy a loaf of bread. Germans were literally burning money to keep warm in the winter. Oftentimes, people in such economies turn to hard currency, which is a trusted currency of a stable country, because nobody wants to buy or sell using currency that is continually devaluing. So obviously, there must be some way to prevent governments from just printing money, and the way that was done was to make it equal, by law, to something else that couldn't be easily made, printed, or found—gold. The advantages of using money backed by gold were numerous: 

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Since every country had gold, a natural material, and most people were familiar with it, it provided a common measure of value. It helped keep inflation in check by keeping the money supply based on the gold standard limited, thus stabilizing economies. Inflation is the result of increasing supplies of money for a given economic state. More money causes the price of everything to go up because it increases the demand for goods and services before the economy has time enough to expand its supply— so prices go up. By tying the amount of currency to the amount of gold that a country possesses, it limits the amount of currency that can be printed. Low inflation allows long-term planning. There are many large projects that must be paid for over time. It would be almost impossible to project future costs without knowing what future prices were going to be.

Fixed Exchange Rates Before there was significant trade between countries, there was little need for foreign exchange, and when there was a need, it was served by gold, since gold was used by most of the major countries. However, as trade expanded, there was a need to exchange currency rather than gold because gold was heavy and difficult to transport. But how could different

countries equalize their currency in terms of another currency. This was achieved by equalizing all currencies in terms of the amount of gold that it represented—the gold-exchange standard.

Gold-Exchange Standard Under this system, which prevailed from 1879 to 1934, the value of the major currencies was fixed in terms of how much gold for which they could be exchanged, and thus, they were fixed in terms of every other currency. Example — Calculating Exchange Rates Based on the Gold Standard When the United States adopted the gold standard in 1879, it fixed the United States dollar to an ounce of gold at the rate of $20.67. Also at this time, the British sterling pound was pegged at £4.2474 per ounce. To calculate the exchange rate between United States dollars and British pounds, divide the value of one currency by the other. So to calculate the number of United States dollars per British pound: $20.67/4.2474 = $4.8665 To calculate the value of British pounds in terms of dollars: £4.2474/20.67 = £0.2055 Note that this is the same method as calculating currency cross rates, where the rate between 2 currencies is determined by calculating their exchange rate with a 3 currency where both exchange rates with the 3 currency are known. rd

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One of the requirements that the countries adhering to the gold standard needed to follow was to maintain their money supply to a fixed quantity of gold, so the government could only issue more money if it had obtained more gold. This requirement, of course, was to prevent countries from just printing money to pay foreigners, which had to be prevented because, otherwise, there could be no foreign trade. Why would a trader accept currency for his goods if the country could just print more of it, thereby reducing the value of the currency that was already available, and thereby reducing the value of the currency held by the trader? A corollary of this requirement is that gold had to flow freely between different countries; otherwise no country could export more than they import, and vice versa, and still maintain its supply of currency to the gold it held in stock. So if there was a net transfer of currency from one country to another, gold would

have to follow. (Or, at least the ownership of it. The New York Federal Reserve, for instance, held the gold of many countries, so countries could settle in gold by updating their accounts at the New York Fed.)

The Collapse of the Gold Standard The main problem with the gold standard was that if a country was not competitive in the world marketplace, it would lose more and more gold as more goods were imported and less exported. With less gold in stock, the country would have to contract the money supply, which would hurt the country's economy. Less money in circulation reduces employment, income, and output; more money increases employment, income, and output. This is the basis of modern monetary policy, which is implemented by central banks to stimulate a sluggish economy by increasing the money supply or to reign in an overheating one by contracting the money supply. During the 1930's, the world was in the throes of the Great Depression. Countries started abandoning the gold standard by reducing the amount of gold backing their currency so that they could increase the money supply to stimulate their economies. This deliberate reduction of value is called a devaluation of currency. When some of the countries abandoned the gold standard, then it just collapsed, for it was a system that could not work unless all the trading countries agreed to it. Of course, at some point, something else would have to take its place; otherwise, there could be no world trade—at least not in the quantities that were then occurring. As World War II was coming to a close, it was obvious that another system would be needed.

Bretton Woods and the Adjustable-Peg System The leaders of the allied nations met at Bretton Woods, New Hampshire in 1944, to set up a better system of fixed exchange rates. The U.S. dollar was fixed at $35 per ounce of gold and all other currencies were expressed in terms of dollars. This official fixed rate of exchange was known as the par value of currency (aka par of exchange, par exchange rate).

However, to avoid making deleterious macroeconomic adjustments to maintain the exchange rate, the new system provided for an adjustable peg, that allowed the exchange rate to be altered under specific circumstances. Thus, this Bretton Woods system was also known as the adjustable-peg system. To actuate this new system, the International Monetary Fund (IMF) was created. Each country had to maintain an account at the IMF that was proportional to the country's population, volume of trade, and national income. One of the services provided by the IMF was to provide accounts for each of the participating countries that held Special Drawing Rights (SDR), which were units of account that could be used to settle IMF transactions through the transference of the SDRs. Although initially the SDR was pegged to gold, it is currently equalized to the weighted average of the currencies of the 5 largest IMF exporters. The new system required that each country value its currency in terms of gold or the United States dollar, which, of course, fixed the exchange rate among all currencies. The countries were required to maintain the exchange rate to within 1% of the peg, but, if special circumstances required, they could allow the exchange rate to fluctuate by up to 10%. However, if this was not adequate, then the country would have to seek approval from the IMF board to change the exchange rate by more than 10%. This prevented countries from devaluing their currency for their own benefit. To maintain the limits, a country could:   

use official reserves, which is the foreign currency held by a country from a previous surplus. borrow from the IMF by borrowing the foreign currency, and using its own currency as collateral. sell gold to a country for its currency. The Bretton Woods system began to weaken in the 1960s, when foreigners accumulated large amounts of U.S. dollars from post World War II aid and sales of their exports in the United States. There were concerns as to whether the U.S. had enough gold to redeem all the dollars.

With reserves of gold falling steadily, the situation could not be sustained and the U.S. decided to abandon this system. In 1971, President Nixon announced that U.S. dollars would no longer be convertible into gold, so the exchange rate was allowed to float. Because of the central role played by the United States, the Bretton Woods system could not be sustained. By 1973, this action led to the system of managed floating exchange rates that exists today.

The Managed Floating Exchange Rate Managed floating exchange rates are rates that float, but are sometimes changed by countries, by having their central banks intervene directly in the forex market, usually by buying or selling the currency that the country wants to influence, so that the exchange rate is changed by the new supply or demand. However, direct intervention by the major countries has been rare. For instance, the Federal Reserve has only intervened 8 days in 1995, and only 2 days in the 10year period 1996-2006. Many smaller countries, however, either peg their currency to the United States dollar, or, like Singapore, peg it to a basket of currencies. The major benefit of the flexible floating exchange rate is that it corrects imbalances automatically. If a country imports more than it exports, then its currency will decline in relation to the importing country's currency, which will make imports more expensive and exports less expensive, thus reversing the imbalance, or at least mitigating it. It also helps to adjust the system when events happen that have a significant impact on the balance of trade, such as the spike in oil prices in 1973-1974 and 1981-1983, or when countries experience significant recessions. Another major benefit of the floating exchange rate is that it allows countries to manage their own economies through monetary policy, expanding the money supply to stimulate the economy, or contracting it to rein in inflation. Indeed, the publication of significant changes in monetary policy, such as the raising or lowering of interest rates, by the major countries increases volatility in their currencies, both before and after the news is published. Many traders stay out of the market

during these times because of its unpredictability. Most major forex trading websites have a calendar of these events for the currency pairs that they offer for trading. Before pegged systems were abandoned, it was feared that flexible exchange rates would diminish trade because of unknown changes in the rate that could affect sales or projects that take time. However, this problem has been solved with FX forward contracts that eliminate any uncertainty about future exchange rates.

Changes in the foreign exchange rates of yen per dollar and dollars per pound from 1970-2001.

Source: New York Federal Reserve Bank.

The International Monetary Fund and the World Bank The IMF has survived the demise of the Bretton Woods system. Today it loans money to developing countries or to those in crisis, or to Communist countries changing over to capitalism. It can impose strict rules, if necessary, over the economies of the loan recipients to help them repay their debt. Another organization created by the Bretton Woods Agreement—the International Bank for Reconstruction and Development (IBRD), or World Bank, has also survived. The World Bank's original purpose was to finance the reconstruction of Europe and Asia after World War II. Today, the World Bank loans money, mostly to developing countries, for commercial and infrastructure projects, and the loans must be backed by the country receiving the loans. It does not, however, compete with commercial banks

Foreign Exchange Reserves of India

FOREIGN EXCHANGE RESERVES INDIA March 01, 2019 401.777 (Billion US Dollars)

USD 2,559.50 million (from Feb 22, 2019) 52 Week High: 426.082 bn (Apr 13, 2018) 52 Week Low: 392.079 bn (Oct 26, 2018)

FOREIGN EXCHANGE RESERVES Trend DATE AMOUNT CHANGE Mar 01, 2019 401.777 0.64% Feb 22, 2019 399.217 0.24% Feb 15, 2019 398.273 0.04% Feb 08, 2019 398.122 0.53% Feb 01, 2019 400.242 0.52% Jan 25, 2019 398.178 0.38% (Billion US Dollars)

GOLD RESERVES OF INDIA 01 March 2019 23.25 Billion US Dollar

Created with Highcharts 6.1.0Source: Reserve Bank Of IndiaUS Dollar Billion ($)Foreign Exchange Reserve of IndiaIndiaForeign Exchange ReserveMay '18Jul '18Sep '18Nov '18Jan '19Mar '19380.00400.00420.00440.00NumberBasket.com 1 Mar 2019● Foreign Reserve:USD 401.777 Billion Source: Reserve Bank Of India

India's Forex Reserves

The Foreign Exchange Reserves of India stood at 401.777 Billion US Dollar as on March 01, 2019. This represents an increase in the Foreign Exchange Reserve by USD 2,559.50 million from last week i.e. Feb 22, 2019. In the 52 week period, the Foreign Exchange Reserves of India touched a high of USD 426.082 Billion on Apr 13, 2018 and recorded a low of USD 392.079 Billion on Oct 26, 2018. Meanwhile, the Gold Reserves of India stood at USD 23.25 Billion US Dollar as on Mar 01, 2019. The Reserve Bank of India (RBI) reported that the Foreign Currency Assets stood at 374.06 US Billion Dollar, the Reserve Trench position at 3.00 US Billion Dollar, SDRs (Special Drawing Rights with the IMF) at 1.46 US Billion Dollar as on Mar 01, 2019. India's Forex Comparision

401.78

Month ago 400.24

1 Year ago 420.59

5 Years ago 294.36

10 Years ago 249.28

Mar 2019

Feb 2019

Feb 2018

Feb 2014

Feb 2009

Current

Billion US Dollar

What is Foreign Exchange Reserves? Foreign exchange reserves (also called forex reserves or FX reserves) is foreign currency or other assets held by a central bank or Government. The main purpose of holding foreign Reserves is that the Central Bank can pay if need be its liabilities, such as the currency issued by the central bank, as well as the various bank reserves deposited with the central bank by the government and other financial institutions. The higher the reserves, the higher is the capacity of the central bank to smooth the volatility of the Balance of Payments.

Foreign Exchange Reserves Composition Foreign Exchange Reserves include: 1. Foreign Currency Reserves held in US Dollars, Euro, British Pound or Japanese Yen. 2. Gold Reserves. 3. International Monetary Fund Reserve Trench Positions. 4. Special Drawing Rights (SDRs). SDR represents aclaim to foreign currencies for which it may be exchanged.  

Our foreign-exchange reserves when I took over were no more than a billion dollars; that is, roughly equal to two weeks' imports. ~ Manmohan Singh

Foreign Reserve Trend of India ▼

Foreign Excha

Foreign Exchange Reserves (Dollar)

Select Created with Highcharts 6.1.0Source: Reserve Bank Of IndiaUS Dollar BillionTotal Foreign ReserveClick and drag in the plot area to zoom in2002200420062008201020122014201620180.0100.0200.0300.0400.0500.0Numb erBasket.com 11 Apr 2008● Foreign Reserve:$312.37 Billion In India, The Reserve Bank of India the is the custodian of India’s foreign exchange reserves and is responsible for maintaining and managing the country’s foreign exchange reserves. Foreign exchange reserves facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India. One benefit of keeping large amount of foreign reserve is that India can effectively handle the situation such as oil shocks or global recession