Sean Lee

What's the difference between the futures market and spot market in Foreign Exchange trading?

"The futures market and spot market are two primary components of the foreign exchange (Forex) market, each with its own distinct characteristics. Here's an overview of the differences between these two markets:

Spot Market:

Immediate Transaction: In the spot market, currencies are bought and sold for immediate delivery. When a trade is executed, the exchange of currencies occurs "on the spot" or within a short period, usually within two business days.
Current Exchange Rates: The spot market reflects the current exchange rates prevailing in the market at the time of the trade.
Physical Delivery: In the spot market, actual delivery of the underlying currencies takes place.
Cash Settlement: Settlement in the spot market involves the actual exchange of currencies and the transfer of funds between the parties involved.
Futures Market:

Future Delivery: The futures market involves contracts to buy or sell currencies at a predetermined price on a future date. The delivery of the currencies occurs at a specified date in the future.
Fixed Contract Size: Futures contracts have standardized sizes, such as standard lots, mini-lots, or micro-lots, which determine the amount of currency being traded.
Speculation and Hedging: Futures contracts are used for both speculative purposes and hedging against potential currency fluctuations.
Margin Trading: Futures trading typically involves margin requirements, where traders are required to deposit a percentage of the contract value as collateral.
Centralized Exchange: Futures contracts are traded on regulated exchanges, such as the Chicago Mercantile Exchange (CME), where buyers and sellers interact through a centralized platform.

In summary, the spot market involves the immediate exchange of currencies at the prevailing rates, while the futures market allows for the trading of currency contracts for future delivery. The spot market is more focused on current transactions, while the futures market caters to future price speculation and risk management."

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by Sean Lee

Explain the Greek symbols in Financial Market options trading

"Greek symbols are widely used in financial markets, particularly in options trading, to represent various measures of risk and sensitivity associated with option contracts. These symbols help traders and investors understand how the price of an option may change in response to changes in underlying variables. Here are some of the key Greek symbols used in options trading:

Delta (Δ): Delta represents the sensitivity of an option's price to changes in the underlying asset's price. It measures the rate of change of the option price with respect to a $1 change in the underlying asset. Delta values range between 0 and 1 for call options (0 to -1 for put options). A delta of 0.5 means that for every $1 increase in the underlying asset's price, the option price will increase by $0.50.

Gamma (Γ): Gamma measures the rate of change of delta. It represents how much the delta of an option will change in response to a $1 change in the underlying asset's price. Gamma is highest for at-the-money options and decreases as options move further in or out of the money.

Theta (Θ): Theta represents the time decay of an option. It measures how much the option's price will decrease over time, all else being equal. Theta is typically expressed as a negative value since options lose value as they approach their expiration date. For example, a theta of -0.05 means the option's value will decrease by $0.05 per day.

Vega (ν): Vega measures an option's sensitivity to changes in implied volatility. Implied volatility reflects the market's expectation of future volatility. Vega indicates how much an option's price will change for a 1% change in implied volatility. A vega of 0.10 means that if implied volatility increases by 1%, the option's price will increase by $0.10.

Rho (ρ): Rho measures the sensitivity of an option's price to changes in interest rates. It represents the change in the option's price for a 1% change in the risk-free interest rate. Rho is more relevant for longer-term options or options with significant time to expiration.

Lambda (λ): Lambda is not as widely used as the other Greeks but represents the percentage change in an option's price for a 1% change in the price of the underlying asset. It provides a measure of leverage.

These Greek symbols help traders assess the risks and potential returns associated with options positions and develop strategies to manage their portfolios effectively. It's important to note that these measures are estimates and rely on various assumptions, and real-world market behavior may deviate from these predictions."

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by Sean Lee

Forex Education: Repurchase Agreements (REPOS) Explained

A repurchase agreement, commonly known as a repo, is a financial transaction in the realm of fixed-income securities and money markets. It involves the sale of securities (typically government bonds) with a simultaneous agreement to repurchase them at a later date. Repos are commonly used by financial institutions, such as banks and hedge funds, to manage their short-term liquidity needs.

Here's how a repurchase agreement works:

Parties involved: There are two primary parties in a repo transaction: the seller (or borrower) and the buyer (or lender). In most cases, the seller is a financial institution in need of short-term funds, while the buyer is a cash-rich entity seeking a safe and temporary investment.

Agreement: The seller sells the securities to the buyer and agrees to repurchase them at a specific date in the future. This repurchase date is often very short-term, ranging from overnight to a few weeks. The terms of the repo, including the repurchase date and the agreed-upon repurchase price, are specified in a legal contract.

Collateral: The securities being sold by the seller act as collateral for the buyer's investment. If the seller fails to repurchase the securities as agreed, the buyer can retain the securities and sell them in the market to recover their investment.

Interest rate: The difference between the sale price and the repurchase price represents the interest earned by the buyer, also known as the repo rate. It is essentially the cost of borrowing funds for the seller and the return on investment for the buyer. The repo rate is agreed upon before the transaction takes place and is typically determined by prevailing market rates.

Benefits for the seller: Repurchase agreements provide a short-term source of liquidity for financial institutions. They can quickly raise funds by selling securities without actually losing ownership, as they agree to repurchase them. Repos are often used to meet reserve requirements, cover temporary cash shortages, or finance trading activities.

Benefits for the buyer: Buyers, such as money market funds or central banks, benefit from repos by earning a relatively low-risk return on their temporary investments. They gain the security of holding government securities as collateral, ensuring the return of their funds.

Variations: Repurchase agreements can take different forms, such as open repos and term repos. Open repos have no fixed maturity date, and the buyer can request the return of funds at any time. Term repos, on the other hand, have a specified maturity date, providing more certainty for both parties.

Overall, repurchase agreements play a vital role in the functioning of financial markets, helping institutions manage their short-term cash needs while offering investors a secure and liquid investment option.

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by Sean Lee

Forex Education: What are Currency Swaps?

"Currency swaps are financial instruments that involve the exchange of one currency for another currency, with an agreement to reverse the exchange at a future date. They are used to manage currency risk, reduce funding costs, and access foreign currency funding.

In a currency swap, two parties agree to exchange principal and interest payments in different currencies. The exchange rate is agreed upon at the time the contract is entered into, and the parties agree to reverse the exchange at a future date.

For example, Company A, based in the United States, may want to borrow Japanese yen to finance a project in Japan, while Company B, based in Japan, may want to borrow US dollars to finance a project in the US. Instead of each company borrowing in their own currency and incurring foreign exchange risk, they could enter into a currency swap agreement where they agree to exchange the principal and interest payments in their respective currencies.

Currency swaps can be customized to meet the specific needs of the parties involved, including the amount of the exchange, the exchange rate, and the duration of the swap. They can also be structured to include a fixed or floating interest rate, and can be used to hedge against interest rate risk as well as currency risk.

Overall, currency swaps are a useful financial instrument for managing currency risk and accessing foreign currency funding. However, they also carry risks and require careful consideration and management of counterparty risk and market volatility."

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by Sean Lee

Forex Education: What are NDFs (non-deliverable forwards)

"Non-deliverable forwards (NDFs) are financial instruments used in foreign exchange markets to hedge or speculate on the future value of a currency. They are a type of forward contract that is settled in cash, rather than by physical delivery of the underlying asset.

NDFs are typically used in countries where the currency is not freely tradable or where the currency is subject to capital controls. In these situations, it may be difficult or impossible to trade the currency in the spot market or to deliver the currency at a future date. Instead, counterparties agree to settle the contract in a more freely traded currency, such as the US dollar.

In an NDF, the two parties agree to exchange a fixed amount of one currency for another currency at a future date, typically ranging from one month to one year. The exchange rate is agreed upon at the time the contract is entered into, and the settlement amount is determined by the difference between the agreed-upon exchange rate and the prevailing spot rate at the time of settlement.

NDFs can be used for hedging or speculation purposes. Companies may use NDFs to hedge against currency risk when doing business in countries with non-convertible currencies or to lock in a future exchange rate for a transaction. Investors may use NDFs to speculate on the future direction of a currency or to profit from interest rate differentials between two currencies.

Overall, NDFs are a useful financial instrument for managing currency risk in countries with restrictions on the free flow of currency. However, they also carry risks and require careful consideration and management of counterparty risk and market volatility."

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by Sean Lee

Forex History: The Basel Accords

by Sean Lee

Forex History: Nick Leeson & Barings Bank

"Nick Leeson is a former derivatives trader who became infamous for his role in the collapse of Barings Bank, a British financial institution, in 1995. Leeson was working as a trader in Singapore for Barings Bank when he made a series of unauthorized trades that resulted in huge losses for the bank. Leeson covered up his losses by creating fictitious accounts and lying to his superiors about the state of his trades.

By the time his fraud was discovered, Barings Bank had lost £827 million, which was more than twice its available trading capital. The bank was forced to declare bankruptcy, making it the first major financial institution to collapse due to rogue trading.

Leeson fled Singapore but was eventually arrested in Germany and extradited to Singapore to stand trial. He was convicted of fraud and sentenced to six and a half years in prison, but was released early due to his diagnosis of colon cancer. Leeson has since written several books about his experiences and has worked as a public speaker and financial consultant."

Sourced from Chat GPT, assessed by Sean Lee

Postscript: Can't believe that they didn't mention that Nick Leeson went on to become CEO at the mighty Sligo Rovers FC.

by Sean Lee

Forex History: The Interbank Market

"The Forex interbank market has a long history dating back to the late 19th century when the gold standard was established as the international monetary system. The gold standard provided a fixed exchange rate between currencies, and banks could exchange their reserves of gold for foreign currencies to settle international transactions.

However, the gold standard was abandoned during World War I, and countries began to use their currencies as a means of financing their war efforts. This led to the creation of a new foreign exchange market, where banks and other financial institutions could trade currencies with each other.

In the 1970s, the Bretton Woods system, which was established after World War II, collapsed, and currencies began to float freely against each other. This led to the development of a more sophisticated interbank market, where banks could trade currencies with each other at market-determined exchange rates.

In the early days of the interbank market, trading was conducted over the phone, and prices were not transparent. However, the advent of electronic trading in the 1990s revolutionized the market and made it more accessible to a wider range of participants.

Today, the Forex interbank market is the largest financial market in the world, with an estimated daily turnover of over $6 trillion. The market is open 24 hours a day, five days a week, and is accessible to participants from all over the world. The market continues to evolve, with the development of new trading technologies and the increasing involvement of non-bank participants, such as hedge funds and retail traders."

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by Sean Lee

Forex History: The GFC and the end of the carry trade

"The global financial crisis of 2008 had a significant impact on the carry trade, which is a trading strategy that involves borrowing money in a low-interest-rate currency and investing it in a higher-yielding currency to profit from the difference in interest rates.

During the years leading up to the financial crisis, many investors and financial institutions took advantage of the carry trade to earn higher returns on their investments. However, when the crisis hit, the value of many higher-yielding currencies plummeted as investors fled to safer assets such as the U.S. dollar, Swiss franc, and Japanese yen. This caused many carry trades to unwind, as investors rushed to sell their higher-yielding currencies and repay their loans in lower-yielding currencies, leading to sharp movements in currency markets.

The carry trade was also affected by the liquidity crunch that followed the crisis, as financial institutions became reluctant to lend money to each other and to investors. This made it harder for investors to borrow money at low interest rates and invest in higher-yielding currencies, further exacerbating the unwinding of carry trades.

Overall, the global financial crisis had a significant impact on the carry trade, highlighting the risks and vulnerabilities of this trading strategy, particularly in times of market turbulence and uncertainty."

Sourced from Chat GPT, assessed by Sean Lee.

Postscript: This article may have all the right words but it doesn't convey the feeling at the time, as investors tried to dump positions which had been built up over years, in a frenzied few hours. I still remember AUD/JPY falling 10% in a matter of minutes in early morning Asian trade. Ah, the good old days, as long as you weren't on the wrong side!

by Sean Lee

Forex History: The Bunker Hunt brothers try to corner the Silver market

"Bunker Hunt was a wealthy Texan oil tycoon who, along with his brother Herbert, attempted to corner the silver market in the late 1970s and early 1980s. The Hunt brothers began accumulating large amounts of silver in the early 1970s, betting that rising inflation and a weak US dollar would cause the price of silver to soar.

Their actions eventually drove the price of silver up to unprecedented levels, from around $6 per ounce in early 1979 to over $50 per ounce by January 1980. This caused a range of economic problems, as the high price of silver led to increased costs for manufacturers and investors, and threatened to destabilize the global financial system.

In an effort to reign in the Hunt brothers and prevent further economic damage, the US government intervened in the market, introducing measures to restrict the buying and selling of silver. The price of silver eventually fell back to more reasonable levels, and the Hunt brothers were forced to sell off their holdings of the metal.

The saga of the Hunt brothers' attempt to corner the silver market remains a cautionary tale of the dangers of speculation and the potential for market manipulation to cause economic harm. It also highlights the importance of government intervention in maintaining stable markets and protecting against excessive speculation."

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by Sean Lee

Forex History: Bernard Lietaer

"Bernard Lietaer was a Belgian economist and author who was known for his work in the field of complementary currencies and monetary systems. He was born on February 7, 1942, and passed away on February 4, 2019.

Lietaer held several high-level positions in the financial industry, including serving as the chief currency trader for the Belgian central bank and as a president of the Belgian Electronic Payment System. He also worked for several multinational corporations and was a co-founder of the Global Alliance for Banking on Values.

In addition to his work in the financial industry, Lietaer was a prominent advocate for complementary currencies and alternative monetary systems. He believed that the current monetary system, based on a single national currency, was inherently unstable and contributed to economic inequality and social instability.

Lietaer argued that complementary currencies, which are designed to circulate within a specific community or region, could help to promote economic stability and social cohesion by providing a means of exchange that is not tied to the fluctuations of the global financial system. He was the author of several books on the topic, including "The Future of Money" and "New Money for a New World".

Lietaer's ideas and contributions continue to be studied and discussed by economists and policymakers interested in alternative monetary systems and the potential for complementary currencies to promote economic and social well-being."

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Postscript: A man well ahead of his time.

by Sean Lee

Forex History: Herstatt Bank

"The Herstatt Bank, also known as Bankhaus I.D. Herstatt KGaA, was a privately owned bank based in Cologne, Germany. The bank was founded in 1948 and grew to become one of the largest privately owned banks in Germany, with a focus on foreign exchange trading.

In 1974, the Herstatt Bank collapsed due to a series of bad investments and fraudulent activities, which left the bank unable to meet its obligations to its creditors. The collapse of the bank was significant, as it was one of the first major international banks to fail in the post-World War II period and raised concerns about the stability of the global financial system.

The collapse of the Herstatt Bank was also notable for the way in which it was handled by regulators and central banks. The collapse occurred during a time when there was no established international framework for managing cross-border bank failures, which led to a number of difficulties in managing the fallout from the collapse.

The Herstatt Bank crisis ultimately led to the establishment of new international regulations and institutions to manage cross-border bank failures and reduce the risks posed by such events to the global financial system. The crisis also served as a wake-up call for the financial industry and regulators, highlighting the need for greater transparency, oversight, and risk management in the banking sector."

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Postscript: This was before my time in the FX market but I started my career in Düsseldorf so it was still much talked about. My recollection is that Herstatt had built a massive short USD/DMK position but the market got wind of the fact and started ramping the market massively in the other direction. The losses were so big that Herstatt basically went bust in 1 day. Those were the days when 20 big figure daily moves weren't unusual.

by Sean Lee

Forex History: Long Term Capital Management

"Long-Term Capital Management (LTCM) was a hedge fund founded in 1994 by a group of prominent financial professionals, including Nobel laureate economists and former Wall Street traders. The fund was designed to use complex mathematical models to generate high returns with low risk by taking advantage of market inefficiencies.

At its peak, LTCM managed over $100 billion in assets and was one of the largest hedge funds in the world. However, in 1998, the fund faced a significant crisis as a result of the Russian financial crisis, which led to a sharp decline in global markets and a liquidity crisis in the hedge fund industry.

LTCM's portfolio suffered significant losses, and the fund was on the verge of collapse. The situation was considered a systemic risk to the financial system, as many major banks and financial institutions had significant exposure to LTCM's investments.

In response to the crisis, the Federal Reserve Bank of New York organized a consortium of banks to provide a bailout package for LTCM, which prevented its collapse and stabilized the financial system. However, the incident raised concerns about the risks posed by highly leveraged hedge funds and the need for greater oversight and regulation of the financial sector.

The LTCM crisis is widely regarded as one of the most significant events in the history of modern finance, as it demonstrated the potential for even the most sophisticated and well-respected financial institutions to fail in the face of unexpected market shocks. It also highlighted the need for greater transparency and risk management in the financial sector, which led to increased regulatory oversight and changes in industry practices."

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Postscript: One of the biggest positions that LTCM had was the basic USD/JPY carry trade and they had a very big one. When the market got wind of the fact that LTCM was starting to bail out of its positions, USD/JPY fell by as much as 14 big figures in a single session (or two, if my memory serves me correctly).

by Sean Lee

Forex History: Asian Financial Crisis

"The Asian financial crisis was a major economic crisis that affected many countries in Asia, beginning in July 1997. The crisis was characterized by sharp declines in the value of the currencies of several Asian countries, as well as a drop in stock prices and other financial assets. The crisis was triggered by a number of factors, including high levels of foreign investment, a lack of financial regulation, and overvalued currencies.

by Sean Lee

Forex History: The Bretton Woods Agreement

"The Bretton Woods Agreement, signed in 1944 in Bretton Woods, New Hampshire, was a landmark international agreement that established a new system for managing the global monetary system. The agreement was negotiated between the Allied nations at the end of World War II and aimed to create a stable economic environment by ensuring a predictable exchange rate regime.

by Sean Lee

Forex History: Soros Vs The Pound Sterling

"In 1992, George Soros, a billionaire investor and philanthropist, made a massive bet against the British pound. He believed that the pound was overvalued and due for a significant correction, and he decided to take a short position against it.

by Sean Lee