FLAME Newsletter - May 23, 2012


QUOTE OF THE WEEK:

“The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.”  -  Ernest Hemingway

Our economy is in a state where investors want to shun risky assets such as equity and commodities. Gold, which is considered a safe-haven investment, has now become too expensive for the common man. Real Estate, which is correlated with equity market movement, is also not showing any signs of improvement. With the Reserve Bank of India bringing down interest rates, banks are also reducing interest rates on their term deposits. In such a case, where does an investor go?

The US dollar is considered the reserve currency of the world, and today, seems to be the best pick of investors globally.   Moreover, the rupee too is at an all-time low versus the greenback and the troubled euro zone’s Euro too, is at a near two-year low to the reserve currency.  With currency movement so active, let us explore the option of forex trading.


A PICTURE SPEAKS A THOUSAND WORDS...

YOUR FINANCE DEMYSTIFIED:

The Advantages of Forex Trading

The online Forex trading market is the largest capital market for investors. You can start investing through a dealer and then conduct trading online. It is a 24-hour trading market with millions in cash flow every day and is a better investment option than stocks in such precarious market situations. Let us enlist benefits of Forex trading.  

The largest market

The size of the Forex trading market is nearly a whopping $2 billion which is much more than the stock market or any other investment option. This is the main reason that Forex market traders never have issues with liquidity and have enough flexibility with trading. Traders from all over the world are trading in the market through the day keeping it active always.    

Safer than the stock market

Forex market trading is safer than trading in the stock market. In a stock market, one can choose from stocks of several companies, each governed by different factors. In Forex trading, one can choose from 14 pairs of currencies. When you sell one currency pair and buy the other one, you can almost be assured of the profit.  

Predictable prices

The currency prices are predictable to a limit. The big changes in currency prices only come with remarkable incidents. The ups and downs of everyday trading are not enough to give you big losses. Because of this nature of the currencies, you can easily decide your buying or selling point. That makes Forex trading a flexible investment option.  Also, currencies move in a very limited range, making the investment less volatile.

No commission is needed

Computer based/online Forex trading does not charge any fees. The entire system is transparent and you can rest assured that you will not face any problem with hidden prices. You can conduct research about the currency online on the Forex market website, free of charge. You can also do a background check on the financial stability of a country whose currency you wish to trade. 

Instant processing

This is the fastest form of trading. Every process is computerized. You have to give the instructions on your computer and the step will be executed within 2-3 seconds.  The value of a currency can change in a second which is why such a fast system is required to trade currencies with an accurate price.

Foreign Currency Derivatives

A security whose price depends upon or is derived from an underlying asset such as a commodity, bond, equity and currency is called a derivative. The derivative itself is only a contract between two or more parties and fluctuations in the underlying asset determine its value. Since derivatives have no value of their own, they are not standalone assets. But some common types of derivatives are traded in markets before their expiration dates as though they are assets.

With a foreign exchange (Forex) derivative, the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-determined exchange rate and date. The forex derivatives market is the largest market in the world, with over $US1 trillion traded every single day.

Speculating and hedging

Forex derivatives are principally used for speculating and hedging. Hedgers use forex financial contracts futures to mitigate risk by insulating themselves against potential price shifts in the future. One the other hand, speculators take risks with profit as their objective.

One of the major advantages of using forex derivatives is the availability of trade spreads that are normally lower, often less than three points. Transaction costs are also usually lower with the buyer enjoying more leverage for each contract.

On the demerit front, there is a need for higher capital investments which cannot be afforded by retail investors, the mandatory fees, and the time limitations as forex derivatives can only be used during an exchange trading session.

Tools

Trading strategies are generally the same as standard trading methods while using forex derivatives for speculation. The history and turning points of the currency are evaluated by the method of trend analysis. However, more complex methods are also used to determine the country’s economic indicators and political climate.

Uses

Forex derivatives are often used for hedging to protect sales revenue. For example, an Indian company with stores in England will be making sales in pounds but needs to receive the income in rupees. In such situations, a forex derivative will allow the firm to purchase a contract in the amount of expected sales in order to erase any changes in the currency market. Forex derivatives may also be in the form of forwards where the underlying cash is not paid until the date of expiry.

DID YOU KNOW?

The rupee was devalued by its highest at 36.5% in 1966 due to macroeconomic concerns such as a failed monsoon, high budget and current deficits and low industrial production.

TERM OF THE WEEK

Free Exchange Rates

Free Exchange Rates are rates of exchange in foreign currencies which are governed by normal forces of supply and demand, without any sort of state supervision or control at a national or international level.

IN THE NEWS THIS WEEK:

The free fall of the rupee has dominated the news this week with the domestic currency hitting a new low to the US dollar almost every day. This depreciation has continued despite efforts by the Reserve Bank of India to stem the fall. What is the way ahead now?

Rupee tumbles to 56 per USD on Greek jitters

Will RBI take the ultimate weapon to save rupee and the economy?

No sign of relief for rupee….What next?   

ABOUT FLAME

FLAME (Financial Literacy Agenda for Mass Empowerment) is an IIFL initiative to promote financial literacy amongst the masses in order to make them an integral part of India's spectacular growth story.

In an era of accelerating GDP and rising per capita growth, financial literacy has become more critical than ever before such that we all reap the tangible benefits of the nation's economic prosperity. Financial inclusion has been quite high on the governmental agenda, given its emphasis on widening the Banking & Financial services network across the country. IIFL's FLAME initiative stands committed to complement this effort by helping common people gain financial growth and security though better awareness and education on the variety of financial products while avoiding the lure of and loss from unrealistic claims made by unscrupulous agents and ponzi schemes.

Our objective is to light a FLAME, as the name suggests, which will set ablaze a chain of FLAMEs across the country. The new-found light of knowledge will undoubtedly dispel the dark clouds of financial illiteracy and ensure the bright sunshine of financial growth and prosperity.

This portal is but one of the various IIFL initiatives that would be part of FLAME.



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