Pip

What is a pip?

A pip is the smallest price unit of a commodity or currency.
(Source: CFTC)

Pip is an acronym for the following terms, which all have the same meaning:

• Price Interest Point
• Percentage in Point
• Percentage Increment Point

One pip is the smallest measure of Price move used in forex trading. For instance, if the currency pair EUR/USD is currently trading at 1.3000 and then the exchange rate changes to 1.3010, the pair did a 10 pips (smallest units) move. The pip is the smallest measure regardless of the fractional representation of the currency exchange rate. Thus, 1.3000 to 1.3010 is the same move in pips terms as 110.00 to 110.10. (Source: Wikipedia)

Exchange Rate

What is a currency exchange rate?

The exchange rate is the price of one currency stated in terms of another currency. (Source: CFTC)

In finance, the exchange rate (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how much one currency is worth in terms of the other. For example an exchange rate of 120 Japanese yen (JPY, ¥) to the United States dollar (USD, $) means that JPY 120 is worth the same as USD 1. The foreign exchange market is one of the largest markets in the world. By some estimates, about 2 trillion USD worth of currency changes hands every day.

The spot exchange rate refers to the current exchange rate. The forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.

If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly as quoted on financial markets, mainly by banks, around the world. A movable or adjustable peg system is a system of fixed exchange rates,but with a provision for the devaluation of a currency. For example, between 1994 and 2005, the Chinese yuan (CNY, ¥) was pegged to the United States dollar at ¥8.2768 to $1. The Chinese were not the only country to do this; from the end of World War II until 1970, Western European countries all maintained fixed exchange rates with the US dollar based on the Bretton Woods system.

An exchange rate quotation is given by stating the number of units of a price currency that can be bought in terms of 1 unit currency. For example, in a quotation that says the EUR/USD exchange rate is 1.2 (USD per EUR), the price currency is USD and the unit currency is EUR.

When looking at a currency pair such as EUR/USD, many times the first component (EUR in this case) will be called the base currency. The second is called the counter currency. For example : EUR/USD = 1.2836, means EUR is the base and USD the counter, so 1 EUR = 1.2836 USD. (Source: Wikipedia)

Euro

What is the euro?

The euro is the official currency of most members of the European Union. (Source: CFTC)

The euro (currency sign: €; banking code: EUR) is the official currency of the European states of Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Slovenia and Spain - also known as the Eurozone - and is the single currency for more than 317 million people in Europe. Including areas using currencies pegged to the euro, the euro affects more than 480 million people worldwide, with more than €610 billion in circulation as of December 2006.

The euro is not the currency of the European Union as not all EU members have adopted the currency. While all nations which have recently joined the EU are pledged to adopt the euro in due course, the United Kingdom and Denmark are under no such obligation. Several small European states (The Vatican, Monaco, San Marino, and Andorra), although not formally EU members, have adopted the euro due to currency unions with member states.

The euro was introduced to world financial markets as an accounting currency in 1999 and launched as physical coins and banknotes in 2002. All EU member states are eligible to join if they comply with certain monetary requirements.

The euro is managed and administered by the Frankfurt-based European Central Bank (ECB) and the European System of Central Banks (ESCB) (composed of the central banks of its member states). As an independent central bank, the ECB has sole authority to set monetary policy. The ESCB participates in the printing, minting and distribution of notes and coins in all member states, and the operation of the Eurozone payment systems. (Source: Wikipedia)

Currency Swap

What is a currency swap?

A swap that involves the exchange of one currency (e.g., US dollars) for another (e.g., Japanese yen) on a specified schedule. (Source: CFTC)

A currency swap is a foreign exchange agreement between two parties to exchange a given amount of one currency for another and, after a specified period of time, to give back the original amounts swapped.

Currency swaps can be negotiated for a variety of maturities up to at least 10 years. Unlike a back-to-back loan, a currency swap is not considered to be a loan by United States accounting laws and thus it is not reflected on a company's balance sheet. A swap is considered to be a foreign exchange transaction (short leg) plus an obligation to close the swap (far leg) being a forward contract.

Currency swaps are often combined with interest rate swaps. For example, one company would seek to swap a cash flow for their fixed rate debt denominated in US dollars for a floating-rate debt denominated in Euro. This is especially common in Europe where companies "shop" for the cheapest debt regardless of its denomination and then seek to exchange it for the debt in desired currency. (Source: Wikipedia)

Cross Rate

What is a cross rate?

In foreign exchange, the price of one currency in terms of another currency in the market of a third country. For example, the exchange rate between Japanese yen and Euros would be considered a cross rate in the US market. (Source: CFTC)

Cross rate is a currency pair that does not include USD, such as GBP/JPY. Pairs that involve the EUR are called euro crosses, such as EUR/GBP. All other currency pairs (those that don't involve USD or EUR) are generally referred to as cross rates. (Source: Wikipedia)

Introduction to the Forex Market

The foreign exchange markets are sometimes referred to as "forex." The forex market is the largest financial market in the world, with daily average trading turnover of approximately $1.5 trillion. Operating 24 hours a day, the forex market is highly liquid and most of the trading is conducted electronically or over the phone. Banks, insurance companies, large corporations and other large financial institutions all use the forex markets to manage the risks associated with fluctuations in currency rates. In recent years, retail investors have also looked to the forex markets as yet another possible investment opportunity.

Foreign currency futures contracts may be legitimately traded either on a recognized futures exchange or in the "interbank market," which generally involves trading between large institutions such as banks and corporations. The interbank market does not typically include individual or retail customers. Fraudulent currency trading firms often tell customers that their trading is done in the "interbank market." Be wary of any firm that claims that you can or should trade in the "interbank market" or that it can or will do so on your behalf. Your losses can be very large in a single day. Companies that tell you otherwise may well be engaged in illegal schemes. (Source: SEC)

The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is by far the largest market in the world, in terms of cash value traded, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The trade happening in the forex markets across the globe currently exceeds $1.9 trillion/day (on average). Retail traders (individuals) are currently a very small part of this market and may only participate indirectly through brokers or banks and may be targets of forex scams.

The foreign exchange market is unique because of:

• its trading volume
• the extreme liquidity of the market
• the large number of, and variety of, traders in the market
• its geographical dispersion
• its long trading hours - 24 hours a day (except on weekends)
• the variety of factors that affect exchange rates

There are several types of financial instruments commonly used in the forex market:

Forward transaction: One way to deal with the Forex risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years.

Futures: Foreign currency futures are forward transactions with standard contract sizes and maturity dates — for example, 500,000 British pounds for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.

Swap: The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not contracts and are not traded through an exchange.

Spot: A spot transaction is a two-day delivery transaction, as opposed to the Futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the Spot market.

Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 32.4% in April 2006. Other large centres include the US (with a 18.2% global share), Japan (7.6%) and Singapore (5.7%) (Chart 2). Most of the remainder was accounted for by trading in Germany, Switzerland, Australia, Canada, France and Hong Kong. (Source: Wikipedia)

See also:
Forex Trading Blog
Forex Directory