In-Depth Notes on the Foreign Exchange Market

INTRODUCTION

  • The study materials are for the Pasaran Kewangan Malaysia Certificate (PKMC) qualification jointly awarded by ACI – Financial Markets Association of Malaysia and Asian Institute of Chartered Bankers (AICB).
  • The PKMC aims to uphold professionalism and integrity in the Malaysian wholesale financial markets.
  • Comprises four modules:
    • Module I: The Regulatory Framework and Structure of the Malaysian Financial Markets
    • Module II: The Money Market
    • Module III: The Foreign Exchange Market
    • Module IV: Risk Management and Basic Derivatives.

ASIAN INSTITUTE OF CHARTERED BANKERS (AICB)

  • AICB is the professional body for banking and financial services in Malaysia, founded in 1977, aims to enhance banking education and establish industry standards.

ACI-FINANCIAL MARKETS ASSOCIATION MALAYSIA (ACI-FMAM)

  • Established in 1974 to serve those engaged in wholesale foreign exchange and money markets in Malaysia.
  • Focused on education and skills enhancement, requiring members to pass PKMC modules to participate in the interbank markets.

ACKNOWLEDGEMENTS

  • Thanks given to members of AICB PKMC Examination Committee and FMAM Education Committee for their contributions.

CHAPTER OVERVIEW

1. Introduction to the Foreign Exchange (‘FX’) Market
  • Foreign Exchange Importance:
    • Largest market globally where currencies are bought and sold.
    • Currencies trade without a centralized location, existing through various geographical dealers and brokers.
  • Types of Foreign Exchange Transactions:
    • Foreign exchange transactions are agreements to exchange certain amounts of currencies at predefined rates, influencing international trade operations.
1.1 Foreign Exchange Transaction
  • Definition:
    • Exchange of a specific amount of one currency for another between two parties at an agreed rate.
  • Foreign Exchange Rate:
    • Price of one currency expressed in terms of another.
1.2 Historical Overview of Foreign Exchange Markets
  • Pre-1914: Barter trade.
  • 1914-1918: Gold standard era.
  • 1944: Bretton Woods Conference establishing fixed currency parities.
  • 1971-73: Adoption of floating exchange rates.
1.3 Features of the Foreign Exchange Market
  • No physical marketplace; transactions happen over-the-counter (OTC).
  • Involves various participants (banks, central banks, corporations).
  • Operates 24/5, showing high liquidity and price transparency.
1.4 Types of Dealers and Exchange Positions
  • Dealers:
    • Classified into interbank dealers (large firms) and corporate dealers (serving clients).
  • Market types:
    • Interbank deals vs. non-bank deals (with customers).
1.5 Foreign Exchange Contracts and Value Dates
  • Immediate delivery contracts, forward contracts, and future contracts based on mutual agreements for specific settlement dates.
  • Most common FX contracts are spot (T+2), tomorrow (T+1), and today (T+0) contracts.
1.6 Recent Market Developments
  • Changes in quantitative easing policies and impacts of negative interest rates on currency values.
1.7 Global Market Practices for Foreign Exchange
  • The establishment of codes of conduct and the need for regulation in response to frequent international banking issues.
1.8 Overview of the Malaysian Foreign Exchange Market
  • The Malaysian ringgit (MYR) market operations, trends in turnover, and regulatory measures taken by Bank Negara Malaysia.

CHAPTER 2: ROLE OF CENTRAL BANKS IN CURRENCY MARKETS

  • Functions: Issue currency, regulate financial institutions, manage monetary policy to ensure economic stability.
  • Interventions to stabilize exchange rates affected by speculations and misalignments.

CHAPTER 3: RISKS IN FOREIGN EXCHANGE

  • Main categories of foreign exchange risks include exposure risks (transaction, translation, economic) and counterparty risks.
  • Strategies for hedging include the use of non-deliverable forwards and various trading strategies.

CHAPTER 4: FOREIGN EXCHANGE MECHANICS AND APPLICATIONS

  • Detailed processes involved in spot transactions, FX quotations, calculating spreads, and types of contracts.
  • Example calculations for profit/loss determination when entering or exiting trades.

CHAPTER 5: FOREIGN EXCHANGE MATHEMATICS AND APPLICATIONS

  • Techniques for calculating cross rates, counter rates for customers, forward deliveries, and recognizing the value of pips.
  • Further discussions on dealing strategies such as stop-loss and take-profit techniques.

CHAPTER 6: THE FORWARD AND SWAP MARKET

  • Mechanics and definitions of FX swaps and forward contracts, how they differ from spot transactions, and how to calculate swap points.

CHAPTER 7: TECHNICAL AND FUNDAMENTAL ANALYSIS

  • Definitions:
    • Technical analysis: Focuses on historical price movements for market trend forecasting.
    • Fundamental analysis: Analyzes economic indicators to understand currency values.
  • Common technical tools include moving averages, MACD, and RSI, while fundamental analysis looks at metrics like GDP and inflation.

SUMMARY OF LEARNING OBJECTIVES

  • Understand the regulatory framework and risks in foreign exchange.
  • Calculate FX profit and loss and analyze market movements through technical and fundamental techniques.
  • Be familiar with different market players and methods to manage and hedge foreign exchange risks.