1. We often hear of currency pairs such as EURUSD, USDJPY or USDINR. What do they mean?
The correct way to write a currency pair is USD INR = 70.
It is interpreted as one USD is equivalent to 70 INR
2. When we write USD INR or EUR USD in Google or any search engine, the rate that we see is the interbank rate. It is the rate at which central banks are pricing their respective currencies when they interact with banks. However, as a retail customer when one approaches a bank the rate that one gets has bank charges built into it and therefore for a retail customer it is very difficult to get the interbank rate.
3. When trading forex, we often hear of swap charges or holding costs. What are these?
It refers to the cost of financing for holding the position overnight. This is because forex pairs that are structured for trading are usually leveraged products. This means that since a trader has to pay only the margin, the non-margin amount must be raised from the market and there is a cost to this. As an example, in a 1:50 leveraged EUR USD product, a trader has to put 1 USD as margin and then an additional USD 49 is made available to him to trade. Arranging this additional USD 49 has a financing cost associated with it and that is what results in swap charges or holding costs.
4. Long USD INR (or short INR USD) means borrowing at risk free rate in USD, buying INR and then lending in INR at the risk-free rate.
5. Short USD INR (or long INR USD) means borrowing in INR at the risk-free rate, buying dollars and lending the same at the risk-free rate in USD
6. Holding overnight positions in Forex is one of the largest trades done globally. Investors borrow in a currency at a lower rate, convert to another currency and then lend at a higher rate in that converted currency. The obvious risk here is adverse exchange rate movement. Central banks use interest rates for currency management because doing so can influence the large market of carry trades and move the central bank’s currency in a desired direction. It is for this reason that Central Banks raise interest rates when their currency is falling.
7. In most exchanges globally, the above structure is achieved by trading futures that are settled at a particular date, example end of the month.
As an example, consider a Futures product designated as 29102019 USD INR or USD INR – 29102019. Going long this product means borrowing at the risk-free rate in USD right now, buying INR, lending the INR at the risk free in India till 29th October 2019. The prices adjust accordingly to reflect the economics of these series of transactions. If prices do not reflect this then an arbitrage will exist.
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