Presents

Speculating with Foreign Currencies

With

Noble DraKoln
author of the best-selling books Futures For Small Speculators and Forex For Small Speculators

Sponsored by:

Risk Disclosure
All of the information provided is for informational purposes and in no instance should the content of this presentation be construed as an express or implied promise, guarantee, or implication that you might profit from or that your potential loss may become limited in any manner whatsoever. Nor is the information provided to be construed as an offer to sell or a solicitation to purchase anything. Recommendations may result in a loss, therefore, no claim is implied or made that a loss will not result from following the information provided. The information provided by Noble DraKoln, on-line Internet sites, email or in a communicated report by other means is subject to change at any time without prior notice. And while the information is obtained from sources and methods believed to be reliable it is not guaranteed as to its accuracy or completeness and therefore those using this information are fully responsible for their own actions. Our analysis may reflect or discuss historical trends which may not repeat themselves. Investing / trading in equities, futures, options, stock indices, foreign exchange, currencies etc. involves an inherent and possible substantial risk. Price can and does move rapidly in a volatile manner from time to time and market conditions can present themselves where the liquidation of an existing position may not be possible at the time / price that execution is desired for your order. Therefore one should conduct their own research to investigate the appropriateness of the related risk before entering into such transactions. Futures trading is risky, only persons who can afford to lose their entire investments should consider this type of trading. Liverpoolgroup.com, Liverpool Derivatives Group Co., its officers, directors, editors, employees, clients, and others may purchase or sell the commodity futures and / or other risk investment vehicles referred to at an on-line Internet site area or contained in other communications, information, or report. All information relating to past performance is to be considered hypothetical or simulated, and therefore does not necessarily represent actual trading results. Past performance results are not necessarily indicative of a future forecasting ability or profitable investing / trading result.

Getting Started With Foreign Currencies

Introduction
What I will cover in this seminar
History of Foreign Currencies Fundamentals of Foreign Exchange Fundamental Influences and Reports Tips to trade foreign currencies

History of Foreign Currencies

Currency Evolution
Pre-Currency Era - 1950's Floating Currency Catalyst - 1970's Modern Currency Foundation - Present

Shaped by three core factors War Gold Standard Dollars in Foreign Banks

1950's United States Currency Policy

World War II
Bretton Woods Agreement is adopted at the end of the War Kept all foreign currencies pegged to the US Dollar. Foreign currency fluctuations rarely exceeded 1%

Rules of Gold Standard

Gold is pegged to the dollar at a fixed rate Gold is valued at $35/ounce 1950's Fort Knox gold reserve exceeds $23 Billion US currency was directly exchangeable for gold

US currency takes the place of gold for many foreign countries

US dollar prominent
After World War II United States is the primary economic super power. Foreign trade begins to escalate and in 1950 foreign countries hold US $8 billion. Oil business begins its nascent development

Shaped by three core factors War Gold Standard Dollars in Foreign Banks

1970's United States Currency Policy Meltdown

War and the Gold Standard

Vietnam war was draining our gold reserves. By 1970 Fort Knox only had US$12 Billion. Oil business and foreign trade caused a boom in the demand for dollars in foreign banks, over US$ 47 Billion was sitting in overseas banks. Our gold reserves were overleveraged by almost 4 to 1.

Eurodollar is Invented
Gold leveraging problems are compounded by the invention of the Eurodollar Foreign banks with US dollars would make low interest loans in US dollars to importers and exporters. Although the dollars are never repatriated, the US is still on the hook to exchange these credit created dollars for gold.

Bretton Woods Agreement Collapses

In the over leveraged gold-dollar environment many countries begin to feel frustrated with the artificial peg. 1971 Germany declares that they will float the deutsche mark in opposition to the Bretton Woods Accord. In the first hour of trading over US$1 billion was exchanged for deutsche marks.

Forced US Policy Change

The ignoring of the Bretton Woods Agreement by Germany put the final nail in the U.S.'s currency policy. 3 months after the deutsche mark began to float the US moved off of the gold standard. Gold was allowed to float freely like any other currency. Oil, although priced in US Dollars, becomes pegged to Gold. Gold and Oil prices jump ten fold.

New Rules of Currency

In 1971 Smithsonian Agreement replaces the Bretton Woods Accord and authorizes forward currency contracts and adds validity to the Eurodollar phenomena. A year later European Joint Float Established. It and the Smithsonian Agreement are scrapped in 1973. Currencies free-float and move in a 20-25% range. 1970-1973 Foreign Exchange volume goes from Billion to US$100 Billion US$25

With oil prices up, gold prices up, and an economy still reeling from the rapid currency shift- stagflation hits the United States soon afterwards.

Today's Currency World

Perpetual war on Terror Introduction of the Euro Currency Oil prices are up and Gold prices are up

Could this be the next shift in currency development?

Historical Anecdotes

George Soros
Through his Quantum Fund, one of the world's first hedge funds, he hunts down investment opportunities around the world. George Soros' focus is macroeconomic theory and the affects of geopolitical events on the U.S. Economy. George Soros is credited with breaking the Bank of England in 1992. He held a highly leveraged short position against the British pound. Within six months he had made $1 billion. George Soros is also known for his part in the collapse in the Russian ruble and the aggressive short stance he took against Asia in 1997.

Asian Tiger Collapse

Early 1997 Soros' groups began heavily shorting Thailand's currency, the baht, and Malaysia's currency, the ringgit. When July of 1997 rolled around Thai officials devalued the baht. That set off a wave of devaluations throughout Asia, particularly Malaysia. South Asia still has not successfully rebounded by such an aggressive currency attack. Soros has said that when the government officials finally devalued the currencies his funds had become bullish. He believed that the currencies had become oversold. So he lost money as well. Prime Minister Mahathir Mohamad of Malaysia didn't agree and had harsh words to say about Soros for a long time to come .

Long Term Capital Management

Long-Term Capital Management (LTCM) was a hedge fund company founded by John Meriwether (a former bond trader at Salomon Brothers bank) in 1994 and with Nobel Prize winners Myron Scholes and Robert Merton on the board. Also joining him as principals were Eric Rosenfeld, Greg Hawkins, Larry Hilibrand, Dick Leahy, Victor Haghani and James McEntee. LTCM developed an arbitrage trading style called convergence trading. They traded U.S., Japanese, and European sovereign bonds. The idea is that over time the value of long-dated bonds issued a short time apart would tend to become identical. A risk-free profit was possible as the difference in the value of the bonds narrowed when a new bond came on the run. Like all currency trades the fund needed to take highly-leveraged positions in order to make a significant profit. In 1998 the firm had equity of $4.72 billion, had borrowed over $124.5 billion with assets of around $129 billion. Their off-balance sheet derivative positions amounted to $1.25 trillion. Coming off of returns in the double digits, the convergence trades failed in August 1998. Russia defaulted on their sovereign debt. Investors sold Japanese and European bonds to buy U.S. treasury bonds. The bonds began to diverge. By the end of August the fund had lost $1.85 billion in capital. To save the global economy the Federal Reserve Bank of New York organised a bail-out of $3.625 billion. By the end of the fiasco the total losses were found to be $4.6 billion.

Hungarian Currency Fiasco

Hungary was slated to be admitted into the European Union. Speculators were heavily long the Hungarian forint. This aggressive push upward on the the Hungarian currency went counter to the needs and goals of the Hungarian Central Bank (HCM). HCM's target convergence was 276.1:1 the speculation had driven it down to 234.69. The forint had to become weaker in order for Hungary to be admitted to the EU. The primary culprits were European banks attempting to capitalize on the upward momentum. Their idea was simple, take a long position in the forint and a short in the Euro Using borrowed money to buy high yielding Hungarian bonds. To reach their convergence ratio of 276.1:1 HCM aggressively slashed interest rates, along with several other intervention techniques costing approx. $5 billion- dollars. The tactic worked and shook out the majority of speculators. One of the biggest losers on the field was Deutsche Bank. They lost more $200 million.

Fundamentals of Foreign Exchange

Foreign Exchange n. Abbr. Forex or FX

Transaction of international monetary business, as between governments or businesses of different countries. Negotiable bills drawn in one country to be paid in another country.

The American Heritage Dictionary of the English Language, Fourth Edition Copyright 2000 by Houghton Mifflin Company.

There are several ways to view foreign exchange: Every country's intrinsic value is represented in the movement of its currencies. Foreign exchange trading can be considered a way of timing a business cycle in a country. Foreign exchange trading can be seen as way of finding countries where economic growth, inflation, and real interest rates are at extreme highs or lows in relation to similar countries. No matter how you look at foreign exchange the values of these currencies are constantly influx around the world.

Arenas of Forex Trading

Foreign Exchange trading falls into two categories Cash and Futures

They are traded in two separate arenas:

Cash in the Interbank/dealer market (OTC) Futures in the exchange traded markets

Cash Market

Interbank/dealer Market (OTC)

Who are the players? What and how do they trade? Advantages and Disadvantages

Banks and dealers

Total of 93 major players in the United States 82 Commercial banks 11 Investment banks or insurance firms The total volume of transactions of the reporting dealers among themselves account for $500 billion + per day. Most are based out of New York and account for 49 percent of all of the foreign exchange activity. Information is maintained at the Federal Reserve Bank of New York Central banks worldwide have a heavy hand in the foreign exchange market as well.

What they trade

Spot : Settled two days after deal date Pre-Spot: Settled one day after deal date Pre-Spot Cash FX Swap: one spot transaction plus one forward transaction Currency Swap: exchange of principal in two different currencies at the beginning and a re-exchange of same amount at the end. Currency Forwards: Customized contracts for future delivery of currency. Currency options: Customized contracts that grant the right, but not the obligation to receive cash.

OTC Currency Pairing

Pricing done in pairs The first quoted currency is known as the base currency. The second quoted currency is known as the counter or quote currency. Today's currency movers are US Dollar, British Pound, Euro Currency, Japanese Yen, and Swiss Franc. Each currency is listed in five numbers with the last number known as a pip.

Small Group of markets to focus on

Hard currency pairs are over 80% of OTC Forex transactions USD/EUR USD/JPY GBP/USD USD/SFR EUR/YEN EUR/GBP

There are approximately 34 soft currencies.

Advantages 1. 24 hour market

Cash Advantages/Disadvantages

2. Margin ability of up to 500:1 leverage 3. 1.5 trillion traded daily. 3 times larger than Stock and bond markets combined 4. No overt commissions 5. Price is negotiated Disadvantages 1. 24 hour market 2. Easy to over leverage 3. No centralized market place 4. Interest charges for holding a position too long 5. Price knowledge is limited to your dealer

Exchange Traded Market

Who are the players? What and how do they trade? Advantages and Disadvantages

Hedgers and Speculators

The exchange traded markets are dominated by only two groups: Hedgers The same banks and dealers that carry cash positions in the interbank market will use futures contracts to protect themselves from over exposure to trades. Speculators- Those that want to profit from the price discrepancy between hedgers. They provide the liquidity that the exchange traded foreign exchange markets need.

Regulated Exchanges
Commodity Exchanges Chicago Mercantile Exchange- Currency Pioneer started in 1972 Offers mini currency contracts in addition to their full size contracts. New York Board of Trade: Finex Division Started 1985 with US Dollar Index. Stock Exchange Philadelphia Stock Exchange (PHLX) - G7 currencies only. Offers customized and standardized currency options.

CME launch of currency futures was the worlds first financial futures contracts, in 1972. This was in direct response to the breakdown of the Bretton Woods Agreement. On May 16, 1972 seven foreign currency futures contracts were listed. British pounds, Canadian dollars, Deutsche marks, French francs, Japanese yen, Mexican pesos and Swiss francs. In April 2001, CME expanded FX market coverage by offering electronic access to its full range of currency contracts virtually 24-hours a day via the GLOBEX electronic trading platform. This electronic trading access occurs "side-by-side" with floor trading in CMEs currency pits during floor trading hours. In March 2003, the total notional value of FX trading at CME was U.S. $347.5 billion. Currency futures are derivatives on the interbank cash and forward exchange rates.

Chicago Mercantile Exchange (CME)

New York Board of TradeFinex

The New York Board of Trade currency and options division Finex was established in 1985. Their most important contribution to the exchange traded currency world was their introduction of the US Dollar Index (USDX) Later in 1994 they added currency cross-rates. The first exchange to provide trading floors on two continents with two facilities (in New York and in Dublin, Ireland). They offer the US Dollar Index and 29 currency pairs for trading.

Philadelphia ExchangePHLX
The Philadelphia Stock Exchange (PHLX) was founded in 1790 as the first organized stock exchange in the United States. In 1982, the PHLX pioneered options on currencies. Forward and futures markets provide a way to protect yourself from obligatory currency transactions, options provide the right - not the obligation - to buy or sell currency at a specific rate within a specified time period. Philadelphia Stock Exchange (PHLX) is the world's leading marketplace for exchange traded currency options. What has fueled their growth is the fact that they offer both customized and standardized currency options. They only trade options on the following currencies Australian dollar, British pound, Canadian dollar, Euro, Japanese yen, Mexican Peso, Swiss franc, and U.S. dollar

Futures Advantages/Disadvantages
Advantages 1. 2. 3. 4. 5. Exchanges have transparency Guaranteed counterparty system Accurate volume and open interest figures No bid/ask spread Able to hold position trades

Disadvantages 1. 2. 3. 4. 5. Most active during central and east coast times Significantly less liquidity than the cash Forex market Margins are typically 2% of the contract value Commission Exchange does not reflect all of the various foreign exchange trading

Influences, reports, and tips to trade these markets

US Dollar Influences and Reports Primary Influences

US Federal Reserve Bank - www.federalreserve.gov Federal Open Market Committee interest rate announcements 8x's/year, http://www.federalreserve.gov/FOMC/ Fed Funds Rate rate that banks charge each other for overnight loans Discount Rate Fed interest rate charges for emergency liquidity Secondary Influences 30-year Treasury Bond cash and futures 10-year Treasury Notes - cash and futures Short-term Eurodollar deposits cash and futures Economic Data - GDP etc.

Foreign Currency Influences and Reports Primary Market Influences

European Central Bank - www.ecb.int Bank of Japan - www.boj.or.jp/en

Secondary Market Influences List of all central banks - http://www.bis.org/cbanks.htm Eastern Europe reports -http://www.ccme.cz/ Emerging market reports - http://www.nber.org/crisis/

Tips to trading cash forex

1. 24 hour market Trade only on major announcements or reports 2. Trading time- frames 15- minute and 60- minute 3. Use US Dollar Index (USDX) as a guidea. US Dollar Index is a composition of all major currencies. b. Strength or weakness can give you an idea of where your cash position will go. 4. Futures counterparts can provide crucial information a. Forward month is just like cash b. Volume c. Open Interest d. Commitment of Trader's Report e. General technical indicators

1. Cash and Futures Convergence watch the cash market as futures contracts expires 2. Trade cash and futures currencies in a spread position. 3. Potential to use futures as a way to protect your long term cash/spot positions. 4. Write options on futures against your cash positions 5. Understand normal markets and backwardation markets 6. Take advantage of longer term trending. 7. Focus your trading mainly in the Chicago Mercantile Exchange.

Tips to trading futures forex

751 Economic Statistics of its member countries Only 16 are vital economy statistics
Discount rate Currency Exchange rate Capital accounts Gross national income Total financing Total net borrowing Claims on private sector Foreign liabilities

International Monetary Fund (IMF)

Balance on goods and services Overall balance Imports of goods Direct investment abroad Trade balance Claims on central government Maximum lending rate Deficit or surplus

Article The fundamentals of forex in Futures Magazine May 2001 by Karlis Sarkans uses these same indicators to trade foreign treasury securities.

Suggested reading
Futures Magazine - www.futuresmag.com FX Week- www.fxweek.com Federal Reserve Bank of New York Free 123 page Forex Book http://www.ny.frb.org/education/addpub/usfxm/ Article - The fundamentals of forex by Karis Sarkans, Futures Magazine May 2001 Article - E-forex: Currency trading for the rest of us by Abe Cofnas, Futures magazine Trading in the Global Currency Markets by Cornelius Luca

Conclusion
History of Foreign Currencies Fundamentals of Foreign Exchange Fundamental Influences and Reports Tips to trade foreign currencies