Foreign Exchange: The Complete Deal. James McDowell. Sharpe
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First published in Great Britain in 2012
Copyright © Harriman House
The right of James Sharpe to be identified as the Author has been asserted in accordance with the Copyright, Design and Patents Act 1988.
ISBN: 978-0-85719-206-6
British Library Cataloguing in Publication Data
A CIP catalogue record for this book can be obtained from the British Library.
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Figure data and information copyright © respective owners and sources.
To Victoria, Katharine, James and Olivia
Acknowledgements
Thanks to G. Ashley, P. Balans, C. Crispin, J. Elston
About the author
James Sharpe has been involved in the financial markets since the late 1970s. He has a degree in economics and a Masters in finance. His early career was geared towards financial analysis and wholesale lending but from 1980 his role has been treasury based. Unlike many who write financial books he is still writing out deal tickets and advising clients.
James’ range of experience is extraordinary and is unlikely to be repeated. He has worked in the US and the Middle East where he was responsible for the region and interbank/central bank relationships. He has combined positions of trader and foreign exchange sales but it is in the latter area that Jim has focused and where he has run a number of desks.
He has worked for a range of institutions around the world, including in the US, Japan, Scandinavia and the UK. He has dealt with an array of counterparties including banks, corporates, central banks, funds and multinationals. In recent years he has completed 'the hand' and deals with high net worth individuals and corporate customers at a leading private bank.
Preface
People have been exchanging money for generations but it is only in the last 100 years or so that currency trading as we would recognise has taken place. It could even be reasonably argued that it is only really in the last 40 years, with the removal of exchange controls, the emergence of floating exchange rates, and improvements in communications, that the market as we know it today fully evolved.
Concurrent with this, and equally important, has been the development of multinational companies and the inexorable rise in government traded debt. The explosive growth of cross-border investment, both direct and portfolio, has brought with it foreign exchange exposures to be managed, often proactively. It is the rapid changes in communications and computing power, though, which have forged the features of the 21st cenutry market, and created a mjaor role for the speculator (both professional and private) – we now have 24-hour dealing and daily foreign exchange turnover in excess of $4trn.
This book is firmly rooted in foreign exchange but I am very much of the mind that markets should be viewed in a holistic fashion – to treat foreign exchange as somehow isolated from the other markets would be a crucial error. It is important to grasp the relationship between the foreign exchange market, in whatever guise, bond and equity performance, national interests and ultimately economic management.
The importance of these relationships is an underlying theme of the book and in this context the initial chapters will explore the historical and theoretical background to the foreign exchange market. My starting point is the end of the First World War in 1918. Since that time, the management of exchange rates and their volatility has become integral to economic performance and indeed to the political landscape.
In less than 100 years, perceptions have altered such that market movements that would previously have been viewed as inevitable or plain economic misfortune are now deemed to be mismanagement. It may then come as no surprise that even in a largely floating rate system central banks continue to directly influence foreign exchange markets. I also provide an invaluable insight to what determines exchange rates. These opening chapters provide a platform for an understanding of the practice of foreign exchange, which is the core of the book. I recommend you read and digest these opening chapters, but if you do wish to skip the history and move straight to the practice of foreign exchange you can do so by starting with chapter 3.
In subsequent chapters, the practical aspects of foreign exchange will be examined in a manner that will leave readers with a clear understanding of the issues and processes involved in foreign exchange transactions. Spot, forwards, non-deliverable forwards, bid-offer spreads and pips, among other concepts, will be explained with straightforward examples and simple arithmetic.
I shall show the methods used to execute transactions, including orders, and how a bank actually deals on the other side. I shall look at whether we should deal directly with the bank or use trading platforms which have proliferated in recent years, and I will discuss how best to choose and manage the relationship with foreign exchange providers. I shall also show how professional traders analyse markets and provide a blueprint for professional trading.
In chapter 7 I look at the subject of price prediction, or forecasting. Market forecasters unfortunately have a distinct tendency to err but still prosper on people’s insatiable demand to know the future. As there is no firm basis of knowledge to hold prices steady, they are subject to sudden and violent changes, which makes prediction difficult. There have been improvements in computing power and coverage of the markets is at an all-time high, but this does not necessarily make them any easier to interpret. I will also look at the growth in technical analysis trading models, which has been assisted by vastly enhanced computer power in recent years.
Foreign exchange can appear remarkably simple, after all there are just two numbers to choose from, and you can either buy, sell or do nothing, but it is important to recognise that foreign exchange is not solely a numbers game. Foreign exchange numbers are driven by a large number of complicated factors, including human psychology, and understanding them requires not so much a grasp of the economic fundamentals as of the irrational way in which people can behave when they join together in crowds. After reading this book you will be in a better position to plan and react to the foreign exchange markets.
This book is intended for the business school student, banker or private investor as well as for corporate treasurers and fund managers. It is my intention that it should be invaluable in unravelling the jargon and mystique of foreign exchange.
1. Exchange Rate Systems: From Fixed to Floating, and Chaos
An exchange rate system is any system which determines the conditions under which one currency can be exchanged for another. Fixed, floating and adjustable peg systems (of which there are various) are the three main systems available. All systems are designed to facilitate trade and investment across national boundaries.