Business Times - 23 May 2011
How to invest in foreign currencies
The asset class is gaining popularity as a means of diversification, says MINDY TAN
THE term 'safer' is relative, to be sure, but it must be said that despite its inherent dangers, the forex market can be a lucrative one, if played right. In particular, because currency markets are not strongly linked to stock and bond markets, forex is gaining popularity as a means of diversification.
Low Buen Sin, director of the NTU-SGX Centre for Financial Education, notes: 'Foreign currencies can be a rewarding asset class to invest in. Having exposure in FX will help investors gain diversification.'
In fact, don't be surprised if you are already exposed to foreign currencies, even though you haven't made a conscious decision to dabble in it!
Prof Low explains: 'Even if you buy a stock that is listed in Singapore, all of the company's revenue could come from other countries. Take, for instance, Global Logistics Properties.'
The company, which was listed on the Singapore Exchange in October last year, owns, manages and leases 296 properties within 122 integrated parks, according to its prospectus. Its network is spread across 25 major cities in China and Japan.
Prof Low says: 'Most of (the company's) income comes from Japan and China . . . (and it) doesn't have any property in Singapore, despite being priced in Singapore dollars.' As such, the company's bottom line is affected by market sentiment, economic performance and natural disasters affecting those two countries.
But what about investors who wish to be directly exposed to FX? There are a couple of options available:
Dual currency deposit
A dual currency deposit (DCD) is a derivative instrument which combines a money market deposit with a currency option to provide a (potentially) higher yield than what is available for a standard deposit.
How does it work?
1. The base currency is deposited for a pre-determined term, from a week to a few months.
2. A specific exchange rate between the two currencies (the strike price) is agreed upon. These two currencies are known as the base currency and the alternative currency.
3. The return you get on your deposit depends on the market movement of the exchange rates between the two currencies, i.e. the investor is obligated to exchange an agreed amount of the base currency for the alternative currency at the strike price when the alternative currency weakens beyond the pre-agreed price.
Factors affecting return:
# Investment tenor: A longer investment period translates into higher returns.
# Strike price: The further away the strike price is from the current price, the lower the return. In other words, the higher the chance of the investor getting the alternate currency, the higher the investor's returns.
# Volatility of currency pair: Currency pairs with higher volatility will reap higher returns.
What are the risks?
# Foreign exchange risk: Apart from the inherent risks involved when dealing with FX, investors should be aware of potential losses when converting currencies. When the maturity proceeds are returned in the alternative currency and subsequently converted back to the base currency, a loss may be experienced due to movements in currency exchange rates. These losses may offset any interest earned on the deposit.
# Liquidity risk: Investors are essentially locking in their money for the tenure of the deposit as penalties are enforced if withdrawal is made prior to maturity.
# No guarantees: This is a non-principal guaranteed product, which means investors may lose part of their principal sum. This may happen especially when the investor ends up holding the alternative currency.
# Credit risk: As this is an investment product, it is not protected by the Monetary Authority of Singapore's guarantee on saving deposits.
Foreign currency fixed deposits The foreign currency fixed deposit (FCFD) is similar to the Singapore dollar fixed deposit in that a sum of money is deposited with the bank for a fixed tenure and at a fixed interest rate. The main difference is that this deposit is denominated in a foreign currency.
Factors affecting returns:
# Investment tenor: A longer investment period translates into higher returns.
# The interest rate is calculated based on prevailing foreign currency market interest rates, and is adjusted to accommodate the bank's costs, risks associated with the product, and the bank's profit margin. The interest rate quoted at the start of the term is fixed for the entire tenure.
# Volatility of currency pair: Generally, an investor has to be confident that the target currency will appreciate in order to ensure positive returns. Alternatively, ensure that you have a sufficiently long investment horizon to ride out exchange rate fluctuations.
Bonds
Bonds are issued by corporations or governments from around the world. Some banks here offer foreign bonds in an international currency.
Such investments can be attractive, especially compared to local bonds. However, as this requires conversion to a foreign currency, it is a good proposition only as long as the Singapore dollar does not appreciate substantially against that currency.
Who should enter the tiger's den?
Broadly speaking, these investment alternatives are suitable for investors who:
# Have sufficient funds to withstand the loss of capital in the event that the currency option is exercised;
# Understand forex risks;
# Don't mind holding an alternative currency.
Finally, an investor should be aware that currency exchange rates can be influenced not only by the monetary policies of his own country's central bank but also the monetary policies of trading partners. Market sentiment, economic performance and even natural disasters can play a role in shifting currencies up or down relative to the currencies of other countries.
The Asian proverb, 'You cannot catch a tiger cub unless you enter the tiger's den', holds true. If you decide to dabble in FX, however, make sure you have a firm grasp of the market and its accompanying risks.
Prof Low points out: '(For) young investors building and establishing their careers, FX trading is definitely not for him/her. They should consider investments in FX instead.'
Saturday, May 28, 2011
Wednesday, May 18, 2011
BT: Forex dos and don'ts
Business Times - 16 May 2011
Forex dos and don'ts
Trading and investing in the volatile currency market calls for understanding and care. MINDY TAN reports
THE global foreign exchange market is huge. In April 2010, the market's average daily turnover was estimated at US$3.98 trillion, a growth of some 20 per cent over April 2007, according to the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2010 conducted by the Bank for International Settlements (BIS).
While it is true that the foreign exchange market is one of the most exciting markets around, is it the right platform for young investors?
Low Buen Sin, director of NTU-SGX Centre for Financial Education, says: 'Newcomers in forex, stock and other asset markets should first try to become investors instead of traders. Trading should be done only after you have accumulated an adequate sum of investment and can afford to put some spare cash to take trading risk.'
While used interchangeably by laymen, a clear line should be drawn between 'trading' and 'investing'.
In trading, the appreciation of capital is the objective; if dividends are paid out, this is an added advantage. Traders look to profit on short-term price fluctuations, which means the amount of time an active trader holds onto an asset is very short.
In contrast, investing looks more towards income over time. Income producers - for example, dividends or bond interest payments - are thus the prime motivation.
Professor Low adds: 'Foreign currencies can be a rewarding asset class to invest in. The investment can be done by directly investing in foreign currency deposits or bonds, or FX funds. It can also be invested indirectly through equities and other foreign currency- denominated assets. A more sophisticated investor can consider capital-protected structured products.'
What is forex?
When talking about forex, the image conjured up in the mind of most people is the risky and exciting world of forex trading.
The foreign exchange market is the figurative place where currencies are traded. The need to exchange currencies is the primary reason why the forex market is the largest, most liquid financial market in the world.
There is no central marketplace for foreign exchange; rather, currency trading is conducted electronically between traders around the world.
The main thing young investors should be aware of is the fact that forex trading has much higher leverage than the stock market. When someone decides to invest in forex, they can expect higher profits - and, conversely, higher losses.
Currency trading is generally short-term in nature. A day trader who buys euros versus the dollar is not trying to predict what is going to happen to the euro in the next 10 years; he is concerned with the price fluctuations after he enters a position.
His goal is for the euro to appreciate in value as soon as possible after his purchase. In order to increase his chances of trading successfully, a currency trader will study the past price history of the currency pair he is trading and compare it to the current prices to determine what the price is probably going to do next.
Many people use forex as a means of diversification. According to Jeremy Goh, associate professor of finance at SMU's Lee Kong Chian School of Business: 'The key to having a diversified portfolio is to not hold just a single class of assets. Hence, having forex in one's portfolio can be a good source of diversification. The basic idea is that forex returns are not perfectly correlated with the market, just like bonds, real estate and commodities. So as long as you have an asset class that is not perfectly correlated to the market, having them in a portfolio will help with diversification of unsystematic (or idiosyncratic) risks.'
The trading pairs
Major currency trading consists of seven international currency pairs which are divided into the majors, and the commodity pairs.
The majors are the most liquid and thus most widely traded major currency pairs. They include euro/US dollar, US dollar/Japa- nese yen, British pound/US dollar, and US dollar/Swiss franc.
The commodity pairs consist of major currencies trading associated with commodities.
US dollar/Canadian dollar is associated with oil commodities, whereas Australian dollar/US dollar and New Zealand dollar/US dollar are closely associated with gold commodities. Forex traders often trade these commodity pairs to gain exposure to commodity volatility.
Each pair responds to different events and requires a unique approach and strategy.
'The specific currency pairs that you choose would depend on several factors,' says Ser-Keng Ang, senior lecturer of finance at SMU's Lee Kong Chian School of Business. 'One such factor is liquidity or volume. Generally, the G-7 currencies have good liquidity or volume. It is also dependent on your appreciation and understanding of the economies of the two countries - for example, to understand how the Australian dollar performs, you would need to understand that its value is driven by commodities (hence it is known as a commodity currency), and who it sells these commodities to (for example, China, to fuel its growth). This explains why the Australian dollar has appreciated significantly, in tandem with China's fast pace of growth.'
A final caveat emptor
Though currencies don't tend to move as sharply as equities on a percentage basis (where a company's stock can lose a large portion of its value in a matter of minutes after a bad announcement), it is the leverage in the spot market that creates the volatility. It is therefore important to take into account the risks involved in the forex market before diving in.
NTU's Prof Low says: 'Before entering the FX market, you must know the forex market well and you must have time. Trading is not something you spend 5-10 minutes on. You must pay attention to market movements because you are essentially taking advantage of short-term changes. You must also understand how to control downside risk and the maximum loss you are willing to incur.'
SMU's Mr Ang adds: 'I would recommend that young investors undergo requisite training to understand the market and to monitor the market carefully before putting a significant proportion of their monies into FX trading. Set some trading rules to ensure trading discipline is maintained - for example, set a time horizon, level of return and/or cut-loss levels. This will provide a non-emotional way of trading. Prudence also dictates that one should diversify one's portfolio.'
(Next week, we will show you how you can get exposure to currencies and forex, without getting involved in forex trading.)
Forex dos and don'ts
Trading and investing in the volatile currency market calls for understanding and care. MINDY TAN reports
THE global foreign exchange market is huge. In April 2010, the market's average daily turnover was estimated at US$3.98 trillion, a growth of some 20 per cent over April 2007, according to the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2010 conducted by the Bank for International Settlements (BIS).
While it is true that the foreign exchange market is one of the most exciting markets around, is it the right platform for young investors?
Low Buen Sin, director of NTU-SGX Centre for Financial Education, says: 'Newcomers in forex, stock and other asset markets should first try to become investors instead of traders. Trading should be done only after you have accumulated an adequate sum of investment and can afford to put some spare cash to take trading risk.'
While used interchangeably by laymen, a clear line should be drawn between 'trading' and 'investing'.
In trading, the appreciation of capital is the objective; if dividends are paid out, this is an added advantage. Traders look to profit on short-term price fluctuations, which means the amount of time an active trader holds onto an asset is very short.
In contrast, investing looks more towards income over time. Income producers - for example, dividends or bond interest payments - are thus the prime motivation.
Professor Low adds: 'Foreign currencies can be a rewarding asset class to invest in. The investment can be done by directly investing in foreign currency deposits or bonds, or FX funds. It can also be invested indirectly through equities and other foreign currency- denominated assets. A more sophisticated investor can consider capital-protected structured products.'
What is forex?
When talking about forex, the image conjured up in the mind of most people is the risky and exciting world of forex trading.
The foreign exchange market is the figurative place where currencies are traded. The need to exchange currencies is the primary reason why the forex market is the largest, most liquid financial market in the world.
There is no central marketplace for foreign exchange; rather, currency trading is conducted electronically between traders around the world.
The main thing young investors should be aware of is the fact that forex trading has much higher leverage than the stock market. When someone decides to invest in forex, they can expect higher profits - and, conversely, higher losses.
Currency trading is generally short-term in nature. A day trader who buys euros versus the dollar is not trying to predict what is going to happen to the euro in the next 10 years; he is concerned with the price fluctuations after he enters a position.
His goal is for the euro to appreciate in value as soon as possible after his purchase. In order to increase his chances of trading successfully, a currency trader will study the past price history of the currency pair he is trading and compare it to the current prices to determine what the price is probably going to do next.
Many people use forex as a means of diversification. According to Jeremy Goh, associate professor of finance at SMU's Lee Kong Chian School of Business: 'The key to having a diversified portfolio is to not hold just a single class of assets. Hence, having forex in one's portfolio can be a good source of diversification. The basic idea is that forex returns are not perfectly correlated with the market, just like bonds, real estate and commodities. So as long as you have an asset class that is not perfectly correlated to the market, having them in a portfolio will help with diversification of unsystematic (or idiosyncratic) risks.'
The trading pairs
Major currency trading consists of seven international currency pairs which are divided into the majors, and the commodity pairs.
The majors are the most liquid and thus most widely traded major currency pairs. They include euro/US dollar, US dollar/Japa- nese yen, British pound/US dollar, and US dollar/Swiss franc.
The commodity pairs consist of major currencies trading associated with commodities.
US dollar/Canadian dollar is associated with oil commodities, whereas Australian dollar/US dollar and New Zealand dollar/US dollar are closely associated with gold commodities. Forex traders often trade these commodity pairs to gain exposure to commodity volatility.
Each pair responds to different events and requires a unique approach and strategy.
'The specific currency pairs that you choose would depend on several factors,' says Ser-Keng Ang, senior lecturer of finance at SMU's Lee Kong Chian School of Business. 'One such factor is liquidity or volume. Generally, the G-7 currencies have good liquidity or volume. It is also dependent on your appreciation and understanding of the economies of the two countries - for example, to understand how the Australian dollar performs, you would need to understand that its value is driven by commodities (hence it is known as a commodity currency), and who it sells these commodities to (for example, China, to fuel its growth). This explains why the Australian dollar has appreciated significantly, in tandem with China's fast pace of growth.'
A final caveat emptor
Though currencies don't tend to move as sharply as equities on a percentage basis (where a company's stock can lose a large portion of its value in a matter of minutes after a bad announcement), it is the leverage in the spot market that creates the volatility. It is therefore important to take into account the risks involved in the forex market before diving in.
NTU's Prof Low says: 'Before entering the FX market, you must know the forex market well and you must have time. Trading is not something you spend 5-10 minutes on. You must pay attention to market movements because you are essentially taking advantage of short-term changes. You must also understand how to control downside risk and the maximum loss you are willing to incur.'
SMU's Mr Ang adds: 'I would recommend that young investors undergo requisite training to understand the market and to monitor the market carefully before putting a significant proportion of their monies into FX trading. Set some trading rules to ensure trading discipline is maintained - for example, set a time horizon, level of return and/or cut-loss levels. This will provide a non-emotional way of trading. Prudence also dictates that one should diversify one's portfolio.'
(Next week, we will show you how you can get exposure to currencies and forex, without getting involved in forex trading.)
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