Exotic currency: Investopedia term of the day

TERM OF THE DAY - MAY 21, 2008

Exotic Currency

What Does it Mean? A foreign exchange term for a thinly traded currency. Exotic currencies are illiquid, lack market depth and trade at low volumes. Trading an exotic currency can be expensive, as the bid-ask spread is usually large.

Investopedia Says... Exotics are not considered major currencies because they are not easily traded in a standard brokerage account. Major currencies include the U.S. dollar, Euro, Canadian dollar and Swiss franc. Examples of exotic currencies include the Thai baht, Uruguay peso or Iraqi dinari...Read more.

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roller coaster

In quiet times, the forex market would be like a kiddy world roller coaster. but in times of economic change and volatility, it would be more like the superman roller coaster at Movie world(really high, really scary, really exhilarating!).

When you go to a foreign exchange counter, you'd see two numbers, the bid(buy) and ask(sell) price, and if in doubt as to which applies to you, follow common sense that states that from a business point of view, we buy low sell high.

Thus if you want to buy USD, and the bid-spread is 1.78/1.83 (totally fictional prices) then by intuition, the higher price of 1.83 would apply to you! And vice versa if you were to sell...

So why is there a spread(difference between the bid and ask)? That's where they make the profits, spreads also depend on the overall demand and supply of the underlying currencies, the lesser the demand, the lesser the chance that it will be traded out again, thus it would command a higher premium.

There are many reasons why people/companies go into forex deals, because they need money in a different currency to pay for a deal, or because their kid is going overseas and they are making provisions for them, etc. Hedges are used, usually, to hedge against the risk of losing money when there is change in the rates between different currencies and to lock in the profit on the companies balance sheet.

Hedges that increase exposure to forex fluctuations should be called speculation, and has lead to big loses, even Buffet has had his share.

The forex market has been really active in Malaysia in the past year and because of that, big losses and big gains were made.

Well, I hope this gave you some insight into the world of forex!

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Forex- money money money

Don't these graphs just scare you? Well... I think they are pretty scary to me... Because you never know when its going to go up or down! BEARish or BULLish... Well, anyhows, I managed to make BIG BIG money today in a forex transaction today! HAHAHA...

The above graph represents the exchange rate movement between the Malaysian Ringgit and the Aussie Dollar for the past 120 days.For those of you who do not know what the term forex refers to, well, it is an amalgamation of the words foreign exchange aka FX! Bet most of you knew it already! The relevant segments of the graph are from January 1st 2008 when I first entered the market till April 4th 2008 when I made an exit.

The lowest market rate was 2.836RM to 1AUD and today, the rate was 2.941 (the closing rate on 4th Apr). This translates into a 3.702% return in the span of 3 months (Jan-Mar) which is equivalent to an annualised rate of 13%.

WOW? Impressed? Don't be. It was speculation. The stuff that brings giants to their feets, like Mr Jerome and Societe Generale bank in France. It was a totally risk exposed position where I would have lost everything( or a significant amount) had the market not turned in my favour. View the article about third part ink for a better insight regarding risks and returns.

No doubt I had garnered an 13% return, but risks of the returns was not factored in! No doubt, the upside potential was huge! But so was the downside! And everytime the rate took a dive, my heart rate would increase, which reminds me of the relationship between interest rates and inflation!

So... My forex transaction... Why did i left it unhedged/fully exposed to market movements? Well mainly because I was taking a wait and see approach and was being bullish about the rates, thus not locking in my position early on! Secondly, because I could afford to take up the risk.

Or was it because it was a small over the counter transaction at the corner shop with Muthu's Money Exchange, where a guy was trying to get his aussie dollars changed to local currency? Definitely maybe.

So yes! A 13% annualised return. Well... I made a big gain amounting to a great grand total of a whopping..... wait for it.... hundred and five ringit malaysia! RM105! Small change for you, but I'm still laughing all the way to the bank~

Having such a personal experience with forex allowed me to better understand about exchange rates, market conditions which affect them and also about the international economy in general. I hope that from this post, you can pick up my enthusiasm for finance too!

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