On the world's financial markets and stock exchanges. Part 1
On the world's financial markets
and stock exchanges
Financial markets are necessary for the functioning of the world production and trading system.
There are 3 types of financial markets in the world today: stock, currency, and commodity markets.
In the stock market, the tools for work are different securities: shares, bonds, bills of exchange, checks, certificates of deposit. In the commodities market, the most popular trading instruments are oil, gold, sugar and grain. In the currency market, the most active, i.e. volatile, instruments are USD (American dollar), EUR (Euro), GBP (British pound), CHF (Swiss franc).
Volatility is a statistical indicator that characterizes the tendency of market prices or income to change over time. It is the most important financial indicator in financial risk management, where it is a measure of risk of using a financial instrument over a given period of time.
The global financial markets are very reliably interconnected and represent a coherent global financial system. Major changes in any one market will necessarily have an effect on other markets. For example, hurricanes periodically hitting the Florida coast force Americans to reduce oil production, which leads to a rise in world oil prices, because the US, being the biggest consumer of "black gold", is forced to buy oil on the world market. Consequently, shares of those companies, which are related to oil extraction, transportation and refining, will rise due to the growth of oil prices - this is the change on the stock market. The currency market, on the other hand, will react with a decline of the dollar against all world currencies due to the loss of millions of dollars to the American economy caused by the post-hurricane devastation.
Almost all serious events in any financial market as well as in the world and in any country have an impact on other financial markets.
The main task of any market is to determine the true value of a product. Due to continuous changes in supply and demand in the financial markets, rates of securities change. Currencies. And also the price of raw materials.
The main players in the financial markets are:
- central banks around the world;
- investment funds;
- brokers and commercial banks;
- hedgers and speculators.
Income in the financial markets is made up of 2 components. In the stock market, one component of income is the share of profits in the form of dividends, depending on the amount invested. The second component of income, which often exceeds the number of dividends many times over, is the CURRENT DIFFERENCE between the purchase price of an asset and its sale price.
Trading in the financial markets can take place both on stock exchanges, i.e. places specially designated for trading, and electronically, i.e. via the Internet. Working in the financial markets via the Internet is carried out through a broker company of your choice, which provides you with access to the financial markets and settles the accounts with you.
1.History of the origin of financial markets.
The stock market has been part of human history since time immemorial. Bills of exchange, i.e. promissory notes, existed in Ancient Egypt. Ancient Greece and Ancient Rome had experience of formalized trade with a central market institution, with general commodity-exchange operations. With a monetary system, with the practice of contracting for delivery on contractual terms. In the modern sense, the market emerged at the end of the sixteenth century, with the emergence of the first joint-stock companies. These societies were maritime trading companies, which operated on the basis of a free collection of capital for commercial expeditions. Depositors' contributions were returned after each voyage with an interest on the profits earned from the sale of the goods brought back.
The emergence of opportunities to freely sell and buy bills of exchange and shares before their execution laid the foundation for the emergence of the first stock exchanges, permanent markets, where securities were traded. Trading technologies were constantly sharpening, variety of circulating securities increased and, gradually, exchange trade became an integral part of European economic life.
State interest loans, for which official exchange rates were set, appeared. In the beginning of the seventeenth century, in the Netherlands, at the Amsterdam Stock Exchange, the oldest existing stock exchange in the world today, transactions in shares were first held. The Netherlands was actively exploring the sea routes, Dutch merchants were not only diligent carriers, but also showed great ability to speculate. Many of the most enterprising people of different nationalities gathered in the Netherlands. Very quickly the rules and methods of trade were worked out, which have survived to this day without significant changes.
With the development of industry and the production of goods in large quantities, the need arose for a permanent wholesale market. This market developed during trade between Spain and Holland in the sixteenth century, in the form of an exchange. The exchanges attracted more and more masses of goods and money, becoming international trading centres. The first international exchange, which corresponded to the new level of development of productive forces, was deemed to be the Antwerp exchange, founded in 1531.
In the XV-XVI centuries, exchanges arose in the places of emergence of manufactures in Italy and Holland, as a manifestation of the need to develop foreign trade in transactions with large consignments of goods. Based on the Antwerp exchange pattern, the Lion exchange (1545), London Royal Exchange (1566) and other exchanges, which were mainly commodity and bill exchanges, were established. In the early 17th century, the most important exchange in the world was Amsterdam (1602), where the historical centre of European trading gradually moved. Here futures transactions appeared for the first time, and technical exchange operations reached a fairly high level. Not only bonds of Dutch, English, Portuguese and Spanish government loans were listed on this exchange, but also shares of Dutch and British East Indies, and later West Indies trading companies.
By the end of XVII century, real exchange battles between buyers and sellers were already going on at the London Stock Exchange. Since then, market players, or traders as they are known today, were referred to as irreconcilable "bulls" and "bears". "The bulls have sought to profit from buying securities, while the bears have sought to profit from selling them.
Despite Europe's historical role, the greatest contribution to the development of the exchange trading system to its current level came from the United States of America.
In the US, commodity markets have existed since 1752. Initially, they traded locally produced goods: homemade products, textiles, hides and skins, metals and timber.
The exchange was exactly what the changing economy needed in the new situation: a place where suppliers of raw materials (finished goods) could sell and buy the right quantity of a certain quality at the right time, without having to transport the entire batch to the place of transaction. It became possible to make preliminary transactions for delivery of raw materials, which may not have been produced yet. Exchange became an exchange of real, but as a rule, not yet produced goods, which facilitated advance of goods from producer to consumer with minimum expenses for transportation, storage, etc.
The emergence of transactions with delayed execution period (forward transactions), when a certain time passed between their conclusion and actual delivery of goods, made it possible to profit from price fluctuations. Speculation became an integral part of exchange trade and became the thing, which immediately separated exchange from usual wholesale market. The first futures markets appeared in the XIX century. In its second half, the world's first grain futures exchange was established in Chicago.
The New York Stock Exchange, established in the late 18th century, developed rapidly and entered the 20th century dictating the financial fashion to the whole world. In the century that followed, the centre of global finance was firmly established on Wall Street, where over a billion shares change hands on a single day.
The word "bourse" itself derives from the name of the merchant family Van der Burset. One of the first bills of exchange was held in Bruges, on the square in front of the house of this family, decorated with the family coat of arms and depicting 3 leather bags-purses. The forerunners of the modern stock exchange were markets and fairs. In markets, trade took place regularly, with cash goods; and buyers were usually consumers of goods. Markets were for a limited number of districts. Fairs were held only once a year. However, their turnover was larger and facilitated international rather than local trade.
The initial exchange was, in its essence, some kind of a wholesale market, since quite a large part of transactions were made with cash goods. But even then, their distinctive features, common for modern exchanges, were: regularity of resumption of trading, confinement of trading to a certain place, subordination of trading to predetermined rules.
By the end of 18 century, the first stock exchanges appeared in Great Britain, the USA and Germany. Since late 19th century and early 20th century, stock exchanges have become major centres of national, international and economic life. In late 19th century and early 20th century, the importance of real commodity exchanges started decreasing. However, an entirely new type of commodity exchange, i.e. futures exchange, started to emerge and rapidly develop. The process of transition was prolonged by terms and different forms in different countries, and exchange trade in iron, coal, liquor, malt, hay and other goods has been stopped.
At present, real commodity exchanges have remained only in separate countries and have comparatively small turnovers. They usually serve as a form of wholesale trade in local commodities, whose markets are characterised by low concentration of production, marketing and consumption. Sometimes they are organised to protect the interests of a country's industry in the export of essential commodities. The largest of them operate in India, Indonesia and Malaysia.
In the developed capitalist countries, there are practically no real commodity exchanges. But at certain periods, they still play a prominent role. For example, large commodity turnovers occurred in the mid-1970s and early 1980s on the oil exchange in London with tanker shipments of English oil, and in the 1970s with grains on the exchange in Milan, etc. At the same time, in all developed countries, commodity exchanges, exist in the form of unions uniting traders, brokers, transport processing firms. For example, in Europe this union is called "European commodity exchanges". Preserved since the heyday of futures trading in real goods, they are mainly engaged in model contract development and information activities. Trading operations are practically nonexistent.
An exchange is a regularly functioning wholesale market for goods, raw materials and securities.
In legal terms, a stock exchange is an enterprise, just like a bank, factory or shop; like any other business, it may be public or private. In France, Italy, Belgium and Luxembourg, stock exchanges are state-owned, i.e. they are founded and regulated by state authorities. In the USA, Great Britain, Germany and Japan, there are private stock exchanges, which are mainly registered as joint-stock companies. Characteristically, shares of these exchanges are most often owned by institutional investors - banks and other companies, various funds, and state bodies.
Exchange transactions are concluded in a designated place. Since at present most stock exchanges trade several instruments at once, as a rule, a separate hall or room is allocated for each of them, or there are separate sections in one large hall, the floor of which is at a lower level than the floor of the hall. The place where a transaction is made is called differently in different countries - the exchange ring, the hold, the pit or the floor.
There are three methods of trading:
Public trading, which is conducted by shouting, sometimes duplicated by hand and finger signals;
So-called whispered trading. The latter is of limited use in Southeast Asia and Japan.
Electronic trading based on high technology, which, in the last decade, has become increasingly popular.
Exchange trading is based on the principles of a double auction, where increasing price bids from buyers meet decreasing price bids from sellers. When the bid prices of the buyer and seller match, a deal is struck.
4. Activities of the world's stock exchanges.
- - There are 10 largest stock exchanges:
- - New York Stock Exchange
- - Tokyo Stock Exchange
- - NASDAQ
- - London Stock Exchange
- Euronext - merged with the NYSE in 2006
- Hong Kong Stock Exchange
- Toronto Stock Exchange
- Frankfurt Stock Exchange (Deutsche Bourse)
- Madrid Stock Exchange (BME Spanish Exchanges)
- Swiss Exchange SWX
The New York Stock Exchange (NYSE) was established on May 17, 1792. The main US stock exchange, the largest in the world. It is a symbol of financial power of the United States and the financial industry in general. It defines the world-famous Dow Jones index for shares of industrial companies as well as the NYSE Composite index.
The Tokyo Stock Exchange (TSE) was founded in 1878. The Tokyo Stock Exchange is a not-for-profit organisation that is a legal entity with broad powers of self-governance.
NASDAQ (National Association of Securities Dealers Automated Quotation) is an American stock exchange specializing in shares of high-technology companies (manufacture of electronics, software, etc.). It is one of three main stock exchanges in the USA (along with NYSE and AMEX), is a division of NASD, controlled by the SEC. It was founded on 8 February 1971. It takes its name from automatic quotation system, which started the exchange. At present, shares of over 3,200 companies, including Russian ones, are traded on NASDAQ.
London Stock Exchange (LSE) - one of the biggest and oldest exchanges in Europe. Officially founded in 1801, but in fact its history began in 1570, when royal broker and counselor Thomas Gresham built "Royal Exchange" on his own money. The London Stock Exchange is a public limited company and its shares are traded on the Exchange itself. A number of well-known Russian companies trade on the exchange (in the form of depositary receipts), including Rosneft, Lukoil, Gazprom and others. In 2005 futures and options for RTS Index were launched on LSE (trade volumes for these contracts are 3 billion rubles and 700 million rubles respectively). In October 2006 the exchange launched the new FTSE Russia index, which is calculated according to price changes of the ten most liquid depositary receipts of Russian companies traded on the LSE.
Euronext NV is a pan-European stock exchange with branches in Belgium, France, the Netherlands, Portugal and the United Kingdom. In addition to equities and derivatives, the Euronext Group provides clearing and financial information services. As of 31 January 2006 all markets managed by Euronext had an aggregate capitalization of US$2.9 trillion, making it the fifth largest exchange on the planet.
Russian stock exchanges.
"The Moscow Interbank Currency Exchange is one of the largest universal exchanges in Russia, the CIS and Eastern Europe. "MICEX Stock Exchange is a leading Russian stock exchange, where stocks and corporate bonds of about 600 Russian issuers are traded daily, with total capitalization of almost 24 trillion rubles. The MICEX Stock Exchange has about 550 professional securities market participants whose clients include over 280,000 investors.
The Russian Trading System Stock Exchange was established in mid-1995 to unite disparate regional markets into a single organised Russian securities market. It is part of the RTS Group. RTS is a recognised pricing centre for shares and bonds of a wide range of issuers. RTS trading information is the most important source of data on the Russian securities market, as it is the platform that services a significant proportion of foreign and Russian portfolio investments in Russian equities. It trades such instruments as stocks, bonds, futures and options.
5. Exchange indices.
An exchange index is a composite indicator of price changes of a certain group of assets (securities, commodities, derivatives).
As a rule, the absolute values of indices are not important. Changes in the index over time are more important, as they provide an indication of the general direction of the market, even in cases where share prices in a selected group change in different directions. Depending on the sample of indicators, a stock index can reflect the behaviour of a particular group of securities (or other assets) or the market (market sector) as a whole.
The very first stock index is the Dow Jones Index. Created by Wall Street Journal editor and Dow Jones & Company founder Charles Dow. This index was created to track the development of the industrial component of the US stock markets.
Based on data from Dow Jones & Co. Inc. at the end of 2003, there were 2,315 stock indexes around the world.
The Russian stock market has a large number of stock exchange indices. The main ones are the RTS Index and the MICEX Index.
RTS Index - calculated as a capitalisation-weighted index of the most liquid shares of Russian issuers admitted to trading on the RTS Stock Exchange. The index has been calculated since September 1, 1995. When calculating capitalisation, the number of freely traded shares is taken into account. In 2005 the index calculation method was changed - it began to be calculated in real time, which allowed FORTS (futures market section of RTS) to launch trading of futures contract for RTS Index, and later options. This instrument proved to be very popular with players and quickly became a leader in terms of turnover on FORTS. The RTS Index is still based on the 'classic' RTS, where shares are traded for the US dollar.
The MICEX Index is an effective capitalization weighted market index of the most liquid shares of Russian issuers listed on the MICEX Stock Exchange CJSC (MICEX Stock Exchange) and included in the index calculation base. The effective capitalization of shares takes into account the share of shares in free float on the secondary market. The MICEX index is used by management companies as an underlying asset for 18 index mutual funds with total assets of 4.2 billion rubles.
The emergence of all kinds of securities and their purchase and sale give rise to the stock market. The main sense of its existence is that the rights to property and income from this property, embodied in securities, can be sold or bought on it.
Securities are documents of property content with which a right is linked in such a way that it can neither be exercised nor transferred to another person without these documents. The main types of securities are shares and bonds.
A share is a security that certifies the owner's right to a certain share in a joint-stock company and entitles them to receive dividends.
Shares can be ordinary or preference shares. Holders of ordinary shares are the rightful owners of the company. They have the right to vote at meetings of the shareholders, who are the supreme governing body of the company.
Preference shares give the owner a higher, more stable dividend, but they do not have the right to vote on most issues regarding the management of the company. Preference shares are also traded on the stock market but have less liquidity and are usually priced lower than ordinary shares of the same company.
Liquidity is an economic term that refers to the ability of a value (asset) to be sold quickly at a price close to the market price. Liquid - convertible into money.
The key concept in stock trading is liquidity. A liquid market is characterized by:
- continuous transactions
- a narrow gap between the seller's price and the buyer's price
- small fluctuations in price from transaction to transaction.
- A deviation from these norms is fraught with economic distortions and panic among investors. In order to get rid of these negative phenomena, the stock exchange does everything in its power to maintain liquidity.
Not all securities are admitted to trading on the stock exchange, but only so-called equity securities.
The basic securities are as follows:
- Fixed-income securities (debentures) - government bonds and bonds of private companies and banks, certificates, etc.
- shares (capital certificates).
In order to be listed on an exchange, a stock must meet certain criteria accepted by that exchange. These may include requirements for the issuer's legal status, amount of equity or share capital, income, face value of securities, etc. For example, shares of some 5,000 corporations are listed at the New York Stock Exchange. Each has at least 2,000 shareholders and at least $100 million in assets. So, for many companies, going public not only means great opportunities to raise debt capital but also to be part of a prestigious group of firms. The difference between listed companies and unlisted companies is about the same as the difference between a high street shop and a high street shop on the outskirts of town. Just as commodities are traded on a commodity exchange, securities are not directly traded on a stock exchange. They are bought and sold in batches, held in special bank accounts.
There are several types of stock transactions:
- Cash transactions, which are realised immediately after conclusion. Payment is made either immediately or within a few days. Until recently, in order to transfer securities from account to account, a special cheque, or certificate, issued by the exchange to the customer and certifying the transfer of ownership, was issued. Nowadays, all transfers are made via a computer network
- Futures and options transactions are similar to bank and commodity exchange transactions, with the only difference being that they end in the payment of the difference in the exchange rates between the time of the transaction and the time of payment
- arbitrage transactions, which are based on securities trading between different exchanges when there are differences in exchange rates. The purpose of such transactions is to smooth out price misalignments arising on different exchanges
- package deals - deals involving the purchase and sale of large batches of securities.
The price at which a security is traded is called its exchange rate. The exchange rate of a security depends on the amount of income it generates and is formed at the time of the transaction between the seller and the buyer. In a simplified form, the purchase and sale of securities looks as follows: an investor (buyer) orders a broker to buy 100 shares of a certain company at the rate of $1 per share. The seller in turn instructs his broker to sell the same batch of similar shares at the same rate.
The brokers contact a specialist dealer who generates a bid package for that company. Seeing that the bids he receives are mutually satisfactory and no other offers are received, the dealer sets the official rate at $1 and both clients are notified of the transaction.
In reality, the dealer receives many more bids and sales of the same securities with the request of quite different rates. His aim is to determine the rate at which most of the bids can be satisfied and the difference between supply and demand. It is this information that he calls out in the exchange hall in search of missing securities or in order to sell a surplus. The dealer's main objective is to balance supply and demand and to sell all lots of securities. As information on supply and demand is constantly being received, the rate of securities also fluctuates throughout the day. Therefore, the exchange sheets record the rates at the opening of the exchange and at the close of business.
If a transaction is made, stock exchange fees are deducted from the sales price of the securities, which include intermediaries' reward stock exchange tax and sometimes some other fees.
The commission is not the only source of income for the intermediary. Another source is income from price fluctuations. This income is also called operating income. At the exchange, for several hours thousands of transactions are made, which causes price fluctuations and gives an opportunity to receive income from the number of operations. The more deals of purchase and sale, with frequent price fluctuations, the more opportunities to get the operating income. Brokers and any investors, who analyse dynamics of exchange rates, also derive operating income from the exchange. These are the operations that can generate the most income. And that is why the stock exchange remains a fairly accurate indicator of the state of the economy. Exchange indices are used for determining the dynamics of business activity on the basis of stock exchange transactions.
The index of each share (bond) price is determined as the product of its rate by the number of shares of this type, quoted at the exchange, divided by the share par value. Later share price indices are used to calculate the aggregate exchange index.
Practically every stock exchange calculates its own indexes, but the most popular is New York Stock Exchange index - Dow Jones index. It was first calculated in 1897 by the editor-in-chief of the Wall Street Journal. Today, the index is an average of the share prices of 30 industrial companies, 12 utility companies and 12 banks listed on the exchange, including General Motors, General Electric, AT&T and others. Despite the inevitable inaccuracies inherent in any arithmetic average, the Dow Jones Index is a benchmark for exchanges and companies around the world.
A bond is a security that pays an annual income in the form of fixed interest.
Securities also include monetary and commodity documents that can be presented to exercise the property rights expressed in them - bills of exchange, cheques, certificates of deposit, bond coupons, bills of lading, warehouse certificates (warrants), etc.
The rights of private investors are protected by legislation. The Securities Market Act and the Joint Stock Company Act were passed in 1996. The legal protection of investments is enshrined in the Civil Code of the Russian Federation, which is the general legal framework for relations between legal entities and citizens in the process of interaction on the stock market.
Two types of securities markets are distinguished:
- Primary - a market that emerges at the time of the issue (issue) of securities
- Secondary - a market where securities can be resold several times.
The primary market is where the initial placement, or IPO (Initial Public Offering), of securities of joint-stock companies, government and municipal authorities takes place.
The placement of securities is possible in two ways - directly by the issuer to investors or by engaging intermediaries. Placement of securities (with the exception of government bonds) is usually carried out by investment banks.
Participants in the primary stock market are: individual investors, credit and financial institutions, pension funds, corporations and government agencies, insurance companies, investment funds private individuals, etc.
The secondary stock market is divided into exchange-traded and over-the-counter markets. In an exchange-based market, certain shares are traded and admitted to trading. Each stock exchange has a listing of securities.
A listing is a list of securities listed on a given stock exchange. Securities that are not listed are traded on an over-the-counter market. On this market, securities that are not listed on a stock exchange for whatever reason are bought and sold, e.g., through banks.
In the secondary fund market, sales and purchases of previously issued securities are made on stock exchanges or over-the-counter markets. The stock exchange and OTC market complement each other organically and are, at the same time, competitors.
In bond trading, the OTC market complements the stock exchange mechanism; in stock trading, exchanges and the OTC market are rivals.
Unlike a stock exchange, with a specially equipped building, operating room, the OTC market is transactions in the purchase and sale of securities, in free circulation. Exchanges operate on an auction basis and transactions therein are governed by rules approved by the management of the exchanges. Prices in the OTC market are set by negotiation and according to the rules governing the OTC market.
The securities traded over-the-counter can be roughly divided into several types:
- shares of small firms with no growth prospects, operating in traditional sectors of the economy;
- shares of companies which are being established in new and emerging industries and which have the potential to become large corporations;
- securities of large financial and credit institutions, which traditionally limit the circulation of their shares to the over-the-counter market;
- government securities, corporate and municipal bonds;
- new equity issues;
- foreign securities which, for various reasons, do not meet exchange requirements.
The FOREX international foreign exchange market
The formation of the global monetary system followed the industrial revolution and the formation of the world economic system. The system passed through three stages in its development, each corresponding to its own type of organization of international monetary relations.
The first stage in the development of global monetary system can be considered a period of its emergence in XIX century before the beginning of World War II. The transition to the second stage began at the end of 1930's. The world monetary system of this stage received its legal form on Bretton-Wood's conference (USA) in 1944. The third stage is the current world monetary system, which was formed in the 1970s. It was institutionalized after the 1976 meeting in Kingston (Jamaica).
The birth year of FOREX, the international foreign exchange market, is believed to have been 1971, when the currency exchanges shifted from fixed exchange rates to floating ones. FOREX is an acronym for 'FOReign EXchange', which translates to 'international exchange'. This market operates 24 hours a day, every day. It is characterised by the lack of a defined place of operation, as transactions take place between participants both directly and through various financial intermediaries, whose intersection of interests can take place in real exchanges, electronic trading, and other financial structures.
One of the most important elements of any currency system is the exchange rate, which shows the price of one country's currency expressed in another country's currency.
In the 1930s the international monetary system broke up into a series of blocks (sterling, dollar, French franc, etc.).
At the Bretton Woods conference held in 1944, international agreements were adopted which became the foundation of the system of monetary relations that became known as the Bretton Woods system.
Bretton Woods was designed to compensate for the lack of free exchange of currencies for gold. It strengthened the regulatory impact of the spontaneous and market-driven nature of international settlements. When the dollar officially ceased being exchanged for gold in 1971, fixed exchange rates gave way to floating ones. These changes in the international monetary system were legally enshrined in an agreement signed in 1976 in Kingston, reflected in the revised IMF Constitution.
The presence in a country of a currency unit, like a flag, coat of arms, anthem, is an indispensable attribute of national sovereignty. Monetary units within national economies fulfil a number of internal functions: a means of communication, a unit of account, a means of preserving value.
In economic relations between countries, national monetary units play the role of world money. Money used in international transactions is commonly referred to as currency.
Currency serves foreign trade in goods and services, international capital movements, transfer of profits from one country to another, foreign loans and subsidies, international tourism, public and private money transfers, etc. Consequently, currency is not a new type of money, but a specific way of functioning that is linked to transactions of an international nature.
A comparison is made by means of the exchange rate. The exchange rate is the price of one currency expressed in the currencies of other countries.
The exchange rate plays an important role in the development of international trade and the movement of capital.
Determining the exchange rate of a national monetary unit in relation to foreign monetary units is commonly referred to as a currency quotation. There are two methods of quoting currencies: direct and inverse (indirect). The most common is the direct quotation, in which a unit of foreign currency is expressed in the national currency. For example, 1 US dollar equals 28 rubles. In a reverse or indirect quotation, a unit of the national currency is taken as the basis, the exchange rate of which is expressed in a certain quantity of foreign currency. In our example, the inverse quotation will be 1/28 = 0.0357 dollars per ruble.
On the foreign exchange market, a commodity is one currency or set of currencies, and another currency plays the role of money. Currencies are traded in the world's financial centres, the most important of which are the markets in London, New York and Tokyo. The national currency markets of many countries around the world are involved to varying degrees in international transactions.
Modern means of communication and telecommunications link the world's financial centres into a single entity. Since 1973, the Society for Worldwide Interbank Financial Telecommunication - SWIFT, established by 240 banks from fifteen countries, has been widely used for immediate money transfers and payments by means of a computer network. Russia joined the SWIFT system in 1989.
Any news capable of affecting the exchange rate spreads all over the world instantly giving rise to a boisterous activity of market agents. The modern foreign exchange market is therefore truly a 24/7 global market.
The daily turnover of the global foreign exchange market amounts to astronomical amounts measured in hundreds of billions of dollars. By volume, the currency market stands out from all the other existing markets. Currency trading exceeds the volume of all world trade in goods and services by a factor of ten. In 1986, the average daily turnover in the currency market was about $330 billion, in 1989 it was $650 billion. - $650 billion in 1989, $1.2 trillion in 1995. - 1.2 trillion dollars, and in 2005, up to 5 trillion dollars per day. - up to 5 trillion dollars per day.
Global currency market development is characterized by strengthening internationalization of relations, extension of services, continuity of operations during a day and a growing scale of transactions and arbitrage operations.
The main economic agents on the external foreign exchange market are:
- Portfolio holders - investors.
Alongside the "primary" subjects of the foreign exchange market - exporters and importers, who form the basic demand and supply of currency, there are "secondary" subjects - those participants of the foreign exchange market who trade directly in currency. These are commercial banks, currency brokers and dealers.
Most of the money assets circulating at the currency market are in non-cash form, in the form of demand deposits, letters of credit, checks, bills of exchange with major banks, trading with each other. Any more or less significant international transaction involves the exchange of bank deposits in different currencies. Commercial banks, in order to satisfy their customers, carry out inter-bank currency trading. It is inter-bank trade that determines the values of exchange rates, which are regularly published in the open press.
In addition, banks finance exports and imports, manage international cash flows, including the electronic transfer of money across national borders, credit and equity finance, and design financial schemes for their clients. Commercial banks are therefore crucial players in the global foreign exchange market. Banknote trading and the exchange of cash account for a small part of the market.
Another economic agent that carries out major transactions in the global foreign exchange market is multinational companies. Operating in many countries around the world, they have to constantly conduct transactions on the world market to convert one currency into another. Quite often the transactions of multinational firms are dictated not by production needs, but by investment considerations.
The global currency market mechanism is also used to shape government macroeconomic policies. For this purpose, the central banks of individual countries intervene in the currency market in order to prevent sharp fluctuations of exchange rates. Although the volume of such operations is often small, participants in the global currency market closely follow the actions of central banks, trying to figure out the meaning of subsequent activities that can affect exchange rates.
In addition to the above-mentioned participants of the global foreign exchange market, foreign currencies are traded by various non-banking financial institutions, in particular investment and pension funds.
The main transactions carried out by economic agents in the foreign exchange market are remittances, hedging, clearing, and credit. A money transfer allows the transfer of purchasing power from one country to another. In hedging, an economic agent protects itself from currency risk. The clearing mechanism allows a large number of transactions to take place without the transfer of currency. A credit is realized when the exporter issues a forward draft to the buyer or to the buyer's bank. The term draft is discounted, sold on the bill of exchange market and the exporter receives its discounted value.
Deposits which are traded on the world currency market generate income for their owners. This income is determined by the level of the interest rate and is expressed in the currency in which the deposit is denominated. In addition, the yield on the deposit is influenced by the expected change in the exchange rate.
The equilibrium of the world currency market can only take place if deposits denominated in different currencies provide an equal comparable income. This condition for the equilibrium of the world currency market is called interest rate parity.
Foreign exchange rates are changed in such a way as to maintain interest rate parity. If, for example, the expected return on dollar-denominated deposits exceeds the expected value of deposits denominated in sterling, sterling will begin to depreciate against the dollar.
Exchange rate movements are influenced by the nature of expectations of its future value. If, for example, there is an expectation of growth of the exchange rate against the pound sterling, then, all other things being equal, the current exchange rate of the dollar against the pound sterling will increase.
The base currency of the world currency market is the US dollar. This means that the vast majority of currency transactions are carried out with the dollar. Even if a bank needs to exchange, say, New Zealand dollars for Israeli shekels, it is cheaper and quicker to do so through the dollar than through a direct exchange.
The other most important currencies, after the dollar, in descending order, are the euro, the Japanese yen, the English pound sterling and the Swiss franc.
All of the currencies listed above are freely convertible currencies. The convertibility of a currency is determined by the particular foreign exchange regulatory regime in a particular country. A currency is regarded as freely convertible if the country fulfils the requirements of Article 8 of the International Monetary Fund, i.e. if there are no legal restrictions on currency transactions of any kind. In particular, a country should not impose restrictions on payments and transfers in international current transactions, avoid discriminatory currency policies, and buy back its currency balances from other countries.
Partially convertible currencies are those of countries where there are quantitative restrictions or special permissive procedures on certain types of transactions or for some participants in foreign exchange transactions. Among the techniques used by governments of such countries are import licensing, multiple exchange rates, the requirement of import deposits, and quantitative controls.
Finally, there are non-convertible or closed national monetary units. The non-convertibility of monetary units is associated with the legal prohibition of most types of currency transactions.
The existence of the above gradations of currencies indicates the degree of "marketability" of the economic mechanism of the countries that emit national monetary units, the extent and prospects for the participation of national currencies in international transactions on the world currency market.
The largest centres of the international currency market are located in London, Tokyo, New York, Frankfurt-am-Main and Brussels. The most important subjects in the sphere of international monetary circulation are governmental bodies. Monetary relations in the global economy affect the national interests of the state. It is natural that in the course of evolution of these relations the rules and laws regulating these relations, acceptable from the point of view of national interests, were elaborated.
Under floating exchange rates, the exchange rate, like any other price, is determined by the market forces of supply and demand. Significant fluctuations due to supply and demand are characteristic of exchange rates of both strong and weak currencies.
The size of the demand for a foreign currency is determined by a country's need for imports of goods and services, tourist spending, the various kinds of payments a country is required to make, etc. The supply of currency will be determined by a country's exports, loans that the country receives, etc.
The demand and supply of foreign exchange, and hence the exchange rate, are directly or indirectly influenced by the totality of the country's economic relations, both internal and external.
Factors directly affecting the dynamics of the exchange rate :
- The national income of the State;
- the level of production costs;
- The real purchasing power of money;
- level of inflation in the country;
- the balance of payments that affects the supply and demand of the currency;
- the level of interest rates in the country;
- the credibility of the currency in the global market.
Established exchange rates, or currency quotations, are systematically published by news agencies specialising in economic reporting, which have a presence on exchanges. Market currency quotations can also show the buyer's rate and the seller's rate or rates for transactions with different terms and conditions. The difference between the seller's rate and the buyer's rate (spread) is the broker's income.
Today, the FOREX international currency market is the most dynamic and liquid market, which, along with modern technologies of exchange trading and analysis, makes it one of the most attractive financial markets both for short-term investments and long-term investments.
The commodity market has now lost its importance. In developed countries all large wholesale trade in raw materials and commodities is done through futures and options contracts. Real commodity exchanges have survived only in certain countries and have relatively small turnovers. They tend to serve as a form of wholesale trade in local commodities, whose markets are characterised by low concentration of production, marketing and consumption.
In the commodities market, the ticker symbol consists of a root symbol (one or two letters - incidentally, the stock rule "The shorter the ticker, the more respectable the contract"), the month of delivery and one or two digits of the year. For example, ticker WH04 corresponds to SWOT wheat W, delivered in March (H) 2004. The exchange ticker can and often does differ from the ticker awarded to the instrument by the particular vendor/data provider you are using. The tickers will then be used accordingly to their designation in the CQG. The symbols for the months of delivery are the same for all exchanges:
January (Jan) - F
February (Feb) - G
March - H
April - J
May - K
June - M
July - N
August (Augie) - Q
September (Sept) - U
October (Oct) - V
November (Nov, Novie, Navy) - X
December (Dec) - Z
Because Sept and Dec sound very similar on the phone and contracts correspond to the very popular March/June/Sept/Dec financial quarterly cycle, we often use the qualifiers Sept Labor Day and Dec Christmas/Xmas, for example - Dec Christmas Silver.
Traditionally, grains include wheat (Wheat), corn (Corn), soybeans (SoyBeans) and soy products - soybean meal and soybean oil (SoyMeal, BeanOil). The main futures and options market for these products is the SWOT, the oldest futures exchange. Beside this exchange, there are so-called secondary markets - Minneapolis, Kansas, etc. Unless otherwise explicitly stated by the broker, the order for these contracts is filled at the swot. Grain futures, along with cotton, are among the most reputable futures contracts. Strictly speaking, soybeans and their by-products are not grains, but they are traditionally lumped into this group.
The contract size for soybeans, wheat and corn is 5,000 bushels (soybean oil is 60,000 pounds or 27,216 metric tons, soybean meal is 100 short tons or 90,7185 metric tons). Since bushels are a measure of volume, the weight equivalent will be different for each variety of grain. Specifically, for SWOT maize one standard lot corresponds to 127.006 metric tonnes, for SWOT wheat to 136.0775 metric tonnes, for SWOT soybean to 136.0775 metric tonnes.
Delivery months are Dec, Mar, May, Jul, Sept (new crop) for SWOT maize; Jul (new crop), Sep, Dec, May for SWOT wheat; for SWOT soya - Sept, Nov (new crop), Jan, Mar, May, Jul, Aug; for SWOT soybean oil - Oct, Dec, Jan, Mar, May, Jul, Aug, Sep; for SWOT soybean meal - Oct, Dec, Jan, Mar, Jul, Aug, Sep.
Tickers: wheat - W, corn - C, soybean - S, soybean oil - BO, soybean meal - SM.
Tick size and quotation - wheat, soybeans and corn are quoted in 1/8th of a cent. After the dramatic events of the mid-1970s, when the price of grain products rose as a result of Soviet procurement, these contracts were quoted at 1/4, but due to the traditional conservatism of the SWOT, the price format was left the same, but the minimum price change (tick) was made double. From then on, the last digit of the quotation became always even - quotation 3604 corresponds to the price of 360 4/8 cents per bushel. Eighths of a cent, however, remained for options. One tick corresponds to $12.50, so a full cent corresponds to $50 per contract. Soybean meal is quoted in dollars per ton, with a tick size of $0.1, corresponding to $10 per contract. Soybean oil is quoted in cents per pound, the tick size is 0.01 cents, corresponding to $6 per contract.
History - the mid-70s was a turning point for grains. Since that time, grain prices moved to other, previously unseen levels. Grain markets received another shock in the summer of 1996. The cause was El Niño, a complex weather phenomenon repeated every 12-15 years with different scales and effects. Historically, wheat has traded in a range from $1.25/bushel in the late 60s to $6.50 in early '74 and $7.50 in early 1996. The average price range is $2.50 to $4.50. Soybeans - from less than $2.50 in the late '60s to nearly $13.00 in June 1973 (the famous slogan of the day was "Beans in the teens!"), with an average price range of $5.00 to $8.00. Corn ranges from $1.00 in the 60s-70s to $5.50 in 1996. Soybean meal has a historical range from $75 a short ton to $450 in June 1973, soybean oil from 75 cents a pound to $51 in October 1974.
What to fear is Mondays and the 11th of every month. "Monday mornings don't take prisoners" is a grain trader adage originating from the Weekly Crop Progress Reports published every Monday. On the 11th, the monthly USDA US and World Supply & Demand Report is published. On those dates, strong price movements are most likely on grain and agricultural markets in general. The most unpredictable and dangerous contracts are those against which new crop grains are delivered - July Wheat; Novie Beans; Sept, Dec Corn. Old/New Harvest spreads involving these months also carry higher risk, which is reflected in the exchange's collateral requirements.
Base and precious metals. Interests in trading are Hi-Grade Copper, Gold and Silver. The primary market for these futures is COMEX (Commodities Exchange), a division of NYMEX (New York Mercantile exchange). Similar contracts are offered by the SWOT, but for some unknown reason, gold and silver do not take root in Chicago. The contract size is 1,000 troy ounces for gold on the NYMEX, 5,000 troy ounces for silver and 25,000 pounds for copper.
Delivery months are all 12 months, but the most liquid months are March/June/Sept/Dec quarterly cycle.
The tickers are: gold - GC, silver - SI and copper - CP.
Ticker size and quote - Gold trades in dollars per troy ounce, with a ticker size of $0.10, corresponding to $10 per contract. Silver is also traded in dollars/cents per ounce, with a tick size of 0.5 cents, corresponding to $25 per contract (curiously, silver is one of the few contracts where the official closing price can have a quote that does not respect the tick size). Copper trades in cents per pound, with a minimum price change of 0.05 cents, corresponding to $12.50 per contract.
History - The metal market is famous for perhaps the biggest scandal in the history of the stock markets. In 1980, the Hunt brothers, Texas oil tycoons surprised the silver market by accumulating huge positions in the cash silver market and the futures market. As a result, the silver market still holds the absolute lead with a price low of $1.40 and a high of over $50 in January 1980. The gold market reacted symmetrically, from $100 to $875 in the same year 1980. The copper market was rocked by a relatively recent scandal, with attempts to manipulate the cash market by the Sumitomo dealer resulting in a dramatic fall in prices in May 1996. The historical spot-month price range is 45 cents to 160 cents/lb (December 1988).
What to fear - metals, especially the precious metals group, are sensitive to the release of financial statistics. Be afraid - first Friday of the month (unemployment release), PPI, CPI, Trade Balance, GDP. Copper correlates quite strongly with the stock indices and reacts painfully to the Industrial Production. Copper traders also keep an eye on the LME cash market and inter-monthly premiums. For gold traders, there is a lot of information about the movement of the Lease rate - the rate at which gold is accepted as collateral on the cash market. Moreover, there is an interbank market of gold and its derivatives, which functions almost around the clock.
The primary market for crude oil, unleaded gasoline, heating oil and natural gas contracts is the NYMEX. The contract size is West Texas crude oil traded in lots of 1,000 barrels, gasoline and heating oil in lots of 42,000 gallons and gas in lots of 10,000 MMBTU (million British thermal units).
Supply months are all 12 months. There is seasonal activity, the spot month is always active almost until the last day.
Tickers: oil - CL, gasoline - HU, fuel oil - HO and gas - NG.
Tick size and quote - the minimum change in oil price is $0.01 , which corresponds to $10. It is traded in dollars per barrel. Gasoline and fuel oil, which are sub-products of oil, are traded in cents per gallon. The tick size is 0.01 cents (in reality the price usually changes by 0.05 cents), which corresponds to $4.20 per contract. Gas is traded in dollars per MMBTU, with a tick size of 0.001, corresponding to $10.
History - Energy contracts are relatively young, but the market has experienced several shocks since the 1980s. The first occurred in November 1985, when the price of oil plummeted from nearly $32 to $9.75 in less than six months. In the summer of 1990, the spot (immediate delivery) price of oil went from $15 a barrel to $40 in a matter of weeks and collapsed to $17.50.
What to fear - factors that could unbalance the energy markets include (among the unplanned) military events in the Gulf and unexpected OPEC statements/actions. Planned shocks include official API figures, the release and expected values of which can be seen in the news lines and on the trading calendar. In addition, the fuel oil and natural gas markets are heavily influenced by the weather.
Softs is a name that unites a large and diversified group of mainly tropical commodities, namely coffee, sugar, cotton, frozen concentrated orange juice, and cocoa. The first three are of investment value, which will be discussed below. The primary market for these is the former New York Coffee, Sugar and Cocoa Exchange, now the New York Board of Trade.
The size of the contract is World Sugar #11 (raw cane sugar, mostly of Brazilian origin) traded in lots of 112,000 pounds, which corresponds to 50.8 metric tons. The name of the contract, World Sugar No. 11, reflects the situation specific to this product. Most of the sugar is sold under intergovernmental agreements at prices which have nothing in common with market prices, and only about 20% of the sugar enters the free market trade. It is this sugar that is traded on NYBOT. Arabica coffee is traded in lots of 37,500 pounds, cotton is traded in lots of 50,000 pounds shipped in sacks.
Supply Months - Sugar is shipped according to the Brazilian harvest cycle against March, May, July, October (new crop). Formally there is a January contract, introduced in 2003, but it is completely inactive. Coffee has March, May, July, September, December as delivery months. Cotton - March, May, July, October, December.
Tickers: Sugar - SU, Coffee - CF, Cotton - CT.
Tick size and quote - sugar is quoted in cents per pound, with a minimum price change of 0.01 cents, corresponding to $11.20. Coffee is quoted in cents per pound, with a minimum change of 0.05 cents, corresponding to $18.75. Cotton is quoted in cents per pound, with a minimum price change of 0.01 cents, corresponding to $5.
History - these markets are classic examples of weather-driven markets. For example, the coffee market experienced four serious price shocks due to frosts in Brazil, which resulted in more than 5-fold price changes. The $1 coffee spot contract price has since served as a sort of watershed, separating a potentially explosive market from a sluggish slide. Many traders do not start buying coffee until it has passed that mark. The sugar market is somewhat unique in that it is the only market which, in the absence of any manipulation or abuse, has shown a price movement of almost 30 times - from a high of 65 cents in November 1974 to 2.29 cents in June 1985, when it was trading at a price comparable to that of the bag. Cotton is perhaps the only commodity market where price fluctuations relative to the average price are symmetrical in both frequency and magnitude, with a range of 30 cents to 115 cents.
What to fear is the weather. Freezing weather in Brazil. The devaluation of the Brazilian rial. The 11th of every month if there's a big position in cotton. Unreasonably large positions in these markets. Unreasonably large short positions in coffee in a rising market with a spot contract price above 100 cents.
Execution of trades in markets
A trade position is a market obligation that includes bought or sold contracts for which no offsetting transactions have been executed. Trading activity takes place using a trading terminal or by telephone. The trader issues orders based on which the dealer opens or closes a trading position.
The management of trading positions consists of:
- opening a position - buying or selling a financial instrument as a result of executing a market or pending order;
- Position modification - modification of Stop Loss (SL) and Take Profit (TP) order levels related to an open position;
- setting pending orders - setting pending orders Buy Limit, Buy Stop, Sell Limit and Sell Stop;
- modification and deletion of pending orders that have not triggered;
- Close position - purchase or sale of a financial instrument for an existing position in order to close it as a result of the execution of a market order or orders of the types SL and TP.
A pending order is an instruction to a dealer to buy or sell a financial instrument at a specified price in the future. This order is used to open a trading position if future quotes are equal to the set level.
There are four types of pending orders:
- Buy Limit - to buy when the future "ASK" price is equal to the set value. The current price level is greater than the value of the set order. Usually this type of orders is set on the assumption that the security price will start to grow when falling to a certain level.
- Buy Stop - buy when the future price is equal to the value set. The current price level is lower than the value of the set order. Usually this type of orders is placed based on the fact that the security price will pass a certain level and will continue its growth.
- Sell Limit - sell when the future BID price is equal to the value set. The current price level is lower than the value of the set order. Usually such orders are placed in expectation that the instrument price will start to decrease, having risen to a certain level.
- Sell Stop - sell when the future "BID" price is equal to the value set. The current price level is higher than the value of the set order. Usually such orders are placed in expectation that the security price will reach a certain level and will continue to decrease.
In addition to the pending order, you can set SL and TP. Once the pending order triggers, its SL and TP are automatically set to the open position.
SL order is intended for loss minimization in case the security price starts to move in an unprofitable direction. If the security price reaches this level, the position will be closed automatically. Such order is always related to an open position or a pending order. It can be given to a dealer only together with a market or a pending order. When checking terms and conditions of this order for long positions, the ASK price is used for long positions, and for short positions the BID price is used.
TP order is intended for gaining the profit when the security price reaches the specified level. Execution of this order results in closing the position. It is always related to an open position or a pending order. The order can be given only together with a market or a pending order. When checking conditions of this order, the ASK price is used for long positions and the BID price is used for short positions.
Ask - the lowest price at which someone is willing to sell a stock, option, futures or currency. The number of securities that the seller is willing to sell at the Ask price is called the Ask Size.
Bid - a bid price, the highest price at which someone is willing to buy a particular stock, option, futures, currency. Realistically, it is the existing price at which any investor can sell his shares.
Leverage is available on the FOREX market and is equal to 1:100. Thus, in order to open a position with a minimum contract corresponding to 0.1 lot, an amount of 100 units of the base currency is needed.