Forex exchange markets

December 2, 2022 by Nakul PANJABI

Forex exchange markets

In this article, Nakul PANJABI (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2024) explains how the foreign exchange markets work.

Forex Market

Forex trading can be simply defined as exchange of a unit of one currency for a certain unit of another currency. It is the act of buying one currency while simultaneously selling another.

Foreign exchange markets (or Forex) are markets where currencies of different countries are traded. Forex market is a decentralised market in which all trades take place online in an over the counter (OTC) format. By trading volume, the forex market is the largest financial market in the world with a daily turnover of 6.6 trillion dollars in 2019. At present, it is worth 2,409 quadrillion dollars. Major currencies traded are USD, EUR, GBP, JPY, and CHF.

Players

The main players in the market are Central Banks, Commercial banks, Brokers, Traders, Exporters and Importers, Immigrants, Investors and Tourists.

Central banks

Central banks are the most important players in the Forex Markets. They have the monopoly in the supply of currencies and therefore, tremendous influence on the prices. Central Banks’ policies tend to protect aggressive fluctuations in the Forex Markets against the domestic currency.

Commercial banks

The second most important players of the Forex market are the Commercial Banks. By quoting, on a daily basis, the foreign exchange rates for buying and selling they “Make the Market”. They also function as Clearing Houses for the Market.

Brokers

Another important group is that of Brokers. Brokers do not participate in the market but acts as a link between Sellers and Buyers for a commission.

Types of Transactions in Forex Markets

Some of the transactions possible in the Forex Markets are as follows:

Spot transaction

As spot transaction uses the spot rate and the goods (currencies) are exchanges over a two-day period.

Forward transaction

A forward transaction is a future transaction where the currencies are exchanged after 90 days of the deal a fixed exchange rate on a defined date. The exchange rate used is called the Forward rate.

Future transaction

Futures are standardized Forward contracts. They are traded on Exchanges and are settled daily. The parties enter a contract with the exchange rather than with each other.

Swap transaction

The Swap transactions involve a simultaneous Borrowing and Lending of two different currencies between two investors. One investor borrows the currency and lends another currency to the second investor. The obligation to repay the currencies is used as collateral, and the amount is repaid at forward rate.

Option transaction

The Forex Option gives an investor the right, but not the obligation to exchange currencies at an agreed rate and on a pre-defined date.

Peculiarities of Forex Markets

Trading of Forex is not much different from trading of any other asset such as stocks or bonds. However, it might not be as intuitive as trading of stocks or bonds because of its peculiarities. Some peculiarities of the Forex market are as follows:

Going long and short simultaneously

Since the goods traded in the market are currencies themselves, a trade in the Forex market can be considered both long and short position. Buying dollars for euros can be profitable in cases of both dollar appreciation and euro depreciation.

High liquidity and 24-hour market

As mentioned above, the Forex market has the largest daily trading volume. This large volume of trading implies the highly liquid feature of Forex Assets. Moreover, Forex market is open 24 hours 5 days a week for retail traders. This is due to the fact that Forex is exchanged electronically over the world and anyone with an internet connection can exchange currencies in any Forex market of the world. In fact for Central banks and related organisations can trade over the weekends as well. This can cause a change in the price of currencies when the market opens to retail traders again after a gap of 2 days. This risk is known as Gapping risk.

High leverage and high volatility

Extremely high leverage is a common feature of Forex trades. Using high leverage can result in multiple fold returns in favourable conditions. However, because of high trading volume, Forex is very volatile and can go in either upward or downward spiral in a very short time. Since every position in the Forex market is a short and long position, the exposure from one currency to another is very high.

Hedging

Hedging is one of the main reasons for a lot of companies and corporates to enter into a Forex Market. Forex hedging is a strategy to reduce or eliminate risk arising from negative movement in the Exchange rate of a particular currency. If a French wine seller is about to receive 1 million USD for his wine sales then he can enter into a Forex futures contract to receive 900,000 EUR for that 1 million USD. If, at the date of payment, the rate of 1 million USD is 800,000 EUR the French wine seller will still get 900,000 EUR because he hedged his forex risk. However, in doing so, he also gave up any gain on any positive movement in the EUR-USD exchange rate.

Useful resources

Academic resources

Solnik B. (1996) International Investments Addison-Wesley.

Business resources

DailyFX / IG The History of Forex

DailyFX / IG Benefits of forex trading

DailyFX / IG Foreign Exchange Market: Nature, Structure, Types of Transactions

About the author

The article was written in December 2022 by Nakul PANJABI (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2024).

The Money Changer and his Wife

February 5, 2024November 27, 2022 by Nakul PANJABI

The Money Changer and his Wife

In this article, Nakul PANJABI (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2024) talks about the The Money Changer and his Wife painting by Quentin Matsys and the related subject of foreign exchange markets.

About the The Money Changer and his Wife painting

This painting called ‘The Money Changer and his Wife’ was painted in 1514 by Quentin Matsys, a 16th century Flemish Artist. It originated at a time when Belgium saw an increase in the number immigrants from Spain and neighboring countries because of the Spanish Inquisition. The immigrants needed local money to buy goods and services in Belgium. Therefore, the business of money changers thrived at that time.

The Money Changer and his Wife painting

Source: Quentin Matsys (Louvre Museum).

In fact, the city of Antwerp was growing in importance at that time. Earlier, Bruges was the trading capital of Belgium. In 13th century, Bruges was the leading trade centre of the North-western Europe and the world’s ever first Stock Exchange was founded in Bruges. However, due to silting up of Zwin due to tidal inlet, Bruges lost access to the North Sea and suffered from economic decline.

At the end of the 15th Century, most foreign trading houses shifted from Bruges to Antwerp and Antwerp became the Sugar capital of Europe. The city attracted Sugar traders from all around the Europe and became a major trading hub. Moneylenders and Financiers capitalized this opportunity and Antwerp became developed an efficient Bourse (Stock Exchange) that even lent money to the English Government.

Money Changer

A money changer was a person who exchanged coins or currency of one country for that of another. Many European cities and towns produced their own coinage during the Middle Ages, and these coins frequently featured the faces of their rulers, such as the local bishop or baron.

It became necessary to exchange foreign coins for local ones at neighborhood money changers when visitors from the outside world—especially traveling merchants—came to town for a market fair.

A foreign coin would be evaluated by money changers for its type, condition, and legitimacy before being accepted as a deposit and having its value converted into local money. The money could then be withdrawn by the merchant in local currency to complete a transaction. This was the humble yet prosperous beginning of the modern day banking and foreign exchange.

As mentioned on the Louvre Museum website, through its deployment of Christian symbolism (representation of the Bible), this depiction of a money changer’s store acts as a moral lesson on the spiritual need to resist worldly temptations (the woman is not looking at the Bible but the money).

The two subjects are pictured sitting behind a table, half-length. They become the center of attention because of how tightly the scenario is framed. They are symmetrical to the letter. On the table in front of him, the man is busy weighing the pearls, gems, and gold pieces. This is keeping his wife from finishing the devotional book she is now reading, as seen by the image of the Virgin and Child.

This painting can currently be seen in the Louvre Museum in Abu Dhabi.

The History of Forex

Trading between tribes began as early as 6000 BC. People started trading by exchanging one good for another. This was followed by systems in which goods like salt and spices became common media of exchange.

Then around 6th century BC societies started using coins as a medium of exchange. The main reasons were portability, durability, divisibility, uniformity, limited supply and acceptability. Most coins were valued by the purity and type of metal used, its weight and its stamp. Gold coins became the most common form of currency around the world.

However, in the 1800’s countries started adopting Gold Standard. England, USA, and other major countries adopted a system in which a piece of paper (fiat currency) is equal to a certain value of gold that can be redeemed by the holder of this paper from the government. Since the notes were a promise to pay a certain level of gold from the government, the value of that paper became equal to the value of gold it was backed by.

During the First and Second World Wars, the limits of this system were tested when the European countries needed to print more money to pay for the war. This led to the creation of Bretton Woods System. In this system, all the major currencies would be pegged (fixed rate) to the US Dollar and the US Dollar would be pegged to gold. It made sense as USD was the benchmark currency at that time and US had the majority of gold reserves in the world. The shortage of gold relative to the US dollars in circulation brought an end to the Bretton Woods agreement in 1971.

After a series of failed agreements, countries made the switch to the free-floating system that we know today. In this system the value of one currency in other currency’s terms is decided by the relative supply and demand of the currencies. Before the Internet, the major players in this market were large financial institutions and central banks. With the internet, anybody with a computer and access to internet can access the forex market and exchange currencies. This changed everything not just for Forex market but also for other financial markets. Now investing in or trading with another country became extremely easy. The costs (spreads) were reduced, and the movement of money (capital) was faster than ever.

The History of Forex

Source: Daily FX.

Although the Forex Markets, as we know it, are relatively new, people have always been exchanging currencies for trade. This lead to a creation and prosperity of a very specific profession- Money Changing.

Useful resources

About the painting

Wikipedia The Money Changer and His Wife

Louvre Abu Dhabi The Money Changer and His Wife

Joy Of Museums virtual Tours “The Money Changer and His Wife” by Quentin Matsys

Brugge Brugge: History in a nutshell

About the foreign exchange

IG Benefits of forex trading

Daily FX The History of Forex

About the author

The article was written in November 2022 by Nakul PANJABI (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2024).

Art as an asset class

January 30, 2024November 2, 2022 by Nakul PANJABI

Art as an asset class

In this article, Nakul PANJABI (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2024) talks about the Art as an asset class.

Before delving into the economics of the art market and art’s significance as an asset class, let us first recollect the definition of an asset and an asset class. An asset broadly refers to a resource from which future economic benefits are expected to flow. An asset class is a group of assets that have similar characteristics and related risk and return behavior. Common examples of asset class would be equities, fixed-income investments, and real estate.

Why have you not invested in art yet?

Although an age-old investment, art as an investment has been available to only a minority of investors most of whom are high-net-worth individuals (HNWI) or even ultra-high-net-worth individuals (UHNWI). The prime reason is that the market faces an inelastic supply. In simple terms, there are very few goods in market to be traded which leads to higher prices of each item and therefore, at equilibrium, only few people with such means could afford the good. This economic explanation of the art market would be enough if there were very few art items available to buy. However, as intuition might suggest, that is not the case. The world is filled with pieces of art and people who own it. Does this fact weaken our previous argument? The answer is simply No. Even though there are lots of art item and anyone with some spare money can buy a piece of art, almost none of those items would be classified as an asset. Art as an Asset class has an extremely limited supply. Only a few pieces of art are purchased as Asset.

Features of the Art Market

Besides limited supply and consequently higher prices, there are few other factors as well that makes art an interesting asset class. Firstly, the investable art items are highly illiquid. Selling a collectible art item is a time-consuming complex process. It requires dealers, auctions and most importantly potential buyers who could afford such an expensive item that provides no economic benefits except capital appreciation. As one might guess, there are only a handful of individuals in the world who own a 50-million-dollar painting.

Secondly, the supply of this asset class is not closely related to the cost of producing it. Most goods’ supply is based on the cost of producing them. For example, it is cheap to produce toothpaste, so it has an elastic supply. If there is a strike at a toothpaste factory, then there would be less people to make the toothpaste. This will increase the wages (cost of production) paid to them. Now fewer toothpastes would be produced at a higher price. This will make the supply of toothpaste relatively inelastic. However, this economic phenomenon seems to be missing in the art market. The supply of this asset class is highly inelastic but the goods that represent investable art are very cheap to produce. The low cost of production does not dictate the supply of collectible art. It is the rarity of these goods that cause such an inelastic supply. A lot of Investable art items are works of deceased artists. Although they probably were very cheap to produce, it is impossible to create more of them. The rarity of such items makes them so valuable.

Art has a very high maintenance cost and most of the art do not provide any recurring cashflows. One source of art cashflows is the income generated from renting art to museums. Because there is a limit to the number of paintings that can be displayed in museums, most of the return from art investments is generated through capital appreciation. However, as we discussed before, it is not so easy to sell a piece of art. Then, why would anyone, let alone the most sophisticated of investors, buy such an asset? Well, there are a lot of reason why one might invest in art.

Reasons to invest in the art market

Low correlation

Art has a low correlation with traditional asset class. Fluctuations in Apple’s stock price would probably have little effect on the price of an authentic Picasso painting. Thanks to this low correlation, a collectible painting can act as a hedge against inflation and market crashes. According to a 2022 Citibank report, art has either a weak positive correlation or zero correlation with other asset classes.

Tax Benefits

Given the fact that the value of investable art does not derive from either its future cashflows or its cost of production, it is relatively easier to manipulate its price than it is for other assets. Manipulating the price of an asset is extremely useful to manipulate income and consequently taxes.

Money laundering

Art Investments have also been used for money laundering. The logic is straightforward. A 50-million-dollar painting can be much easily hidden than cash or gold of similar value.

Status Symbol

Art is a very efficient status symbol. The rarity of the collectible art items makes owning them a source of prestige. If your friend owns one of the only five paintings created by a famous renaissance painter, you don’t need to be an expert in art to judge the economic worth of the painting or of your friend.

What Future looks like for the art market

According to the annual report by Art Basel and UBS Global Art, the worldwide art sales crossed $65.1 billion in 2021. This reflects a 29% increase from the previous year.

Moreover, with increase in the trend of NFT trading, millennials are more interested in (digital) art than ever. According to 2021 study by Art Basel and UBS Global Art, millennials were the highest spenders on fine art in 2020.

Now, with an increase in art investing funds, the barriers for art investing have also been reduced tremendously. People, who could not invest in art because of high capital requirement and lack of expertise, can now do so by investing in an art fund.

Why should I be interested in this post?

As an (wealthy) investor, art represents an asset class which is not highly correlated with traditional assets. It then can be useful for asset allocation in terms of diversification. When you think of your personal portfolio, you may think of art.

About the author

The article was written in November 2022 by Nakul PANJABI (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2024).

Charging Bull on Wall Street

November 2, 2022 by Nakul PANJABI

Charging Bull on Wall Street

In this article, Nakul PANJABI (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2024) talks about the Charging Bull sculpture displayed on Wall Street.

About the Charging Bull sculpture

In mid of December 1989, a bronze sculpture of a bull in its charging position was dropped outside of the New York Stock Exchange. The Bull is a symbol of booming stock prices. Arturo Di Modica, an Italian-American artist, was responsible for this stunt. During the economically depressive period of late 80s, he intended to encourage optimism and hope for a prosperous future among the American Citizens. Anticlimactically, the sculpture was removed just after few hours but was placed just two blocks away from its original place.

Charging Bull sculpture on Wall Street.
Charging Bull sculpture on Wall Street
Source: Arturo Di Modica.

Although the Charging Bull has already become a global symbol for an upward stock price movements and prosperity, understanding the basics of Bull and Bear markets can be useful for Investment Management. Bull market represents the time period where asset and security prices are rising, and it reflects the heightened investor confidence in the financial markets. Conversely, Bear market represents a downward movement in security prices and an increased investor pessimism. The terminology evolves from the behaviour of the animals. Bull market derives its name from the upward attacking technique of a bull and the bear market from the downward attacking technique of a bear.

Price trends

Generally, fundamental investing deals with the fundamental value of the security rather than the movement of its price. However, it does not mean that price movements are completely irrelevant in investment decisions of an individual. It is useful to know whether the market is bullish or bearish. If the security is currently overvalued according to your fundamental analysis, then the ideal action would be to sell the security while it is overvalued. But if the price is expected to rise even higher in the near future, then the rational behaviour would be to sell the Security later at that higher price and to sell it now if the price is expected to dip. Judging the market trends is an important skill to maximise returns on investment.

The price trend approach and market efficiency

Classifying a market as bull or bear derives from studying the trends in prices of assets. The method to identify patterns in price movements and forecasting the direction of price using past market data is known as technical analysis’. Profiting from technical analysis requires the market to be inefficient. It simply means that the current stock price does not reflect all the information represented in the past price points as well as all the public and private information in the market. However, it is widely assumed that developed markets are usually efficient in the semi-strong sense. This means that the prices of the assets reflect all the information from past price points and all the information publicly available. Theoretically, in such a situation an investor cannot benefit (have abnormal returns) by using technical or fundamental analysis.

However, this does not mean that studying price trends is completely useless. In markets which are inefficient, using technical analysis might be even more profitable than fundamental analysis. Generally, the developing economies such as Africa have inefficient markets. In those markets analyzing the past price points might give a reasonable edge to forecast short-term asset prices. Using fundamental analysis can also be tricky in this case. If a stock is undervalued, then the rational behavior would be to buy the stock and wait for its price to increase. However, since the market is inefficient, it is very uncertain when the prices will reflect the public information and, consequently, whether the investor will make a profit or not. In such a case, technical analysis might still work as it relies on market sentiment.

Why should I be interested in this post?

The Charging Bull sculpture on Wall Street is part of the financial culture of every business school student. It is a must see when you visit New York City.

Bull and bear markets are terms that have to be well understood by every investor in financial markets.

Useful resources

Wikipedia Arturo Di Modica.

Antoine Bourdon (22/10/2021) Mort d’Arturo Di Modica, sculpteur du célèbre Charging Bull de Wall Street à New York Connaissances des arts.

About the author

The article was written in November 2022 by Nakul PANJABI (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2024).

Forex exchange markets

Forex Market

Players

Central banks

Commercial banks

Brokers

Types of Transactions in Forex Markets

Spot transaction

Forward transaction

Future transaction

Swap transaction

Option transaction

Peculiarities of Forex Markets

Going long and short simultaneously

High liquidity and 24-hour market

High leverage and high volatility

Hedging

Related posts on the SimTrade blog

Useful resources

Academic resources

Business resources

About the author

The Money Changer and his Wife

About the The Money Changer and his Wife painting

Money Changer

The History of Forex

Related posts on the SimTrade blog

Useful resources

About the painting

About the foreign exchange

About the author

Art as an asset class

Why have you not invested in art yet?

Features of the Art Market

Reasons to invest in the art market

Low correlation

Tax Benefits

Money laundering

Status Symbol

What Future looks like for the art market

Why should I be interested in this post?

Related posts on the SimTrade blog

About the author

Charging Bull on Wall Street

About the Charging Bull sculpture

Price trends

The price trend approach and market efficiency

Why should I be interested in this post?

Related posts on the SimTrade blog

Useful resources

About the author