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What is Arbitrage Trading in Forex ?

Arbitrage trading in forex

Arbitrage trading is widely used for making a profit in different sectors, so it is crucial to understand the definition of arbitrage.

Arbitrage is a trading method where the trader will try to make a profit after noticing the differences in the prices of identical, related, or similar financial instruments available from different brokers, organizations, and companies. Various organizations are selling and purchasing financial assets like currencies to varying prices due to differences in costs, profit margins, demand, supply, and other reasons.

Typically Arbitrage usually involves purchasing the asset from the organization selling at a low price, and almost immediately selling the asset to the organization purchasing at a high price for a profit.

The trader is taking advantage of the differences in the prices quoted by the financial organizations. Since the asset is sold almost immediately after it has been purchased, arbitrage is considered low risk for the trader. Yet there is some risk involved in this type of trading if the prices are fluctuating rapidly or the market liquidity levels are low. Many Forex traders would like to find out what is arbitrage trading in Forex, so a detailed explanation is provided below.

Understanding arbitrage trading

It is possible to make a profit with arbitrage trading because the financial markets are not perfect and efficient. The price of any asset in the financial market depends on the demand and supply of the asset. Hence any change in the supply or demand can result in a decrease or increase in the price of the asset. The arbitrage traders try to make a profit from the temporary glitches in the financial asset values in the markets. The traders will try to be the first to spot the differences in the asset prices, which may occur if there is any mismatch in the demand or supply levels in the exchanges dealing with these assets.

Once the trader notices the difference, he could quickly make a profit, without taking much risk. Traders may use a trading system that is automated as part of their strategy for arbitrage trading. These automated systems incorporate algorithms, which detect the price discrepancies immediately and alert the trader. Hence the trader can exploit the price differences to make a quick profit. After some time, other traders will also notice the difference, and the prices of the asset in the market will get adjusted accordingly.

Types of arbitrage – forex arbitrage opportunities

Forex arbitrage can be classified into three main categories

Two currency arbitrage involves making a profit from the differences in the prices quoted for the currency pairs; It does not consider the differences in the prices of the currencies in the pair which is considered.

Triangular arbitrage utilizes the differences in the prices of three different types of currencies. The asset in one currency is converted into two other currencies before it is converted back into the original currency to make a profit.

Covered-interest arbitrage involves making a profit from the differences in the interest rates in two countries. The trader will use a forward contract for hedging and reduce the risk caused by fluctuations in the exchange rate.

Two-currency arbitrage

Two-currency arbitrage is the most popular form of forex arbitrage. The trader will trade the same currency pair with different forex brokers to make a profit from the differences in prices of the currency pairs. The EUR/USD currency pair is the most widely traded. The selling price and buying price of the different banks may be different. If the selling price for one bank A is lower than the buying price of another bank B, the trader can purchase Euro from bank A paying dollars and sell the Euro to Bank B for a dollar profit. However, the trader should act fast since other traders will also notice the difference in prices.

When many traders try to make a profit from the same difference in bank rates for a currency pair, due to the increase in demand, Bank A will increase its price, and Bank B will decrease in price due to increase in supply, till both the banks offer similar prices.

Triangular arbitrage

Banks are quoting different prices for currency pairs based on supply and demand. So in triangular arbitrage, the trader is exchanging the currency pairs in three banks, hoping to make a profit using the difference in the prices. Exchanging the currencies in the same bank will not result in a profit since banks have an efficient system for pricing currencies and do not allow the traders to make any profit using arbitrage. Usually, the commonly traded currency pairs are the USD/EUR, EUR/GBP and GBP/USD, and the trader should monitor the exchange rates offered by different banks. The trader should also consider the transaction costs which the banks will charge for currency conversion, which may reduce the profit.

Covered-interest arbitrage

In Covered interest arbitrage, the trader exploits the differences in the interest rate of two currencies to make a profit. The trade will also use a forward contract so that they can control the risk they are exposed to. The forward contract allows the trader to purchase currency at the market rate at present, and also fix the exchange rate at a future date. A detailed explanation of the strategy for interest arbitrage for EUR/USD is as follows:

– Determine how much higher the Eurozone interest rates are compared to the US interest rates

– Using the available amount of US dollars, the dollars are converted into euro at the spot price, and the euros are invested at a higher rate in euro-zone. The trader should also arrange for a forward contract that specifies the exchange rate for EUR/USD to protect the investor against any fluctuation in the exchange rate during the duration of the investment.

– The trader will receive an interest in euros

– the euros can be converted back into US dollars at the guaranteed exchange rate, ensuring that the trader makes a profit.

How to make money from currency arbitrage ?
This is very hard because these day’s brokers have the same prices across all currency pairs. Even the small differences in prices, because spreads, it is almost impossible to make a profit from currency arbitrage.

Conclusion

Arbitrage in forex trading involves exploiting the forex market inefficiencies to make a profit without taking much risk. Only high equity accounts with proper technology can do this.

What is Forex Rigging ?

by Fxigor

Forex probe – fx manipulation

Trading in foreign exchange, abbreviated as forex, involves huge amounts of money and financial transactions. Typically trading volumes in the forex market are $4.7 trillion dollars in a day. Any violation of regulatory norms is considered a forex scandal. After any forex scandal is detected the regulatory authorities in the affected country or countries will investigate the scandal, find out who is responsible, how rules were flouted and penalize those guilty of violating the norms. This investigation into a forex scandal is called a forex probe.

How forex rigging takes place

The Bank of international settlements in 2013 conducted a survey, which indicated that the daily turnover was approximate $5.35 trillion. Most of the transactions in the forex market are speculative trades since the currency rates are constantly fluctuating. This makes it extremely suitable for financial institutions like hedge funds, banks that have access to a huge amount of money, to make quick profits by speculation. Though it was widely believed that the huge forex market, would make it difficult to manipulate it, a few major scandals have been detected. More details are provided for those who want more information on what is forex rigging.

The currency fix manipulation

Since the forex market is always open, banks and other traders would like to get a snapshot of the market activity. The benchmark for the forex rates are determined at 4 pm London daily, and they form the closing currency fix. These benchmark rates are called the WM/Reuters rates, and were calculated based on the sell and buy forex transactions by the traders in the interbank forex market during a window of total duration sixty seconds, thirty seconds before and thirty seconds after 4 pm.The median values of all the forex trades which take place during the one minute period are used to determine the benchmark rates for twenty-one major currencies,

Worldwide trillions of dollars are invested in pension funds and $3.6 trillion in index funds controlled by money managers. The value of these investments depends to a large extent on the benchmark rates. Forex traders may collide with each other to set the benchmark rates at artificially high or low levels to increase their profit. However, this profit is at the expense of investors like pensioners, who lose some money.

Collusion using instant messaging for manipulation.

In one of the biggest forex scandals, the two main allegations against the forex traders are discussed below

– Forex traders are colluding by sharing proprietary and confidential information like pending orders from clients just before the fixing time of 4 pm. Instant messaging (IM) groups or chatrooms with memorable names like the cartel or mafia were used to share the information. Access to these groups was closely controlled, and only a few of the senior traders in some of the largest banks dealing in forex could access these groups.

-“manipulating the close” was used to describe the selling and buying of currencies during the sixty-second window fix, using the orders from clients, which the traders had received earlier, to manipulate the forex rate.

These manipulative methods are similar to front running for ensuring a higher closing in the stock markets. Since these practices are prohibited in the stock market, the trader will be penalized if the evidence is found against them. However, the spot-forex market which has a daily turnover of two trillion dollars, and the forex market are largely unregulated. While almost all financial products are subjected to stringent rules, and regulations to prevent fraud, worldwide selling, buying currencies for delivery immediately is not considered an investment, so the regulatory authorities do not monitor any manipulation.

Risk in forex

Front running by forex traders is not considered illegal. One of the reasons why there is no regulation is because the forex market size is so large, that it is considered extremely difficult for a trader or trader groups to manipulate the currency rates to increase or decrease them. However, the regulatory authorities, wish to prevent manipulation of prices and collusion. Traders can reduce their risk while placing orders if they collude with other traders. When the traders share the information they have with and take decisions to move the currency rates in the direction they wish, the risk is reduced when compared to letting market factors like supply, demand determines the rates.

Forex scandals

One of the major forex scandals was related to Libor fixing. In this scandal, the journalists detected that the forex rates provided by the banks were similar during the financial crisis in 2008. Bloomberg News first reported the benchmark rate scandal in June 2013, after price surges were noticed just at the time of the fix at 4 pm. The scandal was noticed after analyzing the forex market data over a period of two years. It was noticed that on the last day of the month, surges were noticed in the forex rates for at least 14 major currency pairs.

These differences were noticed about half the time for popular currency pairs like Euro/Dollar. The exchange rates at the end of each month are important since they are used for determining the net asset values for mutual funds, and other assets. It should be noted that officials at the Bank of England were aware of the market manipulations since 2006. The forex traders were also told by the officials that there were allowed to share information regarding the orders for currencies that were pending, to make the forex market less volatile.

Penalties

The financial regulatory authorities in various countries like the FCA in the UK, European Union, Department of Justice in the United States, Switzerland, investigated the allegations that the traders colluded to manipulate the forex rate. The media reported that more than twenty forex traders who were employed in some of the largest banks dealing with foreign exchange were affected. These traders working with reputed banks like Deutsche Bank, Citigroup and Barclays were either suspended, fired or asked to go on leave while the investigation was carried out. Another forex rate manipulation scandal was reported at the Bank of England.

Fx Investigation

The investigation is mainly focussed on the transcripts of the electronic chatrooms which are used by senior-level currency traders. In these transcripts, the traders discussed the volumes and the types of the forex trades which they were planning to place with their competitors from other banks. These chatrooms had different names like The Bandits Club, The cartel, One team, one dream, and the Mafia. In addition to discussing the forex trades, the traders also joked about the manipulation of the forex market, and repeatedly mentioned women, drugs, and alcohol.

Specifically, the regulators are specifically focussing on a small chatroom nicknamed the Mafia or Cartel which was very exclusive. Some of London’s most influential forex traders were using the chatroom, so many traders were trying to get access. Some of the members of the cartel were Richard Usher, Rohan Ramchandani, Matt Gardiner, Chris Ashton, who were highly placed in JP Morgan, Citigroup, Standard Chartered, Barclay respectively. Usher and Ramchandani were also the members of the group of chief dealers of the Joint Standing committee of the Bank of England which had thirteen members.

Barclays, Goldman Sachs and HSBC were some of the 15 banks which disclosed that they were investigated by the regulators. The senior currency traders at some of the banks like Citigroup, JP Morgan Chase and Barclays were either suspended or asked to go on leave. Deutsche Bank also cooperated with the investigators of the forex scandal, providing information required. By June 2014, UBS, Standard Chartered, RBS, Lloyds, JP Morgan Chase, HSBC, Deutsche Bank, Citigroup, Barclays, Bank of England, had either fired, suspend or sent on leave at least forty forex employees. Rohan Ramchandani was fired by Citigroup. Hundred of traders worldwide were probably involved in the forex scandal, according to Reuters.

Effect

The manipulation of the forex market by the rogue traders affected customers worldwide for more than one decade. Sources indicate that the financial losses caused due to the manipulation of the forex rates, the market is estimated at $11.5 billion yearly for the 20.7 million pensioners in Britain. To date, the total losses caused due to the forex market manipulation are not determined to date.

Foreign exchange manipulation – Fines & other penalties

In 2014, on November 12, the Financial Conduct Authority in the United Kingdom, abbreviated as FCA, imposed fines on five banks for their unethical business practices in their G10 spot forex trading. The fines totaled $1.7 billion and included fines of more than $300 billion each on Citibank, HSBC, JPMorgan, RBS and UBS. For a period of more than five years, ten months and 15 days starting January 1, 2008, FCA found that the banks had violated regulatory norms regarding conflict of interest, keep client information confidential, and trading conduct.

So, How The Forex “Fix” May Be Rigged?

Instead of keeping their customer orders confidential, the banks misused the information for colluding with other unethical banks, and manipulated the forex currency rates, illegally increasing their profit exploiting their customers and market. On the same day, in the United States, the regulatory body Commodity and Futures trading commission (called the CFTC) coordinated with the FCA to impose fines of total value $1.4 billion on the same five major banks. These fines were imposed for attempting to manipulate, helping and abetting the other banks in manipulating the global benchmark forex rates

Further in 2015, on 20 May, these five banks whose faced felony charges by the Department of Justice in the United States, also pleaded guilty to these charges. These banks agreed to pay fines of approximately $5.7 billion. Bank of America was not found guilty, however, it was asked to pay a $204 million fine for its unsafe trading practices in the forex markets. On 18 November, 2015, Barclays was also fined an additional amount of $150 million for its misconduct using the automated electronic systems for foreign exchange. In December 2014, one former RBS trader was arrested.

Forex probe and reforms

After the forex probe was completed regulatory authorities in various countries have announced measures to prevent similar scandals in the future and increase the trust in the banking system and foreign exchange markets. In the UK, FCA announced that firms dealing with forex will have to make changes that will vary depending on the firm size, the share of the market, corrective measures implement and the role of the firm in the forex market. The corrective program recommends that the banks review their IT systems, especially those dealing with the spot forex market. At present, most of the banks are using older systems, where there are some data silos that can be manipulated, without being noticed by the compliance measures. Similarly in Switzerland, the financial regulatory authorities instructed UBS to take corrective measures, automate the forex trading, prevent conflicts of interests and also limit the variable pay for the forex traders.

Conclusion
The various forex scandals again prove that though the forex market is large and important, there is almost no regulation and no transparency, when compared to other financial markets. Financial experts are questioning the risks involved in giving a small group of closely connected individuals great powers to control the exchange rates which affect the real value of investments, assets worth trillions of dollars. Some countries like Germany are proposing that the forex exchanges are regulated. Usually, the regulator will impose fines when scandals are detected, yet most traders are extremely wealthy and can easily pay the fines. However, these scandals adversely affect the reputation of the forex market

Dividend payout ratio Calculator

by Fxigor

Most companies require some money to fund they are the investments they require for growth, to repay debt and keep as cash reserves so that they can pay expenses in the future. Instead of taking a loan or using debt to get these funds, most companies are keeping some of the profit they are making to make these payments or reinvestments. Investors and shareholders can get information on the amount of profit a company is retaining for its growth, expense payment by checking the Dividend Payout Ratio (abbreviated as DPR) of the company which is usually specified in the lower section of the income statement of the company.

Definition

The dividend payout ratio or DPR is a ratio of the dividend amount, which a company pays to its shareholders when compared to the net income of the business. The part of the net income which is not paid out to the investors is described as retained earnings of the company. This ratio is relevant for investors while making a decision in investing in a company. Investors can decide where they wish to invest in a company that pays large dividends or a business that has more growth potential. People should be aware that the DPR is different from the dividend yield, which the ratio of the dividend payout to the share price of the company at present

Dividend payout ratio calculation

Dividend payout ratio = Dividend Payout (DP) / Net Income (NI)

The formula for calculating the DPR based on the Dividend Payout (DP) and Net Income (NI) is as follows. DPR = DP/NI . The dividend payout can be calculated from the information in the balance sheet, which specifies the Retained earnings (RE) at the beginning of the financial year, and also the REclose, the retained earnings at the end of the financial year. DP = (NI + RE) – REclose. Assuming that a company is making some profit, the DPR helps the investor to decide whether he is interested in a steady income from dividends or wishes to reinvest the dividend so that the earnings in future are higher.

Dividend payout ratio calculator

DPR vs Retention ratio

Another ratio that is related to the DPR is the retention ratio, which indicates the ratio of the income retained by the company after paying out the dividends to the shareholders. It is easy to calculate the retention ratio, only the DPR should be subtracted from one. i.e Retention ratio = 1 – DPR. Some investors are more interested in finding out the growth prospects of a company since the share prices and dividends are likely to increase in the future. Hence these investors will be more interested in the retention ratio. On the other hand, investors interested in a regular dividend income will check the DPR for the last few years.

DPR vs Dividend yield

Many investors who wish to have a steady income are focusing on the dividend yield for the company. However, they should be aware that if the DPR is more than 100%, it may not be a good sign, since it may not be sustainable in the future. When the DPR is more than 100%, the company is payout part of the dividend from its cash reserves, which are likely to get exhausted soon. So while a company may have a DPR greater than 100% for one year or a few years to keep investors happy, they will have to reduce the DPR after some time.

Solve for n in present value formula and future value formula

by Fxigor

Finding The Number of Time Periods

Solve for n in present value formula and future value formula
The formula below will solve for the number of periods which is used to calculate the length of time required for a single cash flow (present value) to reach a certain amount (future value) based on the time value of money.

The actual time value of money is a primary thing in the financial concept. In this theory, the money you have at present is far more important than the exact amount of money which you will receive in the future. This is a practical and very true process. The money you have in your hands at present can be invested in something in order to earn a return. This investment may give you a lot of money in the future. So, the actual time value of money is very much important. It is sometimes called the present net value of the money.

How does this work?

Let’s check this simple example which will show you the actual time value of the money. For example, someone is offering you or paying you for your work in two different ways: they will pay you $1000 now or they will pay you $1100 one year from the present. You will have to decide which option is suitable for you. It always depends on the type of investment return that you will earn from that money in the present situation. You will have to solve for the number of periods PV and FV. Actually, $1100 is 110% of $1000. So, you may think that you can earn more than a 10% return from investing money in the upcoming next year. In this way, you may decide to take the money $1000 now. But if you think in another way, then you can see you may not earn more than 9% interest in the upcoming next year by investing the money. So, you decide to take the amount of future payment of $1100.

Formulas for time value for money:

The time value is an important decision. It is not important for the individual but also for the business industrialists. Companies also calculate the time value for money in order to invest that in a new product and acquiring new business policies. You can use this simple formula in order to calculate the future value amount of the money.

FV = PV*[1+(i/n)] (n*t)

Here, PV’ is present value and FV’ is the future value amount of the money. The interest rate and the other return based on the invested money is recognized as i’. The consecutive number of years that you will take into consideration is controlled by t’. At last, n’ represents the consecutive number of periods of interest per year.

This particular formula also uses to figure out the present amount of value of the money that you will be going to receive in the future. You will have to do the division of the future value to get the calculation rather than multiplying the present value. This is very much helpful in order to get the different values of both future and present amounts.

While calculating the future amount of value or FV, you are calculating exactly how much a given amount of money will be worth in the future. But if you want to calculate the future value, then you should know the other three important variables such as present value, number of periods and interest rates. The calculation is very much straightforward. It is not at all complex. You can do it by yourself. You will have to know the basic details and then you can go for it.

What is Debt Coverage Ratio Formula ?

by Fxigor

Debt coverage ratio is the ratio determined by dividing the net operating income of the company and the debt service. Therefore, it is realized that the banking industry applies the usage of the debt coverage ratio in an effort to conduct the determination concerning whether a company possesses the strength to produce an adequate amount of money via the operations of the business in order to have enough coverage for the cost of debt. In addition, the company may attempt to utilize the debt coverage ratio in light of the same purpose.

Debt Coverage Ratio Formula
Debt Coverage Ratio = Net operating income / Debt Service

Determining the net operating income

With this being the case, it is important to realize that the net operating income of a company is determined by subtracting the operational expenses from the revenues. For the sake of conducting a comparison, the net income of a business takes into inclusion interest expenses that are incurred on debt, income that is not achieved via the normal operational scenario as well as taxes. It is noted that the net operating income of a business can be located on the income statement

Example of debt coverage ratio

Thus, an example pertaining to the debt coverage ratio is demonstrated in the scenario where a company indicates the possession of an operational income of two hundred thousand dollars in terms of its income statement. For this period, the debt payments are recorded as being thirty-five thousand dollars. When thirty-five thousand dollars is divided into two hundred thousand dollars, this would result in the company possessing a debt coverage ratio that equates to 5.71.

Debt coverage ratio calculator

Applied by companies and banks

As mentioned earlier, a company may apply the usage of the debt coverage ratio in order to achieve the determination regarding its capability to meet the cost of the payments pertaining to its debt. Also, within the realm of lending institutions, this type of ratio is applied for the same purpose.

In terms of lending, it is typical for financial organizations to resort to the usage of multiple metrics when it comes to the issue of performing the determination of the capability of a borrower to be able to make the payments of the debt. This is true regarding both loans to businesses and consumers. From an expanded perspective, the debt coverage ratio may be seen as an inversion of the ratio of debt to income which is addressed in regard to loans to consumers due to the fact that the income undergoes division by the payments of debt. Yet, it is to be understood that this is not to be comprehended literally because of the reality of differences.

The debt coverage ratio is often abbreviated as DCR. This debt coverage ratio is of vital essence in the domain of financing for real estate as well as lending at the commercial level. The debt coverage ratio is crucial when there is the underwriting of real estate that is commercial or when there is the underwriting of loans for business endeavors. Moreover, the debt coverage ratio must be taken into account in cases of tenant finances. It is a primary factor when there is the conducting of the determination of the maximum level of the amount of the loan that is permitted.

What the numbers of the DCR indicate

You may be wondering what the numbers of the DCR actually mean. If the number of DCR is larger than 1.0, there is an indication that the cash flow is sufficient to pay for the cost of the debt. However, when the number of DCR is less than 1.0, this shows there is insufficient money to cover the cost of the debt. Yet, it is to be realized that though the number of the DCR being at 1.0 indicates that there is sufficient money to pay the debt, this does not mean that this is the only requirement.

Normally, a lending institution will demand that the debt service ratio possess a level of more than 1.0 in order to solidify the presence of extra money for the possibility of such cases that something averse may occur. Take into consideration for example that if there is a requirement for a company to possess a debt coverage ratio of 1.20, this would allow for enough protection so that the net operating income could experience a decline of up to 16.7 percent and yet the company would remain in a good position to pay its debt.

You may wonder what is an appropriate level to consider regarding the debt coverage ratio. The truth is that there is no single answer to this question due to the fact that this element will be different at various banks, will be affected by the type of loan that is being sought and will also be affected by the kind of property. But the range for the debt coverage ratio is generally from 1.20 to 1.40. When properties are strong and stable, they will come in at the lower spectrum of this range. On the other side, properties that demonstrate more risk (which possess leases in the short-term or clients that have credit that is sketchy) will be placed at the higher level of the range.

Adjustments

It is to be noted that the lending institution may reserve the right to make some adjustments in regards to the net operating income of the business. Take into consideration for example that the lending institution may decide to also include reserves for the sake of replacement within the calculation of the net operating income of the business. As well, there may be the inclusion of a management fee. As a result of the lending institution being preoccupied with the capability of the money of the business to be able to pay the debt, such adjustments are often made by the banks in regard to the net operating costs of the business.

Thus, it is understood that reserves are money set aside for capital expenditures that will happen in the future. They can include significant repairs or replacements that may be needed for the maintaining of property for the long-term. This will place an impact on the capability of the borrower to make the debt payment.

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