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Market Analogs at Forex
Parallel Forex Markets
Forex Hedging can only take place in parallel markets, defined as follows: When an item is valued in one market at a price that correlates significantly with the price of another item in another market, the two markets are considered to be parallel.
The world is awash in parallel markets. Commodity traders are certainly familiar with them. They often deal in nothing else. Whenever two contracts are traded as a spread, the trade is-hopefully-in parallel markets strategy. Spreads are used to pair up products such as soybeans and soybean oil, treasury bills and Eurodollars, gold and platinum, heating oil and crude oil, S&P 500 and Value line indices, ad infinitum. Then, of course, the futures market and the cash market in any single commodity can be paired. Also, calendar spreads can be seen as parallel markets (such as July wheat and December wheat). Another way to trade parallel markets is with options and futures, options and forwards, or futures and forwards.
Parallel markets require only one thing: the prices must move together (have a high correlation). They may move up and down in tandem, or mirror each other in an inverse relationship (such as bond prices and yields). Either way, there must be parallel price movement. The entire concept of hedging is based on such movement. Hedges only take place in two or more markets that parallel each other, with one "leg" in each. Considered in this manner, there is no fundamental difference between a hedge and a spread trade. With a hedge, however, one leg always constitutes the exposure.
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Base Currency
 Base currency is the currency in which an investor or issuer maintains its book of accounts. In the FX markets, the US Dollar is normally considered the 'base' currency for quotes.
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Technical Analysis
 An effort to forecast prices by analyzing market data, i.e. historical price trends and averages, volumes, open interest, etc. |
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It's normally condensed as the dollar sign, $. The U.S. dollar is divided into 100 cents.
The euro is the currency of 13 European Union countries.
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Currency Hedges
Forex trade of foreign currency hedges are not restricted to futures, forwards, options, and swaps. They can be constructed in different segments of the same cash market, as with our example of the Japanese auto maker who manufactures in the market place of its customer. In fact, parallel currency markets can consist of any two transactional activities that use the same currency. Assume, for example, that "Wear Forever," a British outdoor woolen wear manufacturer, sells to the Australian consumer market. In this operation, the company is long Australian dollars. Its cash flow is denominated in the local currency. It profits when the Australian dollar strengthens against its home currency; however, this long position is also an operating exposure, since a weaker Australian dollar can price the company's products-produced in pound sterling--out of the market link. The company therefore hedges by forming a manufacturing venture with an Australian partner. Now it has a short Australian dollar position in the labor market, as well as in the local wool market. A weaker Australian dollar translates into lower production costs, allowing price margins to remain unchanged. The long position in the consumer market is offset by a short position in the parallel labor and materials markets. Of course, this is just another way of viewing risk transference to the market place.
Hedging means the offsetting of a given position by taking a position of equal size and opposite direction in a separate, but parallel market. The effect of the offsetting position is to reduce or eliminate the effects of changes in the value of both positions. |
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