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Modified Dietz Method From Wikipedia, the free encyclopedia Jump to: navigation , search The Modified Dietz Method is a calculation used to determine an approximation of the performance of an investment portfolio based on money-weighted cash flow .[1] A more precise way of calculating performance in the presence of external cash flows remains True Time-Weighted Rate of Return . In the absence of daily portfolio valuations, the modified Dietz method weights individual cash flows by the amount of time from when those cash flows occur till the end of the period. The formula for modified Dietz is as follows: where: EMV = ending market value BMV = beginning market value CF = the net cash flow for the period (contributions to a portfolio are entered as positive cash flows while withdrawals are entered as negative cash flows) and the sum of each cash flow, CF i , multiplied by its weight, W i The weight (W i ) is the proportion of the total number of days remaining in the period after the cash flow CF i occurs. W i can be calculated as: where: CD = the number of calendar days during the return period being
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Page 1: Modified Dietz Method

Modified Dietz MethodFrom Wikipedia, the free encyclopediaJump to: navigation, search

The Modified Dietz Method is a calculation used to determine an approximation of the performance of an investment portfolio based on money-weighted cash flow.[1] A more precise way of calculating performance in the presence of external cash flows remains True Time-Weighted Rate of Return.

In the absence of daily portfolio valuations, the modified Dietz method weights individual cash flows by the amount of time from when those cash flows occur till the end of the period.

The formula for modified Dietz is as follows:

where:EMV = ending market valueBMV = beginning market valueCF = the net cash flow for the period (contributions to a portfolio are entered as positive cash flows while withdrawals are entered as negative cash flows)

and the sum of each cash flow, CFi, multiplied by its weight, Wi

The weight (Wi) is the proportion of the total number of days remaining in the period after the cash flow CFi occurs. Wi can be calculated as:

where:CD = the number of calendar days during the return period being calculatedDi = The day in the return period on which the cash flow (CFi) occurred

The result of the calculation is given as a rate for the period. i.e. 50%, whether the period is 3 months, 1 year, 2 years, ...

Note that the Simple Dietz Method is just a special case of the Modified Dietz Method (i.e., in the Simple Dietz Method, all cash flows are assumed to occur at the midpoint of the period -- the Modified Dietz Method better takes into account the timing of cash flows).

Page 2: Modified Dietz Method

Modified Dietz is an example of a money (or dollar) weighted methodology. If modified Dietz returns for finite periods (typically monthly) are geometrically linked, the methodology become time weighted (although not true time weighted which requires valuations at the point of each cash flow).

A cash flow hedge is a hedge of the exposure to the variability of cash flow that

1. is attributable to a particular risk associated with a recognized asset or liability. Such as all or some future interest payments on variable rate debt or a highly probable forecast transaction and

2. could affect profit or loss (IAS 39, §86b)

This is mostly an accountant's definition.

Hedge Management for Financial Asset Management (HM-FAM)

Hedge Management for FAM (HM-FAM) enables you to assign security transactions (hedged items) to each other, that you have hedged against variations in their market value by using forward securities transactions (hedging instruments) (Fair Value Hedge), within a hedging relationship and to perform Hedge Accounting in accordance with the valid regulations for hedge transactions (IAS/IFRS and US-GAAP) for the designated subpositions.

Hedge Management for FAM provides the following functions:

Manage hedging relationships in a central function (transaction TPM100)

Detailed documentation on the hedging relationships (automatic or manual)

Prospective and retrospective effectiveness tests with the dollar-offset-method

Classification of the valuation flows for the designated subpositions in effective and ineffective parts.

You are also supported by release workflows for the business transactions Designation and Dedesignation and for the documentation.

Using the old date transfer you can also transfer hedging relationships managed outside of SAP systems to Hedge Management for FAM.

You can use the initialization to transfer existing hedging relationships to a new valuation area.

Prerequisites

If you want to use these functions, you must first define the necessary settings in Customizing under Financial Supply Chain Management Treasury and Risk Management Transaction Manager General Settings Hedge Management for FAM .

IMG Activity Use ActivitiesDefine and activate groupings The groupings can help you to

define additional information on the hedging relationships in

1. Set the indicator Grouping active for the grouping 1, 2 or 3.

Page 3: Modified Dietz Method

the function Manage Hedging Relationships [transaction TPM100], tab Hedging Relationship Details, area Grouping Fields.

For grouping 1 and grouping 2, you define the values to be assigned in the application menu for Hedge Management for FAM under Treasury and Risk Management

Transaction Manager Hedge Management

for FAM Master Data Grouping 1 /

Grouping 2 If you activate the 3rd

grouping, you can define a text of your choice for a hedging relationship in this field.

2. Define a description for the grouping.

3. Save your entries.

Number Ranges

Here you first define number ranges for the following objects:

Hedging relationships underlying transactions Hedging Instruments

Under Assign Number Ranges define for each company code and valuation area which of the number ranges defined above should be used.

Effectiveness testEffectiveness test method Here you define the

effectiveness test methods that you want to use.

In IMG activity Define Hedging Profiles, you then assign these effectiveness test methods.

1. Choose New Entries.2. Assign a 3-digit code

for the method and a name.

3. Choose the category of the effectiveness test method. Category 11 dollar-offset-ratio is available.

4. Choose the offset calculation category.

Page 4: Modified Dietz Method

5. Define the end date and start date for the propsective effectiveness test.

6. Define in which intervals the dollar-offset test is effective.

7. Under Dividend Inheritance you define whether dividend payments should be included in the effectiveness test. If dividend payments should be included, you must define which.

8. Save your entries.

Alternative setting to delivery scenarios

It is defined in a scenario

which product categories are allowed in a hedging relationship for the hedged items and the hedging instruments

which current value category is used

The scenarios are system settings. You can only use the scenarios provided by SAP.

Scenario 110 is adjusted using FVH exchange rate risk. Spot-spot value date (or currency risk) is provided for the following:

Permitted product categories for hedged items in a hedging relationship are

o 010 Stockso 020 Investment

certificates

1. Choose New Entries.2. Choose scenario 110.3. Choose the product

category of the product type to be excluded.

o For hedged items, choose product categories 010, 020 or 160.

o For hedging instruments, choose product category 740.

4. Choose the product type you want to exclude.

5. Set the Not Allowed indicator.

6. Save your entries.

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o 160 Shareholding

Permitted product categories for the hedging instruments in a hedging relationship:

o 740 Forward securities transaction

As the current value calculation category, the category 210 Adjusted intrinsic spot value is designated.

In IMG activities Alternative setting to delivery scenarios: hedged item and alternative setting for delivery scenarios: With the hedging instrument you can exclude certain product types (that are based on the permitted product categories) from being used in the hedging relationships.

All entries here are optional. The system runs with the scenarios provided by SAP. Entries are possible if you want to deviate from the standard settings. If both tables are empty, then the system is working without any errors.

Define Hedging Profiles A hedging profile is assigned to each hedging relationship in function Manage Hedging Relationships [transaction TPM100], tab Hedging Relationship Details, area Risk and Profile.

In a hedging profile you define which scenario should be valid for the hedging relationship, which effectiveness test

1. Choose New Entries.2. Assign a 3-character

name and a description for the profile.

3. Choose scenario 110.4. Choose the

effectiveness test methods you want for the prospective and retrospective effectiveness test.

5. Specify the validity of

Page 6: Modified Dietz Method

methods should be used, how often the effectiveness test should be performed and how long (in days) an effectiveness test is valid, as well as whether the documentation should occur automatically and if so, which PDF form should be used for this.

an effectiveness test in days.

6. Define the rhythm for the test plan.

o Monthlyo Quarterlyo Annuallyo Manually

7. If you want to get the documentation on the hedging relationships of this profile generated automatically, set the Autom.Docum. indicator and define the PDF form to be used.

SAP provides the form TR_F_THX_NOTE_HREL.

8. Save your entries.

Update TypesDefine Update Types and Assign Usages

Here you define all the required update types.

Assign the update types for the business transactions (HM) to the product types

Here you assign the update types to be used for each product type for the following business transactions of HM-FAM to:

Designation Dedesignation Classification

Release If you want to use a release approval procedure in HM-FAM for the documentation on a hedging relationship and the business transactions designation and dedesignation (such as the dual control principle), you can set up release workflows in the following IMG activities. For these release workflows, the SAP Business Workflow is used for which you must define the necessary settings in Customizing for Basis under Business Management SAP Business Workflow Maintain Standard

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Settings .

DocumentationRelease object TRM_HMD is available for the release workflow for documentation.

See the documentation on the IMG activities. Designation/

Dedesignation

Release object TRM_HM is available for the release workflow for designation/dedesignation.

DocumentationThe documentation for a hedging relationship is stored in Document Management (CA-DMS).

Define the workstation application

The indicator Start Authorization for Application must be set here for the workstation application PDF Acrobat Reader, and all the other settings for the application must be defined.

NOTE

In Customizing for DMS under Cross-Application Components Document Management

Control Data Define Document Types , the indicator Generate Change Documents must be set for document type THX.

In Customizing for DMS under Cross-Application Components Document Management

General Data Settings for Storage Systems Maintain Storage System , the following must be configured for content repository THX_HDOC:

o DocArea

See the documentation on the IMG activities.

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Document Management System

o Storage category SAP System Database

o Storage subcategory Normal

o Versions no. 0046 Content Server Version 4.6

o Content table THXT_HDOC_DMS

In Customizing for DMS under Cross-Application Components Document Management

General Data Settings for Storage Systems Maintain Storage Categories , the category THX_HDOC is defines and the above-mentioned content repository THX_HDOC is assigned.

Define data medium

BAdI: Documentation

If you want to use your own PDF forms and not the form defined by SAP for automatic documentation, you can use this BAdI.

Initialization of Hedging Relationships in Parallel Valuation AreasAdditional settings in the Transaction Manager for HM-FAMChange message control In this IMG activity you can

configure the appearance (the message category) of system messages in HM-FAM to suit your requirements.

You will find the IMG activity under Transaction Manager

General Settings Tools Configurable Messages Change Message Control .

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Message 255 'Sicherungsbeziehung &1 in Acc.kreis &2 und Bew.bereich &3 ist betroffen''Sicherungsbeziehung &1 in Acc.kreis &2 und Bew.bereich &3 ist

betroffen' is issued when a position outflow affects a hedging relationship.

Define whether the message should be issued as a warning (W) or as an an error (E).

You can control the message category user-dependently in dialog and in a batch run differently.

If you do not make any entries here, the message is issued as an error.

NOTE

If you have chosen W as the message category here, you must execute function Distribute Position Outflows to Subpositions (TPM103) after such a position outflow.

1. Call the IMG activity.2. Choose work area:

TPM_TRGTreasury Position Management: Cross-Package Messages.

3. Define the settings you want for message 255.

4. Save your entries.

Assigning Update Types for Derived Business Transactions

On the following tabs you define settings for HM-FAM:

Classification Hedging-related transfer

postings Value adjustment Position Outflows Reconciliation flows Currency Swap

You will find the IMG activity under Transaction Manager

General Settings Accounting Derived Business Transactions Assign Update Types for Derived Business Transactions

.

Define Account Determination Enter the posting specifications here for the update types relevant for account

You will find the IMG activity under Transaction Manager choose General Settings

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determination:

Accounting Link to Other Accounting Components Define Account Determination

.

Process

Before creating a hedging relationship

1. A security purchase (share, investment, or shareholding) is executed using transaction management.

2. To hedge the price risk, a forward securities transaction is completed and executed using transaction management.

Creation and designation of the hedging relationship

1. Create the hedging relationship in function Manage Hedging Relationships (transaction TPM100) and assign the security purchase as a hedged item and the forward securities transaction as the hedging instrument.

NOTE

The positions assigned to a hedging relationship (as hedged items or as a hedging instrument) are managed in subpositions in position management, whereby a distinction is made between the free-standing subpositions and the designated subpositions.

A free-standing subposition is generated for the positions by assigning a hedged item and a hedging instrument to a hedging relationship.

If designation then occurs later on, the free-standing subpositions are reduced by the designated part and a subposition is generated for the designated part.

You can see whether and which subpositions can exist for positions in the position list (transaction TPM12). This contains a Subpositions column in which each position that has a subposition(s) has an icon. You can click on the icon to display the subpositions. In the Free column of this list, you can see whether the respective subposition is a free-standing or a designated subposition.

Execute a prospective effectiveness test for the hedging relationship in function Manage Hedging Relationships on tab Effectiveness Test.

2. If the effectiveness test shows a positive result, you must then execute a key date valuation (transaction TPM1) for the affected positions.

3. Now you have to create and release the documentation for the hedging relationship in function Manage Hedging Relationships on tab Documentation.

NOTE

A release approval workflow can be defined for releasing the documentation.

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Designate the hedging relationship using function Manage Hedging Relationships.

NOTE

A release approval workflow can be defined for releasing the designation.

Depending on the setting in Customizing for the derived business transactions, they may have to be posted using function Fix and Post Derived Business Transactions (TPM18).

Managing the Hedging Relationship During its Term

Retrospective and prospective effectiveness tests must be performed during the term of the hedging relationship in regular intervals (according to the test plan or manually). As long as they are effective, the valuation results are updated in accordance with the Hedge Accounting rules.

NOTE

You can start the effectiveness test for several hedging relationships simultaneously using function Perform Effectiveness Test(TPM110).

After this valuation of the positions, you can perform the classification (transaction TPM101) of the valuation flows of the designated subpositions in effective and ineffective parts.

If the effectiveness test shows the hedging relationship to be ineffective, the hedging relationship must be dedesignated immediately and no Hedge Accounting is allowed to take place.

If parts of the positions in the hedging relationship are sold during its term, you must define which subposition this stems from (free-standing or designated) using function Distribute Position Outflows to Subpositions(transaction TPM103). If the designated subposition is affected, then the position assigned to this must also be reduced accordingly in the hedging relationship.

Dedesignation at the End of the Hedging Relationship

1. On the key date of the dedesignation, you perform a retrospective effectiveness test for the hedging relationship.

2. Once the effectiveness test has been successful, you perform the key date valuation for the positions.

3. You must then perform the classfication (transaction TPM101) of the valuation flows.

4. You now perform the dedesignation of the hedging relationship in function Manage Hedging Relationships.

NOTE

If a release approval workflow was defined for the dedesignation, the dedesignation must also be released.

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Depending on the setting in Customizing for the derived business transactions, they may have to be posted using function Fix and Post Derived Business Transactions (TPM18).

The following functions are available for mapping Hedge Management for FAM processes:

Manage Hedging Relationships (TPM100)

Grouping 1 (TPM_HR_GROUP1)

Define the values you want for grouping field 1.

Grouping 2 (TPM_HR_GROUP2)

Define the values you want for grouping field 2.

NOTE

You can select the hedging relationships based on the groupings.

Perform Effectiveness Test (TPM110)

Ineffective Hedging Relationships: Overview (TPM112)

This report can be used to determine ineffective hedging relationships.

Enter net present values (NPV)

In this transaction you can define net present values for financial transactions/loans. The values defined here can be included in the valuation (transaction TPM1).

Determine net present values (TPM60)

You can use this transaction to calculate and store the net present value for the selected financial transactions of Transaction Manager and for the loan for a specific key date. The net present values are calculated by the Market Risk Analyzer and saved (table VTVBAR, view V_VTVBAR). The results can be included in the valuation. You can look at the results using function Enter Net Present Values (NPV).

Execute Valuation (TPM1)

The valuation of the affected positions in a hedging relationship takes place using the valuation function of Transaction Manager. The valuation flows of the designated subposition are posted in accordance with the Hedge Accounting rules and the rules intended for the free-standing subposition for non-hedged positions in the position management procedure.

Reverse Valuation (TPM2)

NOTE

See also: Key Date Valuation

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Execute Classification (TPM101)

The classification determines the effective and ineffective parts for the valuation flows for the designated subpositions.

Example:

Valuation results and the resulting classification

Valuation on March 31.Hedging Instrument: -18 depreciationHedged item: 20 write-upClassification on March 31.Hedging Instrument: -18 effective

Hedged item:+18 effective

+ 2 ineffective

Reverse classification (TPM102

Distribute position outflows to subpositions (TPM103)

Define structure curve for market data change rates

You will find this function in the application menu under Treasury and Risk Management Basic Functions Market Data Management Manual Market Data Entry Tools Define Structure Curve for Market Data Change Rates . The structure curve is necessary to perform the prospective effectiveness.

Assign the respective structure curve in function Manage Hedging Relationships on tab Effectiveness Test and then on tab Test Plan in area Test Plan Details.

More Information

Manage Hedging Relationships

Old data transfer (Hedge Management for FAM)

Initialization of Hedging Relationships in Parallel Valuation

The functions for creating and managing forward securities transactions are delivered with business function TRM, Hedge and Exposure Management, SWIFT (FIN_TRM_LR_FI_AN_2).

The documentation on the forward securities transactions can be found in the SAP Library, if you have activated this, under Treasury and Risk Management Transaction Manager General Information on Transaction Manager Product Types of Transaction Manager Derivates Forward Securities Transactions .

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True Time-Weighted Rate of Return(TWROR) is a way to measure the performance of an investing portfolio in the presence of external cash flows. It determines the return for an investor who has not invested any additional cash flows during the investment period:

Where r is the "True Time-Weighted Return" of the portfolio, M0 is the initial portfolio value,

Mt is the portfolio value at the end of sub-period t, immediately after cash-flow t, Ct is the cash

flow which occurs at the end of sub-period t, and n is the number of cash-flows (also the number of sub-periods). Cash flows into the portfolio are positive and cash flows out of the portfolio are negative.

Contents[hide]

1 Discussion/Derivation 2 See also 3 References 4 Further reading

[edit] Discussion/Derivation

1) Measuring the performance of a portfolio in the absence of cash flows is trivial:

Where M2 is the portfolio's final value, M1 is the portfolio's initial value, and r is the portfolio's return over the period.

2) The presence of external cash-flows during the period being analyzed complicates the performance calculation. If external cash-flows are not taken into account, a cash-flow into the portfolio would wrongly overstate the true performance, while cash-flows out of the portfolio would wrongly understate the true performance.

3) The best way of taking into account external cash flows is the Internal Rate of Return. The Internal Rate of Return does not only take into account the timing of cash flows but also the value invested at any time in the portfolio. Internal rates of return are however computationally awkward.

Page 15: Modified Dietz Method

Money-Weighted Rate Of Return(MWROR) - also measure of the rate of return for an asset or portfolio of assets. It is calculated by finding the rate of return that will set the present values of all cash flows and terminal values equal to the value of the initial investment. The money-weighted rate of return is equivalent to the internal rate of return (IRR).

Linked Internal Rate of Return(LIROR) - is another measure that is sometimes used. It is a variant of the time-weighted rate of return which approximates the flow of new money into and out of the fund. In this TWROR will be approximated with MWROR over reasonably frequent time intervals and then those returns will be chain-linked. eg: LIROR = (1.04) (1.09) (1.05) (1.11) – 1 = 32.12%; when MWROR are 4%, 9%, 5% and 11%

4) Simple Dietz Method is an approximation of the Internal Rate of Return, in that it takes into account timing of external cash flows, assuming that they are made in the middle of the time period in question.[1] However, this assumption is still generally not accurate, leading to undesired errors.

5) Modified Dietz Method is another approximation of return, weighting the external cash flow for where in the time period in question it actually occurred. While this is certainly an improvement over Simple Dietz, it is still an imprecise approximation.

6) Another method of calculating returns in the presence of external cash flows is to divide the period of analysis into contiguous sub-periods, with cash flows occurring at the end of sub-periods. A return would be calculated for each sub-period and then the returns of each sub-period would be "chained together" to give the "True Time-Weighted Return" of the portfolio for the period in question.

Let M0 be the initial portfolio value and M1 be the portfolio value immediately after the cash

flow C1 at the end of the sub-period. Then the return r1for that sub-period would be:

Rearranging,

All such sub-period returns must be chained together to give the True Time-Weighted Rate of Return for the overall period:

Page 16: Modified Dietz Method

Where r is the True Time-Weighted Rate of Return for the portfolio, M0 is the initial portfolio

value, Mt is the portfolio value at the end of sub-period t, immediately after cash-flow t, Ct is

the cash flow which occurs at the end of sub-period t, and n is the number of cash-flows (also the number of sub-periods).

7) Unfortunately the "True Time-Weighted Rate of Return" depends on portfolio valuations during the investment period that are not necessarily realized by an investor. It can therefore substantially overstate or understate the true portfolio performance and should not be used a way of measuring an investor's return. A simple example illustrates this problem: If an investor invests $500 at the beginning of year 1, $1000 at the beginning of year 2 and his portfolio has a total value of $1500 at the end of the year 2, the total return is clearly 0%. This is also the internal rate of return. If we assume that the initial investment has gone up by 100% over the first year, but the portfolio has declined by 25% over the second year we obtain the same cash flows but a "True Time-Weighted Rate of Return" of (1 + 1.0)(1 − 0.25) − 1 = 0.5 = 50%, which massively overstates the return realized by the investor. Similary if the intermediate valuations of the portfolio are below the valuation at the end of the investment period we will understate the real portfolio return.

Hedge fundFrom Wikipedia, the free encyclopediaJump to: navigation, search

Financial marketparticipants

Collective investment schemes

Credit unions · Insurance companies

Investment banks · Pension funds

Prime brokers · Trusts

Finance series

Financial market · Participants

Corporate finance · Personal finance

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Public finance · Banks and banking

Financial regulation

v · d · e

A hedge fund is a private, actively managed investment fund that utilizes sophisticated strategies in international and/or domestic markets designed to offset losses during a market downturn and/or generate returns higher than traditional stock and bond investments.[1][2]

The first hedge fund began in 1949 and was designed solely to neutralize the effects of a bear market on an investment portfolio. However in modern times many hedge funds have become aggressively managed and may speculate in volatile assets such as foreign currencies and commodities, and aspire to accumulate capital gains based on future price movements.[1][2][3] Hedge funds are privately managed, loosely regulated, utilize advanced investment strategies, have high management fees and are open only to qualified private investors or institutions.[4] The hedge fund industry has grown rapidly in the past decades and is estimated to have $1.9 trillion in assets under management globally.[5]

Hedge funds utilize a wide array of investment strategies according to the goals of their managers and clients. Some investment strategies include Global macro, directional, event-driven, relative value (economics), and many others. Hedge funds are generally unsupervised by national regulatory agencies and, on occasion, have been accused of destabilizing various financial markets.[

Value at Risk Analysis

Definition

Value at risk (VaR) represents the potential loss in value of a position (expressed as NPV) which could (with a certain probability) be realized before the position is hedged or liquidated. VaR is thus an extension of NPV analysis, leading to uniform risk quantification. The difference being, that VaR takes into account the uncertainty of future market developments.

Use

Uniform application of the NPV approach within VaR allows for a consolidation of VaR over every part of a company. You can aggregate risk any way you’d like from product, currency, and organizational unit, and use the results together to represent total risk. Value at Risk analysis therefore plays an important role in controlling global risk for the entire company.

Within the framework of Risk Management, value at risk represents a key value for controlling. VaR also provides the basis for the internal risk controlling models proposed by the Basel Committee on Banking Supervision. Keep in mind that the final decision about which operative controlling measures are appropriate has to be made by the risk controlling department of your company. As a key figure, VaR only has a warning function.

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Risk/Return control represents a further use of VaR analysis. Within modern portfolio management, expected yields are viewed in relation to committed risks.

Structure

In principle, value at risk is determined by the value of the committed position and the volatility of market prices. VaR is also influence by the average holding period of the position, until the position is hedged or liquidated. The following calculation methods are used for VaR:

Historical simulation of change in NPV, based on historical changes in market prices

In the historical simulation, n comparative NPV calculations are carried out. This involves calculating n net present values resulting from the current market data modified by n historical market data changes. These simulated NPVs are compared with the NPV calculated from current market data. This results in n potential gains/losses.

The correlations of the individual market prices and the dependencies between the positions are implicitly taken into account.

The historical simulation can be carried out using one of the following approaches:

Full valuation

In the full approach, n NPV calculations are carried out for all market data records valid in the past and compared with the NPV of the current market data. This results in n potential gains/losses.

Delta valuation

In the delta approach, the elasticity of the price function to the various price-determining parameters is estimated. The NPV differences result from weighting the sensitivity with the price differences from the historical market data. As in the full valuation, this results in n potential gains/losses.

Variance/covariance approach for determining change in NPV based on the volatility of individual market prices

In the variance/covariance approach, potential loss is calculated from the volatility of the risk factors. The volatility of the risk factors can be estimated from historical market data from each of the respective risk factors (standard deviation), or imported from external sources (datafeed, market data file).

The resulting risks are aggregated via correlation matrices, taking any interdependencies into account.

Single Value Analysis: Executing a VaR Analysis

1. Choose Accounting Bank Applications Risk Analysis Market Risk Analysis Information System Single Value Analysis VaR Individual Analysis

2. Specify under Eval. parameters the VaR type, the Evaluation type, the Evaluation date, the Risk hierarchy and if required a Risk hierarchy node.

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To display the risks within value-at-risk evaluations, it is important that the risk hierarchy and the evaluation type match. An interest rate risk can only be displayed if the yield curve type of the evaluation type is the same as that of the risk hierarchy.

3. You define the selection of historic market data by defining the Start of history.

Using the market data from the day in the historical period which is furthest back in the past to the Start of history, the system determines the market price changes as base values for the historical simulation and the variance/covariance approach

4. Choose the Display currency and select the flag, if you need a detailed log. 5. Enter the selection criteria for the financial transactions on the tab page Gen. data select. You

can select transactions right down to the single transaction level. Note the following Special Features for Selecting Transactions. You can also use the buttons Only real, Only simulated, Insert real and All as input assistance. The fields Position number and No. simulation run are then filled according to your choice.

6. Restrict the transactions additionally by choosing characteristic values on the tab page Characteristics.

7. Choose .

Result

You receive a list of all selected transactions containing an overview of the value-at-risk, the current net present value, the delta and the gamma per transaction. After selecting a transaction you have the option of carrying out the following actions:

Button Meaning

Single transaction You navigate to the master data of the transaction.

Detail log You navigate to the detail log for net present value calculation.

Node Risk hier. This takes you to the risk hierarchy display. By choosing a node you will get back to the result list. This will only show the transactions and the value-at-risk key figures for the selected part of the risk hierarchy. If you want to come back to the original list, choose Node risk hier. again and select the highest node of the risk hierarchy.

P/L-distribution

On the left side of the screen you see the profits and losses distributed over the historic period. On the right side of the screen these values are sorted by amount and the frequency distribution is shown graphically. For comparison, a normal distribution with an expected value of 0 and the standard deviation of the profits/losses is shown with the frequency distribution.

Page 20: Modified Dietz Method

Commodity marketFrom Wikipedia, the free encyclopedia

Jump to: navigation, search

This article needs additional citations for verification. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. (November 2008)

Financial markets

Public market

ExchangeSecurities

Bond market

Fixed incomeCorporate bondGovernment bondMunicipal bondBond valuationHigh-yield debt

Stock market

StockPreferred stockCommon stockRegistered shareVoting shareStock exchange

Derivatives market

SecuritizationHybrid security

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Credit derivativeFutures exchange

OTC, non organized

Spot marketForwardsSwapsOptions

Foreign exchange

Exchange rateCurrency

Other markets

Money marketReinsurance marketCommodity marketReal estate market

Practical trading

ParticipantsClearing houseFinancial regulation

Finance seriesBanks and bankingCorporate financePersonal financePublic financev · d · e

Page 22: Modified Dietz Method

Chicago Board of Trade Futures market

Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts.

This article focuses on the history and current debates regarding global commodity markets. It covers physical product (food, metals, electricity) markets but not the ways that services, including those of governments, nor investment, nor debt, can be seen as a commodity. Articles on reinsurance markets, stock markets, bond markets and currency markets cover those concerns separately and in more depth. One focus of this article is the relationship between simple commodity money and the more complex instruments offered in the commodity markets.

See List of traded commodities for some commodities and their trading units and places.

Page 23: Modified Dietz Method

Contents[hide]

1 History o 1.1 Early history of commodity markets

2 Size of the market 3 Commodities trading

o 3.1 Spot trading o 3.2 Forward contracts o 3.3 Futures contracts o 3.4 Hedging o 3.5 Delivery and condition guarantees

4 Standardization 5 Regulation of commodity markets

o 5.1 Oil o 5.2 Commodity markets and protectionism

6 Commodities exchanges o 6.1 Largest commodities exchanges

7 See also o 7.1 Commodity exchanges o 7.2 Supervising commission o 7.3 Related software

8 References

[edit] History

The modern commodity markets have their roots in the trading of agricultural products. While wheat and corn, cattle and pigs, were widely traded using standard instruments in the 19th century in the United States, other basic foodstuffs such as soybeans were only added quite recently in most markets.[citation needed] For a commodity market to be established, there must be very broad consensus on the variations in the product that make it acceptable for one purpose or another.

The economic impact of the development of commodity markets is hard to overestimate. Through the 19th century "the exchanges became effective spokesmen for, and innovators of, improvements in transportation, warehousing, and financing, which paved the way to expanded interstate and international trade."[citation needed]

[edit] Early history of commodity markets

Historically, dating from ancient Sumerian use of sheep or goats, other peoples using pigs, rare seashells, or other items as commodity money, people have sought ways to standardize and trade contracts in the delivery of such items, to render trade itself more smooth and predictable.[citation

needed]

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Commodity money and commodity markets in a crude early form are believed to have originated in Sumer where small baked clay tokens in the shape of sheep or goats were used in trade. Sealed in clay vessels with a certain number of such tokens, with that number written on the outside, they represented a promise to deliver that number. This made them a form of commodity money - more than an I.O.U. but less than a guarantee by a nation-state or bank. However, they were also known to contain promises of time and date of delivery - this made them like a modern futures contract. Regardless of the details, it was only possible to verify the number of tokens inside by shaking the vessel or by breaking it, at which point the number or terms written on the outside became subject to doubt. Eventually the tokens disappeared, but the contracts remained on flat tablets. This represented the first system of commodity accounting.[citation needed]

Classical civilizations built complex global markets trading gold or silver for spices, cloth, wood and weapons, most of which had standards of quality and timeliness. Considering the many hazards of climate, piracy, theft and abuse of military fiat by rulers of kingdoms along the trade routes, it was a major focus of these civilizations to keep markets open and trading in these scarce commodities. Reputation and clearing became central concerns, and the states which could handle them most effectively became very powerful empires, trusted by many peoples to manage and mediate trade and commerce.[citation needed]

[edit] Size of the market

The trading of commodities consists of direct physical trading and derivatives trading. Exchange traded commodities have seen an upturn in the volume of trading since the start of the decade. This was largely a result of the growing attraction of commodities as an asset class and a proliferation of investment options which has made it easier to access this market.

The global volume of commodities contracts traded on exchanges increased by a fifth in 2010, and a half since 2008, to around 2.5 billion million contracts. During the three years up to the end of 2010, global physical exports of commodities fell by 2%, while the outstanding value of OTC commodities derivatives declined by two-thirds as investors reduced risk following a five-fold increase in value outstanding in the previous three years. Trading on exchanges in China and India has gained in importance in recent years due to their emergence as significant commodities consumers and producers. China accounted for more than 60% of exchange-traded commodities in 2009, up on its 40% share in the previous year.

Commodity assets under management more than doubled between 2008 and 2010 to nearly $380bn. Inflows into the sector totalled over $60bn in 2010, the second highest year on record, down from the record $72bn allocated to commodities funds in the previous year. The bulk of funds went into precious metals and energy products. The growth in prices of many commodities in 2010 contributed to the increase in the value of commodities funds under management.[1]

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[edit] Commodities trading

[edit] Spot trading

Spot trading is any transaction where delivery either takes place immediately, or with a minimum lag between the trade and delivery due to technical constraints. Spot trading normally involves visual inspection of the commodity or a sample of the commodity, and is carried out in markets such as wholesale markets. Commodity markets, on the other hand, require the existence of agreed standards so that trades can be made without visual inspection.

[edit] Forward contracts

A forward contract is an agreement between two parties to exchange at some fixed future date a given quantity of a commodity for a price defined today. The fixed price today is known as the forward price.

[edit] Futures contracts

A futures contract has the same general features as a forward contract but is transacted through a futures exchange.

Commodity and futures contracts are based on what’s termed forward contracts. Early on these forward contracts — agreements to buy now, pay and deliver later — were used as a way of getting products from producer to the consumer. These typically were only for food and agricultural products. Forward contracts have evolved and have been standardized into what we know today as futures contracts. Although more complex today, early forward contracts for example, were used for rice in seventeenth century Japan. Modern forward, or futures agreements, began in Chicago in the 1840s, with the appearance of the railroads. Chicago, being centrally located, emerged as the hub between Midwestern farmers and producers and the east coast consumer population centers.

In essence, a futures contract is a standardized forward contract in which the buyer and the seller accept the terms in regards to product, grade, quantity and location and are only free to negotiate the price.[2]

[edit] Hedging

Hedging, a common practice of farming cooperatives, insures against a poor harvest by purchasing futures contracts in the same commodity. If the cooperative has significantly less of its product to sell due to weather or insects, it makes up for that loss with a profit on the markets, since the overall supply of the crop is short everywhere that suffered the same conditions.

[edit] Delivery and condition guarantees

In addition, delivery day, method of settlement and delivery point must all be specified. Typically, trading must end two (or more) business days prior to the delivery day, so that the

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routing of the shipment can be finalized via ship or rail, and payment can be settled when the contract arrives at any delivery point.

[edit] Standardization

U.S. soybean futures, for example, are of standard grade if they are "GMO or a mixture of GMO and Non-GMO No. 2 yellow soybeans of Indiana, Ohio and Michigan origin produced in the U.S.A. (Non-screened, stored in silo)," and of deliverable grade if they are "GMO or a mixture of GMO and Non-GMO No. 2 yellow soybeans of Iowa, Illinois and Wisconsin origin produced in the U.S.A. (Non-screened, stored in silo)." Note the distinction between states, and the need to clearly mention their status as GMO (Genetically Modified Organism) which makes them unacceptable to most organic food buyers.

Similar specifications apply for cotton, orange juice, cocoa, sugar, wheat, corn, barley, pork bellies, milk, feedstuffs, fruits, vegetables, other grains, other beans, hay, other livestock, meats, poultry, eggs, or any other commodity which is so traded.

[edit] Regulation of commodity markets

In the United States, the principal regulator of commodity and futures markets is the Commodity Futures Trading Commission but it is the National Futures Association that enforces rules and regulations put forth by the CFTC.

[edit] Oil

Building on the infrastructure and credit and settlement networks established for food and precious metals, many such markets have proliferated drastically in the late 20th century. Oil was the first form of energy so widely traded, and the fluctuations in the oil markets are of particular political interest.

Some commodity market speculation is directly related to the stability of certain states, e.g., during the Persian Gulf War, speculation on the survival of the regime of Saddam Hussein in Iraq. Similar political stability concerns have from time to time driven the price of oil.

The oil market is an exception. Most markets are not so tied to the politics of volatile regions - even natural gas tends to be more stable, as it is not traded across oceans by tanker as extensively.

[edit] Commodity markets and protectionism

Developing countries (democratic or not) have been moved to harden their currencies, accept International Monetary Fund rules, join the World Trade Organization (WTO), and submit to a broad regime of reforms that amount to a hedge against being isolated. China's entry into the WTO signalled the end of truly isolated nations entirely managing their own currency and affairs. The need for stable currency and predictable clearing and rules-based handling of trade

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disputes, has led to a global trade hegemony - many nations hedging on a global scale against each other's anticipated protectionism, were they to fail to join the WTO.

There are signs, however, that this regime is far from perfect. U.S. trade sanctions against Canadian softwood lumber (within NAFTA) and foreign steel (except for NAFTA partners Canada and Mexico) in 2002 signalled a shift in policy towards a tougher regime perhaps more driven by political concerns - jobs, industrial policy, even sustainable forestry and logging practices.

[edit] Commodities exchangesMain article: Commodities exchange

[edit] Largest commodities exchangesExchange Country Volume per month $M

CME Group USA 19[3]

Tokyo Commodity Exchange Japan -

NYSE Euronext USA -

Dalian Commodity Exchange China -

Multi Commodity Exchange India -

Intercontinental Exchange USA, Canada, China, UK

Foreign exchange marketFrom Wikipedia, the free encyclopedia

Jump to: navigation, search

"Forex" redirects here. For the football club, see FC Forex Braşov.

Foreign exchange

Exchange ratesCurrency bandExchange rate

Exchange rate regimeExchange rate flexibility

DollarizationFixed exchange rate

Floating exchange rateLinked exchange rate

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Managed float regimeMarkets

Foreign exchange marketFutures exchange

Retail forexAssets

CurrencyCurrency future

Non-deliverable forwardForex swap

Currency swapForeign exchange optionHistorical agreements

Bretton Woods ConferenceSmithsonian Agreement

Plaza AccordLouvre Accord

See alsoBureau de change / currency exchange (office)

Hard currency

The foreign exchange market (forex, FX, or currency market) is a global, worldwide decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.[1]

The primary purpose of the foreign exchange is to assist international trade and investment, by allowing businesses to convert one currency to another currency. For example, it permits a US business to import British goods and pay Pound Sterling, even though the business' income is in US dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation on the change in interest rates in two currencies.[2]

In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.

The foreign exchange market is unique because of

its huge trading volume representing the largest asset class in the world leading to high liquidity; its geographical dispersion; its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday

until 22:00 GMT Friday; the variety of factors that affect exchange rates;

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the low margins of relative profit compared with other markets of fixed income; and the use of leverage to enhance profit and loss margins and with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding currency intervention by central banks. According to the Bank for International Settlements,[3] as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion.[4]

The $3.98 trillion break-down is as follows:

$1.490 trillion in spot transactions $475 billion in outright forwards $1.765 trillion in foreign exchange swaps $43 billion Currency swaps $207 billion in options and other products

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Contents[hide]

1 Market Size and liquidity 2 Market participants

o 2.1 Banks o 2.2 Commercial companies o 2.3 Central banks o 2.4 Forex fixing o 2.5 Hedge funds as speculators o 2.6 Investment management firms o 2.7 Retail foreign exchange traders o 2.8 Non-bank foreign exchange companies o 2.9 Money transfer/remittance companies and bureaux de change

3 Trading characteristics 4 Determinants of FX rates

o 4.1 Economic factors o 4.2 Political conditions o 4.3 Market psychology

5 Financial instruments o 5.1 Spot o 5.2 Forward o 5.3 Swap o 5.4 Future o 5.5 Option

6 Speculation 7 Risk aversion in forex 8 Further reading 9 See also 10 Notes 11 References 12 External links

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[edit] Market Size and liquidity

Main foreign exchange market turnover, 1988–2007, measured in billions of USD.

The foreign exchange market is the most liquid financial market in the world. Traders include large banks, central banks, institutional investors, currency speculators, corporations, governments, other financial institutions, and retail investors. The average daily turnover in the global foreign exchange and related markets is continuously growing. According to the 2010 Triennial Central Bank Survey, coordinated by the Bank for International Settlements, average daily turnover was US$3.98 trillion in April 2010 (vs $1.7 trillion in 1998).[3] Of this $3.98 trillion, $1.5 trillion was spot foreign exchange transactions and $2.5 trillion was traded in outright forwards, FX swaps and other currency derivatives.

Trading in the UK accounted for 36.7% of the total, making UK by far the most important global center for foreign exchange trading. In second and third places, respectively, trading in the USA accounted for 17.9%, and Japan accounted for 6.2%.[5]

Turnover of exchange-traded foreign exchange futures and options have grown rapidly in recent years, reaching $166 billion in April 2010 (double the turnover recorded in April 2007). Exchange-traded currency derivatives represent 4% of OTC foreign exchange turnover. FX futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.

Most developed countries permit the trading of FX derivative products (like currency futures and options on currency futures) on their exchanges. All these developed countries already have fully convertible capital accounts. A number of emerging countries do not permit FX derivative products on their exchanges in view of controls on the capital accounts. The use of foreign exchange derivatives is growing in many emerging economies.[6] Countries such as Korea, South Africa, and India have established currency futures exchanges, despite having some controls on the capital account.

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Foreign exchange trading increased by 20% between April 2007 and April 2010 and has more than doubled since 2004.[8] The increase in turnover is due to a number of factors: the growing importance of foreign exchange as an asset class, the increased trading activity of high-frequency traders, and the emergence of retail investors as an important market segment. The growth of electronic execution methods and the diverse selection of execution venues have lowered transaction costs, increased market liquidity, and attracted greater participation from many customer types. In particular, electronic trading via online portals has made it easier for retail traders to trade in the foreign exchange market. By 2010, retail trading is estimated to account for up to 10% of spot FX turnover, or $150 billion per day (see retail trading platforms).

Because foreign exchange is an over-the-counter (OTC) market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading center is the UK, primarily London, which according to TheCityUK estimates has increased its

share of global turnover in traditional transactions from 34.6% in April 2007 to 36.7% in April 2010. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. For instance, when the International Monetary Fund (IMF) calculates the value of its Special Drawing Rights (SDRs) every day, they use the London market prices at noon that day.

[edit] Market participantsFinancial markets

Public market

ExchangeSecurities

Top 10 currency traders [7]

% of overall volume, May 2011

Rank Name Market share

1 Deutsche Bank 15.64%

2 Barclays Capital 10.75%

3 UBS AG 10.59%

4 Citi 8.88%

5 JPMorgan 6.43%

6 HSBC 6.26%

7 Royal Bank of Scotland 6.20%

8 Credit Suisse 4.80%

9 Goldman Sachs 4.13%

10 Morgan Stanley 3.64%

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Bond market

Fixed incomeCorporate bond

Government bondMunicipal bondBond valuationHigh-yield debtStock market

StockPreferred stockCommon stock

Registered shareVoting share

Stock exchangeDerivatives market

SecuritizationHybrid securityCredit derivativeFutures exchange

OTC, non organized

Spot marketForwards

SwapsOptions

Foreign exchange

Exchange rateCurrency

Other markets

Money marketReinsurance marketCommodity marketReal estate marketPractical trading

ParticipantsClearing house

Financial regulation

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Finance seriesBanks and bankingCorporate financePersonal financePublic finance

v · d · e

Unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest commercial banks and securities dealers. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and not known to players outside the inner circle. The difference between the bid and ask prices widens (for example from 0-1 pip to 1-2 pips for a currencies such as the EUR) as you go down the levels of access. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the foreign exchange market are determined by the size of the "line" (the amount of money with which they are trading). The top-tier interbank market accounts for 53% of all transactions. From there, smaller banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail FX market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown markedly over the 2001–2004 period in terms of both number and overall size”.[9] Central banks also participate in the foreign exchange market to align currencies to their economic needs.

[edit] Banks

The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. Many large banks may trade billions of dollars, daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, which are trading desks for the bank's own account. Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for large fees. Today, however, much of this business has moved on to more efficient electronic systems. The broker squawk box lets traders listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few years ago.[citation needed]

[edit] Commercial companies

An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable

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impact when very large positions are covered due to exposures that are not widely known by other market participants.

[edit] Central banks

National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading.

[edit] Forex fixing

Forex fixing is the daily monetary exchange rate fixed by the national bank of each country. The idea is that central banks use the fixing time and exchange rate to evaluate behavior of their currency. Fixing exchange rates reflects the real value of equilibrium in the forex market. Banks, dealers and online foreign exchange traders use fixing rates as a trend indicator.

The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank.[10] Several scenarios of this nature were seen in the 1992–93 European Exchange Rate Mechanism collapse, and in more recent times in Southeast Asia.

[edit] Hedge funds as speculators

About 70% to 90%[citation needed] of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor.

[edit] Investment management firms

Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.

Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well

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as limiting risk. Whilst the number of this type of specialist firms is quite small, many have a large value of assets under management (AUM), and hence can generate large trades.

[edit] Retail foreign exchange traders

Individual Retail speculative traders constitute a growing segment of this market with the advent of retail forex platforms, both in size and importance. Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in the USA by the Commodity Futures Trading Commission and National Futures Association have in the past been subjected to periodic foreign exchange scams.[11][12] To deal with the issue, the NFA and CFTC began (as of 2009) imposing stricter requirements, particularly in relation to the amount of Net Capitalization required of its members. As a result many of the smaller and perhaps questionable brokers are now gone or have moved to countries outside the US. A number of the forex brokers operate from the UK under Financial Services Authority regulations where forex trading using margin is part of the wider over-the-counter derivatives trading industry that includes Contract for differences and financial spread betting.

There are two main types of retail FX brokers offering the opportunity for speculative currency trading: brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail customer. They charge a commission or mark-up in addition to the price obtained in the market. Dealers or market makers, by contrast, typically act as principal in the transaction versus the retail customer, and quote a price they are willing to deal at.

[edit] Non-bank foreign exchange companies

Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not offer speculative trading but rather currency exchange with payments (i.e., there is usually a physical delivery of currency to a bank account).

It is estimated that in the UK, 14% of currency transfers/payments[13] are made via Foreign Exchange Companies.[14] These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services.

[edit] Money transfer/remittance companies and bureaux de change

Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000 agents globally followed by UAE Exchange[citation needed]

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Bureau de change or currency transfer companies provide low value foreign exchange services for travelers. These are typically located at airports and stations or at tourist locations and allow physical notes to be exchanged from one currency to another. They access the foreign exchange markets via banks or non bank foreign exchange companies.

[edit] Trading characteristicsMost traded currencies by value

Currency distribution of global foreign exchange market turnover[3]

Rank CurrencyISO 4217 code

(Symbol)% daily share(April 2010)

1  United States dollar USD ($) 84.9%

2  Euro EUR (€) 39.1%

3  Japanese yen JPY (¥) 19.0%

4  Pound sterling GBP (£) 12.9%

5  Australian dollar AUD ($) 7.6%

6  Swiss franc CHF (Fr) 6.4%

7  Canadian dollar CAD ($) 5.3%

8  Hong Kong dollar HKD ($) 2.4%

9  Swedish krona SEK (kr) 2.2%

10  New Zealand dollar NZD ($) 1.6%

11  South Korean won KRW (₩) 1.5%

12  Singapore dollar SGD ($) 1.4%

13  Norwegian krone NOK (kr) 1.3%

14  Mexican peso MXN ($) 1.3%

15  Indian rupee INR ( ) 0.9%

Other 12.2%

Total[15] 200%

There is no unified or centrally cleared market for the majority of FX trades, and there is very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments

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are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are often very close, otherwise they could be exploited by arbitrageurs instantaneously. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. Major trading exchanges include EBS and Reuters. A joint venture of the Chicago Mercantile Exchange and Reuters, called Fxmarketspace opened in 2007 and aspired but failed to the role of a central market clearing mechanism.[citation needed]

The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.

Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of changes in monetary flows caused by changes in gross domestic product (GDP) growth, inflation (purchasing power parity theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses, large cross-border M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. However, the large banks have an important advantage; they can see their customers' order flow.

Currencies are traded against one another. Each currency pair thus constitutes an individual trading product and is traditionally noted XXXYYY or XXX/YYY, where XXX and YYY are the ISO 4217 international three-letter code of the currencies involved. The first currency (XXX) is the base currency that is quoted relative to the second currency (YYY), called the counter currency (or quote currency). For instance, the quotation EURUSD (EUR/USD) 1.5465 is the price of the euro expressed in US dollars, meaning 1 euro = 1.5465 dollars. The market convention is to quote most exchange rates against the USD with the US dollar as the base currency (e.g. USDJPY, USDCAD, USDCHF). The exceptions are the British pound (GBP), Australian dollar (AUD), the New Zealand dollar (NZD) and the euro (EUR) where the USD is the counter currency (e.g. GBPUSD, AUDUSD, NZDUSD, EURUSD).

The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency correlation between XXXYYY and XXXZZZ.

On the spot market, according to the 2010 Triennial Survey, the most heavily traded bilateral currency pairs were:

EURUSD: 28% USDJPY: 14% GBPUSD (also called cable): 9%

and the US currency was involved in 84.9% of transactions, followed by the euro (39.1%), the yen (19.0%), and sterling (12.9%) (see table). Volume percentages for all individual currencies should add up to 200%, as each transaction involves two currencies.

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Trading in the euro has grown considerably since the currency's creation in January 1999, and how long the foreign exchange market will remain dollar-centered is open to debate. Until recently, trading the euro versus a non-European currency ZZZ would have usually involved two trades: EURUSD and USDZZZ. The exception to this is EURJPY, which is an established traded currency pair in the interbank spot market. As the dollar's value has eroded during 2008, interest in using the euro as reference currency for prices in commodities (such as oil), as well as a larger component of foreign reserves by banks, has increased dramatically. Transactions in the currencies of commodity-producing countries, such as AUD, NZD, CAD, have also increased.

[edit] Determinants of FX ratesSee also: exchange rates

The following theories explain the fluctuations in FX rates in a floating exchange rate regime (In a fixed exchange rate regime, FX rates are decided by its government):

(a) International parity conditions: Relative Purchasing Power Parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world.

(b) Balance of payments model (see exchange rate): This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit.

(c) Asset market model (see exchange rate): views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people's willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.”

None of the models developed so far succeed to explain FX rates levels and volatility in the longer time frames. For shorter time frames (less than a few days) algorithms can be devised to predict prices. It is understood from the above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply. The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.

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Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology.

[edit] Economic factors

These include: (a)economic policy, disseminated by government agencies and central banks, (b)economic conditions, generally revealed through economic reports, and other economic indicators.

Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates).

Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency.

Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency.

Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation.

Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be.

Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Its effects are more prominent if the increase is in the traded sector [1].

[edit] Political conditions

Internal, regional, and international political conditions and events can have a profound effect on currency markets.

All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one

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country in a region may spur positive/negative interest in a neighboring country and, in the process, affect its currency.

[edit] Market psychology

Market psychology and trader perceptions influence the foreign exchange market in a variety of ways:

Flights to quality: Unsettling international events can lead to a "flight to quality", a type of capital flight whereby investors move their assets to a perceived "safe haven". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The U.S. dollar, Swiss franc and gold have been traditional safe havens during times of political or economic uncertainty.[16]

Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends.[17]

"Buy the rumor, sell the fact": This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being "oversold" or "overbought".[18] To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices.

Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. "What to watch" can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.

Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns.[19]

[edit] Financial instruments

[edit] Spot

A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira, EURO and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction.

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[edit] ForwardSee also: forward contract

One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties.

[edit] SwapMain article: foreign exchange swap

The most common type of forward transaction is the FX swap. In an FX swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange.

[edit] FutureMain article: currency future

Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.

[edit] OptionMain article: foreign exchange option

A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world.

[edit] Speculation

Controversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Nevertheless, economists including Milton Friedman have argued that speculators ultimately are a stabilizing influence on the market and perform the important function of providing a market for hedgers and transferring risk from those people who don't wish to bear it, to those who do.[20] Other economists such as Joseph Stiglitz consider this argument to be based more on politics and a free market philosophy than on economics.[21]

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Large hedge funds and other well capitalized "position traders" are the main professional speculators. According to some economists, individual traders could act as "noise traders" and have a more destabilizing role than larger and better informed actors.[22]

Currency speculation is considered a highly suspect activity in many countries.[where?] While investment in traditional financial instruments like bonds or stocks often is considered to contribute positively to economic growth by providing capital, currency speculation does not; according to this view, it is simply gambling that often interferes with economic policy. For example, in 1992, currency speculation forced the Central Bank of Sweden to raise interest rates for a few days to 500% per annum, and later to devalue the krona.[23] Former Malaysian Prime Minister Mahathir Mohamad is one well known proponent of this view. He blamed the devaluation of the Malaysian ringgit in 1997 on George Soros and other speculators.

Gregory J. Millman reports on an opposing view, comparing speculators to "vigilantes" who simply help "enforce" international agreements and anticipate the effects of basic economic "laws" in order to profit.[24]

In this view, countries may develop unsustainable financial bubbles or otherwise mishandle their national economies, and foreign exchange speculators made the inevitable collapse happen sooner. A relatively quick collapse might even be preferable to continued economic mishandling, followed by an eventual, larger, collapse. Mahathir Mohamad and other critics of speculation are viewed as trying to deflect the blame from themselves for having caused the unsustainable economic conditions.

[edit] Risk aversion in forexSee also: Safe-haven currency

Fig.1 Chart showing MSCI World Index of Equities fell while the US Dollar Index rose.

Risk aversion in the forex is a kind of trading behavior exhibited by the foreign exchange market when a potentially adverse event happens which may affect market conditions. This behavior is caused when risk averse traders liquidate their positions in risky assets and shift the funds to less risky assets due to uncertainty.[25]

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In the context of the forex market, traders liquidate their positions in various currencies to take up positions in safe-haven currencies, such as the US Dollar.[26] Sometimes, the choice of a safe haven currency is more of a choice based on prevailing sentiments rather than one of economic statistics. An example would be the Financial Crisis of 2008. The value of equities across world fell while the US Dollar strengthened (see Fig.1). This happened despite the strong focus of the crisis in the USA.[27]

[edit] Further reading

The National Futures Association (2010). Trading in the Retail Off-Exchange Foreign Currency Market. Chicago, Illinois.

[edit] See also Balance of trade Bretton Woods system Currency codes Currency pair Currency strength Foreign currency

mortgage

Foreign exchange autotrading

Foreign exchange controls

Foreign exchange hedge Foreign exchange

reserves Foreign exchange scam Foreign exchange swap

Money market Nonfarm payrolls Special Drawing Rights Tobin Tax World currency

Use of the Results Database in Portfolio Analyzer

BasisPortfolio Analyzer saves the results of all evaluations in the Results Database (RDB); it does not contain any online runs.

Unlike Market Risk Analysis, which also uses the Results Database, the final results procedure is a two-step method in Portfolio Analyzer. The final results are calculated as follows:

Single record procedure

The positions and flows are transferred to the Results Database.

Final results procedure 1

Values are translated into the evaluation currency.

Final results procedure 2

Rate-of-return (yield) key figures are calculated.

Key Figure TypesPortfolio Analyzer calculates all key figures based on the key figure categories, which are predefined in the system. You assign each key figure to an evaluation procedure. You can assign more than one key figure to each evaluation procedure, but each key figure can be assigned once only. When you define key figures, you can access key figure categories for positions (PAPOS and PAPOSCC), flows (PAFLW and

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PAFLWCC), and rates of return (PAYLDCC and PAYLDSNCCC). The following table shows which key figure categories you can use in which evaluation procedures:

Evaluation Procedure Key Figure Types Reason for Creating Multiple Evaluation Procedures

Single record procedure PAPOS (position in position currency)

PAFLOW (flow in transaction currency)

Final results procedure 1 PAPOSCC (position in evaluation currency)

PAFLWCC (flow in evaluation currency)

Key figures that have the same basic key figure but different evaluation currencies

Final results procedure 2 PAYLDCC (rates of return with fixed yield periods from the evaluation currency)

PAYLDSNCCC (rate of return from start of period to date from the evaluation currency)

Key figures that have the same basic key figures but rate-of-return methods or different rate-of-return periods

In Customizing for Financial Supply Chain Management choose Treasury and Risk Management

® Portfolio Analyzer ® Results Database ® Edit Key Figures and Evaluation Procedures. In this IMG activity, you can create key figures by choosing a key figure category and entering the attributes of the key figure. You can also use existing key figures as the basis for defining new key figures. You do this by specifying a basic key figure when you define the new key figure. The system then copies the values of the basic key figure and adds them to the new key figure.

If you use basic key figures to define new key figures, the results of single records methods that have already been calculated are retained. You then only need to define the new final results procedure you require.

Single Record Procedure (SRP)In the single record procedure, the system takes the position values stored in Treasury and Risk Management and loads them into the Results Database. The step takes a long time, as the system has to calculate the NPVs of all items in the positions. You must assign two key figures to the single records procedure: one for the position (key figure category PAPOS) and one for the flows (key figure category PAFLW).

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To delete singe records, on the SAP Easy Access screen choose Accounting ®Financial Supply Chain Management ®Treasury and Risk Management ®Portfolio Analyzer ®Tools ®Results Database ®Delete Non-Archived Single Records. You should use this transaction in your test system only. In your productive system, you should delete single records. On the SAP Easy Access screen choose Accounting ® Financial Supply Chain Management ®Treasury and Risk Management ®Portfolio Analyzer ®Tools ® Results Database ® Determine Single Records.

To run the single records procedure as a parallel job, on the SAP Easy Access screen choose Treasury and Risk Management ® Portfolio Analyzer ® Tools ® Parallel Processing.

Final Results Procedure 1 (FRP 1)In final results procedure 1, the system translates the position values and flows calculated in the single records procedure into the evaluation currency. For each evaluation currency, you assign two key figures to the final results procedure: one category PAPOSCC key figure and one PAFLWCC key figure.

If, for example, you want to analyze a portfolio in EUR and CHF, then you must define four key figures for the final results procedure. Each key figure should have the same abstract basic key figure; you should use the key figures of the single results procedure (key figure category PAPOS or PAFLW). This ensures that the system calculates the key figures of final results procedure 1 on the basis of the results of the single record procedure.

Since single record procedure 1 contains additive key figures only (those that can be totaled, which are positions and flows in the evaluation currency), it is independent of the portfolio hierarchy.

Final Results Procedure 2 (FRP 2)In final results procedure 2, the system calculates the non-additive key figures. In Portfolio Analyzer, these are rate-of-return (yield) key figures. You can assign only the key figures of the key figure category that has the prefix PAYLD* to final results procedure 2. Furthermore, you must assign a portfolio hierarchy to final results procedure 2.

Note that the rate-of-return key figures that you assign to final results procedure 2 must have the same interval category. Therefore, for each procedure you can use either the key figure categories PAYLD and PAYLDCC, or the key figure categories PAYLDSNC and PAYLDSNCCC. The system checks whether all the key figures assigned to the procedure have the same period. The key figures of category PAYLD and PAYLDCC should therefore have the same values for the Yield Period Start indicator: In the same way, key figures of category PAYLDSNC or PAYLDSNCCC must have the same value in the Interval for Periods field. If this is not the case, the system displays a warning message.

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The results for the final results procedure are based on the data of a single records procedure, and can be recreated at any point in time provided that the single records still exist. This means that you can delete the final results from the database if required.

Additional NotesIf you want to improve system performance during the evaluations, note the following:

Choose only a small number of analysis characteristics.

Do not use characteristics that refer to too small an entity (such as business partner number or transaction number).

Specify the start date and the end date in the analysis parameters of the financial objects.

Use the continuous compounding method in the yield curve to improve the runtime.

Ensure that portfolio hierarchies do not contain more than 10,000 end nodes.