Market liquidity

What is Market Liquidity? 

• In Business, Economics or Investment, Market Liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value. Money, or cash in hand, is the most liquid asset, and can be used immediately to perform actions like buying, selling for goods and services, or paying debt, meeting immediate wants and needs.

• A market may be considered highly liquid if there are ready and willing buyers and sellers in large quantities. This is related to the concept of Market Depth that can be measured as the units that can be sold or bought for a given price. The opposite concept is that of Market Breadth measured as the price change per unit of liquidity.

What is Liquidation?

An act of exchange of a less liquid asset with a more liquid asset is called Liquidation. Liquidity also refers both to a business's ability to meet its payment obligations, in terms of possessing sufficient liquid assets, and to such assets themselves. A liquid asset is something that can easily be converted into cash. An illiquid asset is something like a house, it is worth money, but takes time to be sold and converted into cash. 

Key Contributors to Market Liquidity - 

Speculators and market makers are key contributors to the liquidity of a market, or asset. Speculators and market makers are individuals or institutions that seek to profit from anticipated increases or decreases in a particular market price. By doing this, they provide the capital needed to facilitate the liquidity.

Forms of Liquid Market - 

• Future Markets - In the Futures Markets, there is no assurance that a liquid market may exist for counteract a commodity contract at all times. Some future contracts and specific delivery months tend to have increasingly more trading activity and have higher liquidity than other contracts. The most useful indicator of liquidity for these contracts is the trading volume.

• Banking - In banking, liquidity is the ability to meet obligations when they come due without incurring unacceptable losses. Managing liquidity is a daily process requiring bankers to monitor and project cash flows and financial statements to ensure adequate liquidity is maintained. Maintaining a balance between short-term assets and short-term liabilities is vital For an individual bank, clients' deposits are its primary liabilities (in the sense that the bank have to give back all client deposits on demand), whereas reserves and loans are its primary assets (in the sense that these loans are owed to the bank)

Thank You !

Hedging in Currency (Forex) Market

What is Hedging?

• Currency hedging is the act of entering into a financial contract in order to protect against unexpected, expected or anticipated changes in currency exchange rates. Currency hedging is used by financial investors and businesses to eliminate risks they encounter when conducting business internationally. 

• Hedging can be accomplished by purchasing different types of contracts that are designed to achieve specific goals. These goals are based on the level of risk the customer is exposed to and seeking protection from and allow the individual to lock in future rates without affecting, to a great extent, their Market Liquidity.

Methods of Hedging Currency Trades 

1. Spot contracts
2. Foreign currency options

• Spot contracts are essentially the regular type of trade that is made by a retail Forex trader. Because spot contracts have a very short-term delivery date (two days), they are not the most effective currency hedging strategy. 

• Foreign currency options, however are one of the most popular methods of currency hedging. As with options on other types of securities, the foreign currency option gives the purchaser the right, but not the obligation, to buy or sell the currency pair at a particular exchange rate at some time in the future.

Forex Hedging Strategy 

A Forex hedging strategy is developed in four parts, including an analysis of the Forex trader's risk exposure, risk tolerance and preference of strategy. These components make up the Forex hedge:

• Analyze risk: The trader must identify what types of risks he is taking in the current or proposed position. From there, the trader must identify what the implications could be of taking on this risk un-hedged, and determine whether the risk is high or low in the current Forex currency market. Right analysis of risk is essential.

• Determine risk tolerance: In this step, the trader uses their own risk tolerance levels, to determine how much of the position's risk needs to be hedged. No trade will ever have zero risk; it is up to the trader to determine the level of risk they are willing to take, and how much they are willing to pay to remove the excess risks. So, this level is dependent on the risk factor.

• Determine Forex hedging strategy: If using foreign currency options to hedge the risk of the currency trade, the trader must determine which strategy is the most cost effective.

• Implement and monitor the strategy: By making sure that the strategy works the way it should, risk will stay minimized and never cause any dramatic problems.

The Forex currency trading market is a risky one, and hedging is just one way that a trader can help to minimize the amount of risk they take on.

Speculating in Currency (Forex) Market

What is Speculating? 

• This is the broad category under which activities of most investors fall, which involves buying or selling a financial asset, usually in the face of higher-than-ordinary risk, in order to take advantage of an expected move. Speculators in the currency market wager that, in the future, the value of a currency will move higher or lower relative to another currency. In addition to individual investors, speculators in the currency market can include hedge funds, commercial banks, pension funds or investment banks.

Roles of Speculators


Speculators play one of three primary roles in financial markets, 

• Hedgers who engage in transactions to offset some other pre existing risk, 

• Arbitrageurs who seek to profit from situations where interchangeable instruments (goods that consist of many identical parts which can be easily replaced by other, identical goods) trade at different prices in different market segments

• Investors who seek profit through long-term ownership of an instrument's underlying attributes. The role of speculators is to absorb excess risk that other participants do not want, and to provide liquidity in the marketplace by buying or selling when no participants from the other categories are available.

• It may sometimes be difficult to distinguish between speculation and investment, and whether an activity qualifies as speculative or investing depends on a number of factors, including the nature of the asset, the expected duration of the holding period, and the amount of leverage.  

By taking advantage of already unstable currencies, Speculation can sometimes create more instabilities also. National banks will sometimes react to stabilize their currency, though it is unclear as to exactly how much of an effect that they can have. Market forces sometimes overwhelm the attempts of a central bank to stabilize its national currency, as the combined strength of worldwide Forex investors often outstrips the purchasing power of national banks.


Thank You !

Balance of Payment

What is Balance of Payment? 

Balance of payments of a country will cause the exchange rate of its  domestic currency to fluctuate. The balance of payments is a summary of all economic and financial transactions between the country and the rest of the world. It reflects the country’s international economic standing and influences its macroeconomic and micro-economic operations.The balance of payments can affect the supply and demand for foreign currencies as well as their exchange rates.

• Balance of Payment is a system of recording all the economic transactions of a country, with the rest of the world over a period, say one year.

• Typically, the transactions included in BOP are country's exports and imports of goods, services, financial capital, and financial transfers. Thus, in nut shell we can say, the BOP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned.
  
  

Components of Balance of Payment - 

The components of BOP are as follows - 

• Current Account - (Net export/import of goods (trade balance) Net export/import of services Net income (investment income from direct and portfolio investment plus employee compensation) Net transfers (sums sent home by migrants and permanent workers aboard, gifts, grants and pensions)

• Capital Account - (Capital transfers related to the purchase and sale of fixed assets such as real estate

• Financial Account - (Net foreign direct investment Net portfolio investment Other financial items 

• Net errors and Omissions Account - (Missing data such as illegal transfers)

• Reserves and related items: official reserve account - (Official reserve account Changes in official monetary reserves including gold, foreign exchange, and IMF position.

Calculation of Balance of Payment

BOP = BOT + (Net Earning  on foreign investment i.e. payments made to foreign investors) + Cash Transfer + Capital Account + or - Balancing Item

or

BOP = Current Account + Capital Account  + or - Balancing item ( Errors and omissions)

Favorable & Unfavorable Balance of Payment (Surplus & Deficit)

• Balance of Payment will be favorable, if  the country has surplus in current account for paying your all past loans in her capital account.

• Balance of payment will be unfavorable, if the country has current account deficit and it took more loan from foreigners. After this, it has to pay high interest on extra loan and this will make  BOP unfavorable.

Factors affecting Balance of Payments

• Conditions of foreign lenders. 

• Economic policy of Govt. 

• The cost of Production (Land, Labor, Capitals, Taxes, Incentives) in the exporting economy vis-a-vis those in the importing economy.

• The cost of availability of Raw materials, Intermediate goods and other inputs.

• Exchange Rate Movements.

• Different levels of Taxes or restrictions on trade.

• External or unavoidable factors like environmental, health or safety standards.

• The availability of adequate foreign exchange with which to pay for the imports.

• Price of goods manufactured at home in response to supply.

Significance of Balance of Payment

• Judge economic and financial status of a country in the short-term.

• In the case of a developing country, the balance of payments shows the extent of dependence of the country’s economic development on the financial assistance by the developed countries.

• Deficit signifies a tendency to take stiff measures for diminishing imports, exchange control and restrictions on repatriation of dividends/ interest.

• It helps the government in taking decisions on monetary and fiscal policies on the one hand, and on external trade and payments issues on the other.

Thank you !