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Applications of Foreign Exchange Margin Trading


Basic Information

 

Applications of Foreign Exchange Margin Trading

The applications of FX Margin Trading are described as below. Please note that all the information provided is for reference only.

 

1. Carry out foreign exchange transactions with narrower trading spread

Trading spread is the major cost of foreign exchange investment. In case of foreign currencies versus USD, the trading spread under FX Margin Trading is about one-fifth of that under the General Foreign Exchange Services (by T/T or banknote rate). For example,

FX Margin Trading VS Foreign Exchange Services (in terms of trading spreads)


GBP/USD

Bid

Ask

Spread

T/T

1.6342

1.6396

54 pips

Margin Trading

1.6370

1.6378

8 pips

 

Due to the narrow spread of FX Margin Trading, you can buy GBP at a relatively low price while sell it at a relatively high price. You can also deposit the contract amount in full to the Margin Account so as to manage the risks further.

 

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2. Mitigate the Currency Risk of Trading Businesses

When you expect to receive some cash in foreign currency (e.g. by the export of product items), you can utilize FX Margin Trading to manage the currency risks and to fix the amount of cash flow from currency fluctuation.

  • For instance, you sell a batch of toys to the foreign country (Japan) and expect to receive JPY 10,000,000 after 30 days (assume USD/JPY is currently 82.00, the USD amount is equivalent to USD 121,951.22)
  • Currency risk:

i. JPY depreciates, the amount received after 1 month drops in terms of USD (which does not favor the seller)

ii. JPY appreciates, the amount received after 1 month increases in terms of USD (which favors the seller)

  • To mitigate the drop of relative USD amount (i.e. Case (i)), you can choose to hedge the currency risk (either partially or fully)
  • Assume you choose to hedge the cash inflow in full. You may enter the contract to sell JPY 10,000,000 @ 82.00 relative to USD

a. Upon receiving the cash, USD/JPY reaches 83.00.

  • The equivalent USD amount = USD 120,841.93 (10,000,000/83.00).
  • The cash inflow drops in USD amount = USD 1,469.29 (121,952.22 - 120,481.93)
  • Profit of the contract = (1/82.00 - 1/83.00) x 10,000,000

= USD 1,469.29

  • Results: The profit of the contract offsets the depreciation of cash inflow (in USD amount)

 b. Upon receiving the cash, USD/JPY reaches 81.40

  • The equivalent USD amount = USD 122,850.12 (10,000,000/81.40).
  • The cash inflow increases in USD amount = USD 898.90 (122,850.12 - 121,951.22)
  • Loss of the contract = (1/82.00 – 1/81.40) x 10,000,000

= USD 898.90

  • Results: As JPY strengthens, the USD amount received by the export increases by 898.90. However, this amount is totally offset by the loss of the contract, which is also USD 898.90


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    3. Carry Trades

    You can take advantage of FX Margin Trading to make profit from the interest spreads between two currencies (e.g. buy AUD while sell USD), in the case that the high-yield currency goes up or just remains steady. However, in the case where the value of the high-yield currency drops, you may suffer a loss. For example, you can enter the contract to buy AUD 50,000 at 1.0900 for 1 month.

    Currency

     Amount

     Interest Rate

     Interest Amt

    Interest Amt (in HKD)*

    AUD

     50,000

     4.23%

    176.25

    1,498.48 (received)

    USD

     54,500

     2.01%

    91.29

    712.06 (paid)

    Monthly Interest Income =

     786.42 (received)

    (*Assume USD/HKD = 7.8, AUD/HKD = 8.502)

    a. If the AUD/USD rises from 1.0900 to 1.1000 after 1 month

    Profit/Loss from currency exchange = (1.1000-1.0900) x 50,000 = +USD 500
    Total Profit/Loss (Currency Exchange + Interest Income)
    = (500 x 7.8) + 786.42 = HKD 4,686.42 (Profit)

    b. If the AUD/USD remains unchanged (i.e. 1.0900) after 1 month

    Profit/Loss from currency exchange = (1.0900-1.0900) x 50,000 = USD 0
    Total Profit/Loss (Currency Exchange + Interest Income)
    = (0 x 7.8) + 786.42 = HKD 786.42 (Profit)

    c. If the AUD/USD drops from 1.0900 to 1.0820 after 1 month

    Profit/Loss from currency exchange = (1.0820 – 1.0900) x 50,000 = -USD 400
    Total Profit/Loss (Currency Exchange + Interest Income)
    = -(400 x 7.8) + 786.42 = HKD 2,333.58 (Loss)

     

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    4. Leverage Your Investment

    For instance, if you hold a bullish view on EUR, you may invest in two ways:
    (I) Pay the USD full amount in exchange of EUR 25,000 @ 1.4200
        (a transaction without leverage)
    (II)  Pay 5% initial margin amount (leverage ratio: 20) to buy EUR 25,000 @ 1.4200
        (a transaction with leverage)

    If EUR/USD rises from 1.4200 to 1.4300, then

    Case Amount Capital invested Profit (Amount)  Profit (%)
    (I) EUR25,000 USD35,500 USD250  0.7%
    (II) EUR25,000 USD1,775 USD250  14.08%

    On the other hands, if EUR/USD drops from 1.4200 to 1.4050, then

    Case Amount Capital invested  Loss (Amount)  Loss (%)
    (I) EUR25,000  USD35,500 USD375 1.06%
    (II) EUR25,000  USD1,775 USD375 21.13%

    Compared with the general foreign exchange service, the FX Margin Trading can leverage your investment, profit and loss.

     

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    5. Can either Go Long or Short the Currencies

    You can make use of our foreign exchange service to buy a currency in case you are bullish on it. In case you hold a bearish view, short selling of currency is not available. By FX Margin Trading, you can either long or short a currency. In other words, you can seize every opportunity to make profit in the volatile foreign exchange market.

     

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    6. Various Order Types and Currencies Pairs Make FX Investment More Flexible

    To cater for your views of the currency market and your personal or business needs, our FX Margin Trading provides you with a variety of currencies and order types (such as limit orders, stop orders, etc.) for your selection.

     

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    7. Extended Trading Hours

    The opening hours of general foreign exchange are limited. In fact, the FX market is a near seamless 24-hour market. You can do nothing in case the currency goes up and down off the foreign exchange service hours, however, FX Margin Trading offers you with opportunities to react on the currency movement since the corresponding trading hours cover major global FX markets. For our trading hours, please refer to Question 5 of “Basic Information”.

     

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    Basic Information

    1. Foreign Exchange Margin Trading

    Foreign Exchange Margin Trading is a “geared” or “leveraged” investment. Basically, by entering into a leveraged FX contract, you invest in one currency on margin in the expectation that its exchange rate against another currency will rise or fall.

     

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    2. Initial Margin

    When you open a long (buy) or short (sell) FX contract, you are required to deposit a small percentage of the FX contract instead of full contract amount. Profit and loss of the contract is calculated based on the contract amount rather than the initial margin. In Hong Kong, the minimum initial margin required by most financial institutions for opening a leveraged FX contract is 5% of the contract amount of each contract, the maximum leveraging is equivalent to 20 times of the minimum initial margin.

     

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    3. Profit and Loss

    Calculation of the profit and loss of the leveraged FX contract can be divided into two parts.

    (1) Exchange rate differential: Leveraged FX contract is traded on a contract basis. Profit and loss of a contract depends on how the exchange rate of the base currency against the counter currency changes (moves) after a position has been opened. Any profit or loss arise during the contracting period are unrealized and would only be realized upon squaring the position at the end of the contract.

    Example:

    If you hold a bearish view on JPY, you open a short JPY 5,000,000 position on 01/03/2011 at an exchange rate of 82.40. At the same time, you long USD 60,679.61 (JPY 5,000,000 / 82.40), which is equivalent to the short JPY position.

    The initial margin in HKD for opening a JPY 5,000,000 contract is USD 60,679.61 * 5% (i.e. only 5% margin is required to open the position) *7.76 (Assuming the exchange rate of USD/HKD is 7.76), i.e. HKD 23,543.69.
    1. If you square off your position at 83.00 on the same day, that is, you go long JPY 5,000,000 and short USD 60,240.96 (5,000,000 / 83)
        Profit = USD 438.65 (USD 60,679.61 – USD 60,240.96)
    2. If you square off your position at 81.35 on the same day, that is, you go long JPY 5,000,000 and short USD 61,462.81 (5,000,000 / 81.35)
        Loss = USD 783.20 (USD 61,462.81 – USD 60,679.61)

    Depending on the FX rate for squaring your position, a profit or loss will be sustained.

    (2) Interest rate differential: Interest calculations are based on positions per currency pairs. If you enter a long position in a higher yield base currency and short a lower yield counter currency (e.g. long AUD/ short USD), your interest incomes will increase. If you enter a short position in a higher yield base currency and long a lower yield counter currency (e.g. short AUD/ long USD), your interest burden will be increased instead.

    Example:
    (1) As the previous example, assuming you are not squaring your position on the same day. On 01/03/2011, the short JPY 5,000,000 contract will be settled on 03/03/2011.
    (2) On 02/03/2011, you go long JPY 5,000,000 to square the position. The settlement date will be 04/03/2011.
    (3) Long JPY 5,000,000 at 83.00 equivalent to simultaneously short USD 60,240.96 (JPY 5,000,000 / 83)
    (4) Assuming USD deposit rate is 0.01%, JPY loan interest rate is 1.01%. The interest will be calculated from 03/03/2011 to 04/03/2011. (1 day in total)

    Interest Earned/Paid:
    = USD (60,679.61*0.01% / 360) – JPY (5,000,000*1.01% / 360)
    = USD 0.02 – JPY 140
    = USD 0.02 – USD 1.7
    = - USD 1.68 (i.e. you have to pay USD 1.68 interest for 1 day)
    (Assuming USD/ JPY exchange rate is 82.40, JPY 140 is converted to USD1.7)


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    4. FX Market Analysis

    There are two basic and common approaches to analyze the currency market, fundamental analysis and technical analysis. The fundamental analyst concentrates on the study of macroeconomic factors, such as finance, economic theory and political considerations, which influence supply and demand and consequently prices in the market place, while the technical analyst studies the price movements themselves.

    Fundamental Analysis studies specific factors such as macroeconomic indicators, asset markets and political considerations when evaluating a nation’s currency in terms of another. Macroeconomic indicators include figures such as growth rates, as measured by GDP, interest rates, inflation, unemployment, money supply, foreign exchange reserve and productivity. Political considerations impact the level of confidence in a nation’s government, the climate of stability and level of certainty.

    Technical Analysis predicts future price movements based on past time framed analysis of price and trading volumes. Technical analysts tend to specialize on graphics and formulas to capture the dominant and pre-dominant trends therefore to identify buy / sell signals.

     

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    5. Trading Hours

    The ability of the FX market to trade over 24-hour period is due in part to different time zones. The FX market can be split into four main regions: Australia, Asia, Europe and America. As one region’s markets close another opens, or has already opened, and continues to trade in the FX market. Often these markets will overlap for a couple hours providing some of the most active FX trading. With little attention to time and space, there is no point during the trading week that a participant (through FX dealers from retail or corporate banking or networks of computers) in the FX market can’t potentially make a currency trade. Our FX Margin Trading Service commences from Monday to Friday (06:00am - 03:30am next day). There is no trading on Saturday and Sunday. In general, our FX Margin Trading Service opens on HK public holidays, except the New Year Holiday.


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    6. Is leveraged FX trading suitable for everyone?

    As leveraged FX contract is traded on margin, the risk of loss of this type of investment can be substantial. You may sustain losses in excess of the amount of your initial margin deposit. The amount of money you are required to deposit is a small percentage of the contract value. There is a “gearing” or “leverage” effect on the trading profit and loss. It follows that the lower the margin amount used to open a contract, the higher will be the gearing. You should therefore carefully consider whether such trading is suitable for you in light of your own financial position and investment objectives. Investment involves risks. Investors should read the relevant risk disclosure statement, leaflet and terms and conditions of the services for details before making any investment decision.
     

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    Risk Disclosure:

    This is a structured product involving derivatives. The investment decision is yours but you should not invest in the Structured Products unless the intermediary who sells it to you has explained to you that the product is suitable for you having regard to your financial situation, investment experience and investment objectives. Customers should make a decision to invest only after understanding the foreign exchange market risks and assessing his/her financial position, investment objectives and willingness and ability to bear the risks involved. Customers may also wish to seek independent professional advice from financial consultants.

     

    The risk of loss in leveraged foreign exchange trading can be substantial. You may sustain losses in excess of your initial margin funds. Placing contingent orders, such as “stop-loss” or “stop-limit” order, will not necessarily limit losses to the intended amounts. Market conditions may make it impossible to execute such orders. You may be called upon at short notice to deposit additional margin funds. If required funds are not provided within the prescribed time, your position may be liquidated. You will remain liable for any resulting deficit in your account and interest charged on your account. A demand for additional deposit is not a precondition to and does not in any way limit our right to liquidate your open positions according to the relevant terms and conditions. You should therefore carefully consider whether such trading is suitable in light of your own financial position and investment objectives.

     

    Effect of Leverage:

    Trading in leveraged foreign exchange carries a high degree of risk. The amount of initial margin is small relative to the value of the foreign exchange contract so that the transactions are "leveraged" or "geared". A relatively small market movement will have a proportionately larger impact on the funds you have deposited or will have to deposit; this may work against you as well as for you. You may sustain a total loss of initial margin funds and any additional funds deposited with the firm to maintain your position. If the market moves against your position or margin levels are increased, you may be called upon to pay substantial additional funds on short notice to maintain your position. may be liquidated at a loss and you will be liable for any resulting deficit.

     

    Currency risks:

    The profit or loss in transactions in foreign currency-denominated contracts (whether they are traded in your own or another jurisdiction) will be affected by fluctuations in currency rates where there is a need to convert from the currency denomination of the contract to another currency.


    Exemption of Liabilities:

    The Bank and its staff do not warrant in any respect the completeness, accuracy and validity of the contents of any foreign exchange information provided by the Bank through the Bank. Investment approaches are for reference only and do not constitute any form of trading recommendation. Customers should conduct independent assessment and appropriate research in order to reach their own conclusion. Investment involves risks. Customers should read the relevant risk disclosure statement, leaflet and terms and conditions of the services for details before making any investment decision. The above information does not constitute an offer, or an invitation to offer, or a recommendation to enter into any FX margin transaction.

     

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