Basics and Terms
How to Invest: Quick Easy Definitions
Here are 5 Quick and Easy terms of investing.
Futures – Foreign currency futures are one way, characterized by an exchange contract to purchase or sell a currency at a predetermined price on a future date. Futures can be used to speculate and profit from perceived fluctuations in exchange rates.
Options – Foreign currency options are another way to invest in currencies. An option is a contract that gives the holder the right to purchase or sell a currency at a specific exchange rate within a given amount of time, where a premium is paid to the broker. Foreign currency options are a great way to hedge against adversity in the volatile forex market.
ETFs and ETNs – Two more investment approaches require using ETFs and ETNs, which presents attractive options for investors hoping to hedge their exposure to the dollar. ETFs, or exchange-traded funds, are funds invested in a single currency whose purpose is to duplicate shifts in a currency by holding multiple currencies. In other words, ETFs can take advantage of fluctuations between currencies, and are widely used by investors who wish to gain exposure to certain currencies without directly entering the market. ETNs (exchange-traded notes), on the other hand, are non-interest paying debt instruments. The price of ETNs fluctuates with an underlying currency exchange rate. Since ETNs are debt obligations, they are subject to the affluence of the issuer. In other words, more stable ETNs will be based off more stable currencies and more volatile ETNs off more volatile currencies.
Certificates of Deposit (CDs) – A certificate of deposit is an instrument issued by an institution as evidence of a timed deposit in the forex market; having a fixed term. At the end of the term, the deposit is returned with interest. They typically have a fixed interest rate, and are both negotiable and transferable. Domestic CDs are issued within a country by a domestic institution. Foreign CDs are issued within a country by a domestic branch of a foreign depository institution. Finally, a Euro CD is issued outside of a country but denominated in that country’s currency.
Foreign bonds – Foreign bonds are issued in a domestic market by a non-domestic issuer, in the domestic market’s currency. Typically, foreign bonds are issued in a domestic market by non-domestic firms to raise capital in a domestic market. This is done in an effort to purchase back debt. Foreign bonds are common for foreign firms doing a large amount of business in the domestic market. Investors in foreign bonds are usually the residents of the domestic country, so investors view them as an attractive way in which they can add content to their portfolios without exposure to the added exchange rate.
What you need to know
The currency exchange, or Forex, market is the largest financial market in the world and carries a significant level of risk, which may not be suitable for all investors. Learning, understanding and mastering this market can take a lifetime. It certainly requires an on-going education, extreme attention to detail and an understanding of both, trading the markets and overall global economics.
Forex markets are constantly shifting due to a multitude of variables in the global economy, geopolitical events and central bank activity, as well as the many divergent actions of the multitude of players in the marketplace.
While currency trading does offer a high degree of leverage, while requiring reasonably low barriers to entry, both of these factors can be detrimental. Due to the distinct possibility that you could sustain a significant loss on your initial investment, you should look hard at your investment goals, experience in this particular market and your appetite for risk. Before you dive into the exciting world of trading foreign currencies you should further educate yourself on all the associated risks and seek advice from an independent financial adviser.