Investing In Currency

Investing in currency refers to the act of buying one currency by selling the other pair or leg, which is usually done through a foreign exchange market known as forex. This kind of trading always happens in currency pairs. In this, one currency is exchanged for another currency.

Such trading of currencies are done with the aim of capitalizing on the volatility of the currency values, which is actually very similar to trading for stocks in the stock exchange. Every paired currency has an exchange rate that is used for calculating how much one has to pay while exchanging them.

• Investing in currency can provide opportunities for diversification and potential profit by taking advantage of fluctuations in exchange rates.
• Understanding fundamental factors such as economic indicators, central bank policies, and geopolitical events is crucial for successful currency investing.
• Currency investing carries inherent risks, including exchange rate volatility and political instability, which can impact investment returns.
• Investors can participate in currency markets through various instruments, including currency exchange-traded funds (ETFs), currency futures, and forex trading platforms.

Usually, there are the top 3 ways in which investing in foreign currency is possible, and they, are listed as under

1. Spot Trading: In this method of investing, one currency is exchanged for the other, and the settlement usually happens on a T+2 basis (Trade date+2 days)
2. Forward Trade: In this investing contract, the party enters into a contract to exchange one currency for the other at a set price on a certain future date. It is OTC (Over The Counter) traded and is sometimes customizable.
3. Futures Trade: It is similar to a forward trade of currencies except that the contract is furthermore standardized.

Below are examples of investing in foreign currency.

Example #1

Mr. Smith is observing the USD/INR fluctuations. He has reason to believe that the USD will strengthen against the INR. Hence he may enter into a spot contract of buying 1 USD at 70.83 INR per USD and then sell into a three months futures contract at USD/INR=71, thereby making a profit in terms of 0.17 INR

Example #2

An exporter in the US is looking at the exchange rate for the purpose of investing in currency exchange, which is currently going on at USD/GBP=0.81. He is concerned that the USD may appreciate the GBP in 3 months when he receives his UK receivables. Home currency appreciation is bad for the exporter. Hence he may hedge this contract with a three-month forward on USD and GBP by buying a USD forward at the same rate of USD/GBP=0.81.

Example #3

SuperMoney LLC, a hedge fund that has entered into a short trade of security ABC Co in a different currency with a time horizon of 3 months and is worried about the FX rates when it needs to undertake cover trades and hence may enter into an FX transaction to hedge the exposure in this regard.

Some of the advantages of investing in currency markets are as follows -

• Availability: It is often noted that stock markets operate during a fixed period of time in a day. However, a currency market is open 24*7 round the clock as the closing of one market in one country would open up another market in another part of the world. Hence there is a great convenience in investing in currency exchange as forex markets are open all the time 24*7
• Hedging: It serves as a great tool to protect the investors from uncertainties related to FX rate changes over time. A hedge fund may be concerned about the FX rate when it wants to cover a short trade over a time horizon of certain months, involving a different currency and hence may choose to hedge and protect itself by having to enter into forward and futures contracts so that such uncertainty is avoided. Similarly, even an exporter or importer may be very well worried about the FX rates when they have to receive/make payments for the trades in a foreign currency and thus, to protect themselves from the varied uncertainties, they may very well choose to enter into a forward or even a futures FX contract so that they are not affected by such fluctuations
• Diversification: A fund manager or even an individual investor may choose to add currencies in their set of portfolios so as not to put all the eggs in one basket and achieve the benefit of diversification, thereby managing risk. Currencies stand as an asset class compared to a traditional mix of stocks, bonds, and even mutual funds for the common investor
• Scope for profit: A person can very well try to speculate in the currency market and make short term profits if he/she understands the forex markets very well. It becomes imperative that one has a clear idea of the trends and keenly follows on this market and to take advantage of market opportunities
• Lower costs: Unlike stocks, trading in currencies involves comparatively lesser costs and thus seeks to enhance returns for the investor when undertaking trade/investment in such forex markets involving currencies.

Given below are the pointers that seek to elucidate on how investing in currency markets tend to be disadvantageous in some regards –

• Huge volatility: No doubt that the currency market stands to be a strong source of hedging; it exposes one to significant volatility much more than what one would expect in the normal course of stock movements. Hence it becomes important for the amateur investor to very well understand their tolerance of risk and only then venture into investing in currencies. The risks too, tend to be higher than the other investment strategies.
• Scope for Speculation: Given the high amount of volatility that is prevalent in the stock market, there is often a great amount of speculation that is involved with regard to the currencies and their movements. Sometimes the bets or positions entered into may go down south and cause a huge amount of losses to the investors. Hence it becomes important that the investor be really cautious in this regard and not indulge in excessive speculation.

• Investing in currency trading is not simple, contrary to investing in equity markets. Thorough knowledge and understanding of the forex market are required to undertake any investment trades or contracts involving currencies.
• These currency markets stand as a brilliant source for an investor or a fund to hedge their foreign currency exposure, to diversify their portfolios, and also gain from FX gains in the process.
• However, one must understand that investing in currency trading is pretty complicated, with many uncertainties and fluctuations, thereby creating scope for considerable speculation, which may need to be revised for the typical amateur investor.
• Hence before venturing into investing in the currency market, one needs to understand and be clear of the dynamic to avoid huge unnecessary losses. Nevertheless, over the years, the currency markets have provided an excellent hedging source for investors and funds alike to protect them with their FX exposures.

This has been a guide to Investing In Currency and its definition. We explain it with examples, advantages, disadvantages and their risks. You can learn more about investment banking from the following articles –

• OTC Market
• Currency Depreciation
• Currency Devaluation
• Money vs Currency