The Nuts & Bolts of Currency Speculation

Each time our currency appreciates/depreciates or markets face a liquidity problem, our respected finance minister makes a TV appearance and promptly blames it to currency speculation. An analogy to this syndrome can be found in home minister blaming every militant attack on “Foreign Hand”. Intrigued, I decided to engage my mental faculties to understand this phenomenon a bit more.

To understand the role of speculators, we must follow the mechanics of going short the domestic currency. Going short means that individuals sell a currency which they do not own. This is done in hope that they can buy it back at a later time at a cheaper price. In foreign exchange, the short sale is accomplished by selling the currency in a forward transaction. A forward foreign exchange transaction, has its value date further out on the settlement calendar than spot, the latter being a trade for nearly immediate settlement.

The forward sale of a currency involves paying a “lending fee” that is based on the spread between the interest rate of the currency being sold and the currency being bought. But this lending rate, rather than being explicitly stated is folded into the forward exchange rate. The amount by which the forward exchange rate diverges from the spot exchange rates, called the forward points, determines the cost of going short the currency. Herein lies the basic principle of currency trading: The higher the domestic interest rates, more expensive it is to maintain a short position in that currency.

This is why central banks may choose to hike its short-term interest rate to defend its currency in the face of market pressure. The idea is to try to muscle speculators out of the market by raising the cost of their going short but in doing so the bank must accept that it is damaging its own economy. Higher interest rates may lead to bankruptcies and higher rates of unemployment. That damage can be catastrophic, as has been evident in the history of emerging market nations where bank loans are typically based on floating interest rates. Needless to say, you would be seeing the finance minister a lot more on TV.

In Defense of Capital Market

By Chandan Pal

If one copies from one source, it’s known as plagiarism and copying from multiple sources is known as research. To that extent, you would find this post, my first on this blog, a very well researched one. In fact, I have spent the last few months hopping from one economic blog to another in a vain attempt to understand the economic turmoil that we all are faced with. The financially turbulent era of “Sub prime crisis” is a challenge for market oriented economist to explain. The crisis has plagued countries around the world, leaving skeptical observers confounded by economic reversals and seasoned professional investors flat footed.

The age old debate of Free Capital Markets vs. Regulated Markets has been clinched; it seems for the time being, in favour of the latter. A broad spectrum of reforms has been recommended in the International financial system, following the remarkable collapse of Lehman Brothers and other financial giants. And when confronted with financial crisis, many leaders, if not all, hunt for villains and indict the Capital Markets instead of re-examining the policy blunders of their own making. The first blame goes to capital markets and the system that affords mobility to these markets. The witch hunting season has hit full bloom while and perpetrators of greed and mayhem roam scot-free under the cover of financial bailouts.

There exists remarkable evidence in history of all financial crises, that it is the government policies that has almost always, exacerbated the upheavals. In other words, the predisposing conditions of a crisis are local in nature; crisis comes from within and not outside, and certainly not because capital moves freely from one market to another or market determined forces. One lesson rings loud and clear, regulation or no-regulation, the world will see many more such financial crises unless governments refuse to indulge themselves in markets.

Mutual Funds & Dramatics

Just finished the classes for the second last term of the

course.Normally, I have a feeling of relief and easy going after the
classes get over but this time its another story. This term was
brutual in another form. The classes that started at 9 AM in the
morning somtimes lasted till 10 PM in the night. We did have few hours
of break (sometimes) in between depending upon the electives one has
chosen, but it did not made our life easy.Moreover, we attended more
than 8 extra classes or contact classes for Investment Management with
the professor.I did bunked few of them as well but few students like
Anupam and Bacha attended all of the classes.The total experience of
studying investment management is no less terrifying then the
experience of people who have invested in stock markets ! The prof was
great but he worked so hard that it was impossible to meet his
standards.Moreover, being a novice it was even more difficult.Now the
real test starts. The next 20 days we have to submit more than 8
projects and assignments, courtsey we did not have any End Term exams
this term.So all grades have been translated to projects and
assignments.Its going to be a real night mare and thats the reason why
people are dull and looking tired.
The most fun part of this phase was the Business Ethics course where
each group had to give presentations or do role plays, small skits to
express the topic that was given to them. Our group comprising of
myself, Anupam,VPP,Pradeep, Riddhi, Jatin and Ajay Pandey did multiple
role plays on consumer behaviour and ethics. Our director and producer
was Anupam and the hero was Ajay Pandey who was the narrator or
"Sutradhar" for the skit(s).Needless to say the director was excellent
and everything was planned to the minutest details and well rehersed
as well.Our actual performance was much better then what we usually
did in our rehersals. I know ours was the best peformance of the
entire batch. Ajay Pandey played a fantastic role of sutradhar and his
command over hindi resulted in a classical style of speaking and
narrating the events, mixed with humour and facts. I believe each one
us performed the best but Ajay was exceptional.Our director also
played the role of music director and how he managed that was only he
can explain.

We should have video recorded the entire skit but unfortunately I was
not carrying the recording device with me this time. Even the photos
were not taken of the live performance. I do have some photos of the
rehersals that I took one night before. More about this later.But
right now I am feeling extremely tired and nervous as I estimate the
workload I have to complete befor the term end on 15th Nov 2008 and we
move into our final term at IIM Indore, the hillock that never sleeps!
Tomorrow evening am back on a flight to Delhi for Diwali and I only
thinking about mutual funds and my hunt for efficient portfolios!