Added: 02/13/2006 |
Money market rates - What are they?The money market is a general term for the markets in which banks lend to and borrow from each other, trade financial instruments such as Certificates of Deposit (CDs) or enter agreements such as Repos and Reverses. The market normally trades in maturities up to one year. It provides short to medium term liquidity in the global financial system. Derivatives of the money market include forward rate agreements (FRAs) and futures.
The money market rates between for example two currencies Japanese Yen to the Dollar means that Ґ120 is worth the same as $1. The money market rates are also known as a foreign money market rates. The Currency Market or money market is the largest market in the world. By some estimates, about $2 trillion worth of currency changes hands every day.
The quotation of money market rates is given by stating the number of units of a price currency that can be bought in terms of a unit currency. For example, in a quotation that says the Euro-United States Dollar money market rate is 1.2 dollars per euro, the price currency is the dollar and the unit currency is the euro.
Quotes using a country's home currency as the price currency are known as direct or price quotation (from that country's perspective) and are used in the US and most other countries.
Quotes using a country's home currency as the unit currency are known as indirect or quality terms quotation and are used in British newspapers and are also common in Australia and New Zealand"
- direct quotation: Home Currency / Foreign Currency;
- indirect quotation: Foreign Currency / Home Currency.
Note that, using direct quotation, if a unit currency is strengthening (i.e. appreciating, i.e. if the currency is becoming more valuable) then the money market rate number increases. Conversely if the price currency is strengthening, the money market rate number decreases and the unit currency is depreciating.
The only real currency market is the 'deliverable' orders for individuals and businesses who need to buy and sell x currency at any money market rate. If you are buying a house in New Zealand, or a farm in Ireland, you will exchange your dollars regardless of the money market rates. This deliverable business drives the prices up and down unless rates are pegged like China's Yuan is pegged to the US dollar 8.23 YUAN to 1 USD.
It is possible for investors to speculate on currency fluctuations and realize profits by parking funds in one currency, and after it appreciates in value, switching to another. In our floating point system actually every investment in the world is calculated in some domestic currency. So when you are making 20% on your investment in the USDollar by investing in the DJIA, realize that if the dollar has gone down by 40% you have actually lost! This will not be reflected in your bank statements of course, but it will be reflected in the purchasing power of your dollars when you go to spend them. This is tied to inflation. Let's say you turn a $10,000 investment into $15,000 - you are very happy! But because the US dollar is down by 50%, it now costs 2$ for a gallon of gas than 1$ - so you may have a nice fuzzy feeling about making 50% but in fact you have lost.
Like any market there is a bid and an ask (buying price and selling price). The real spread between currencies is actually 1 or 2 pips. In the EURO/USDOLLAR price of 1.4238 a pip would be the '8' at the end. So the bid/ask quote of EUR/USD might be 1.4238/1.4239 - however a bank will mark up the difference to say 1.41 / 1.43 . To most travelers exchanging 10 or 100 or even 1,000 dollars this is only a few dollars, but if you are a business exchanging millions, this can be a huge risk. To mitigate this risk a business will hedge (finance) a currency, for example buying a contract to buy 6 months worth of EURO at a set price. He will never make money on the currency, but he will never lose, and he can make a budget for selling his products.
People say 'but I buy everything in dollars' - there are several instances where you should consider currency: when you are investing (in anything), when you are travelling, when you are conducting business (other than mom and pop shops). The only airline who is not filing bankruptcy is the one who hedged the price of oil by buying 2 years worth of fuel. Currency and money market rates are not something to be passed aside.
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