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Forex

What is the difference between LIBID and LIBOR?
A:

Both LIBID and LIBOR are reference rates set by banks in the London interbank market. The London interbank market is a wholesale money market in London where banks exchange currencies either directly or through electronic trading platforms.

The acronym LIBID stands for London Interbank Bid Rate. It is the bid rate that banks are willing to pay for eurocurrency deposits and other banks’ unsecured funds in the London interbank market. Eurocurrency deposits refer to money in the form of bank deposits of a currency outside that currency’s issuing country. They may be of any currency in any country.

The most common currency deposited as eurocurrency is the U.S. dollar. For example, if U.S. dollars are deposited in any bank outside the U.S – Europe, the U.K., anywhere – then the deposit is referred to as a eurocurrency.

LIBOR (officially ICE LIBOR – see “Why Is LIBOR Sometimes Referred to As LIBOR ICE?”) stands for London InterBank Offered Rate. LIBOR is the interest rate at which banks can borrow money (unsecured funds) from other banks in the London interbank market for a specified period of time in a specified currency. The benchmark rate is calculated for seven maturities for five currencies: the Swiss franc, the euro, the pound sterling, the U.S. dollar and the Japanese yen. There are actually 35 rates that are released to the market every day.

LIBOR and LIBID are both calculated and published daily. However, unlike LIBID, which has no formal correspondent responsible for fixing it, LIBOR is set and published daily around 6:45 a.m. EST (11:45 a.m. in London) by the ICE Benchmark Administration (IBA).

Both these rates (especially LIBOR) are considered the foremost global reference rates for short-term interest rates of a variety of global financial instruments such as short-term interest futures contracts, forward rate agreements, interest rate swaps and currency options. LIBOR is also a key driver in the eurodollar market, and is the basis for retail products like mortgages and student loans. They are derived from a filtered average of the world’s most creditworthy banks’ interbank bid/ask rates for institutional loans with maturities that range between overnight and one year.

The London Interbank Mean Rate (LIMEAN) is the calculated average between LIBOR and LIBID and can be used to identify the spread between the two rates. LIMEAN is also used by institutions borrowing and lending money in the interbank market (rather than using LIBOR or LIBID), and is a reliable reference to the the mid-market rate rate of the interbank market.

To learn more, see “An Introduction to LIBOR.”

What is the difference between pips, points, and ticks?
A:

Point, tick and pip are terms used to describe price changes in the financial markets. While traders and analysts use all three terms in a similar manner, each is unique in the degree of change it signifies and how it is used in the markets. A point represents the smallest possible price change on the left side of a decimal point, while a tick represents the smallest possible price change on the right side of a decimal point. A pip, short for point in percentage, is similar to a tick in that it also represents the smallest change to the right of the decimal, but it is a crucial measurement tool in the forex market.

A point is the largest price change of the three measurements and only refers to changes on the left side of the decimal, while the other two include fractional changes on the right. The point is also the most generically used term among traders to describe price changes in their chosen markets. For example, an investor with shares in Company ABC stock might describe a price increase from $125 to $130 as a five point movement rather than a $5 movement.

Some indexes restate prices in a manner that allows investors to track price changes in points. For example, the investment grade index, or IG Index, tracks price movements to the fourth decimal. However, when quoting prices, it shifts the decimal four places to the left so movements can be stated in points. Therefore, a price of 1.23456 is stated as 12,345.6.

A tick denotes a market’s smallest possible price movement to the right of the decimal. Going back to the IG Index example, if this index elected not to shift the decimal place to use points, its price movements would be tracked in increments of 0.0001. A price change, then, from 1.2345 to 1.2346 would represent one tick. Ticks do not have to be measured in factors of 10. For example, a market might measure price movements in minimum increments of 0.25. For that market, a price change from 450.00 to 451.00 is four ticks, or one point.

A pip measures the price change in the currency market, with one pip equivalent to 0.0001. 

(To learn more about pips and their significance to forex markets, see “What Is a Pip?”)

What is the name of the currency in New Zealand?
A:

The New Zealand currency is known as the New Zealand dollar. The currency was decimalized in 1967, and divided into 100 parts or cents. Before 1967, the currency was called the New Zealand pound. But since its decimalization, it has been called the New Zealand dollar. The currency, affectionately referred to as the Kiwi, trades under the symbol NZD or NZ$.

Since 1999, the New Zealand government has produced polymer or plastic versions of the New Zealand dollar, which has made the note more secure against counterfeiting. In addition, the new polymer composition has increased the longevity of the note. It is estimated that the polymer note lasts four times longer than regular linen or paper notes. Interestingly, the polymer note can go through a washing machine without suffering any material damage. Will other countries around the world follow suit and move their currencies from paper to polymer?

(For more on this topic, see What are the most common currency pairs traded in the forex market?)

What is the value of one pip, and why are pips different between currency pairs?
A:

In forex markets, currency trading is conducted most frequently among the U.S. dollar, the Japanese yen, the euro, the British pound and the Canadian dollar.

A currency pair such as EUR/USD, for example, represents the relationship between the euro and U.S. dollar. The first currency is the base currency and the second currency is the quote currency. So, to buy EUR/USD at 1.1200 on a trade for 100,000 currency units, you would need to pay US$112,000 (100,000 * 1.12) for 100,000 euros.

Four major currency pairs are the most traded and have the highest volume. These are known as the major pairs. They are the EUR/USD, USD/JPY, GBP/USD and the USD/CHF. These pairs all contain the U.S. dollar. In yen-denominated currency pairs, a pip is only two decimal places, or 0.01. This is 1/100th of a cent. Currencies are often traded in lots that are 1,000 units of the underlying currency.

A pip, an acronym for “price interest point”, is a tool of measurement related to the smallest price movement made by any exchange rate. Currencies are usually quoted to four decimal places, meaning that the smallest change in a currency pair would be in the last digit. This would make one pip equal to 1/100th of a percent, or one basis point. For example, if the currency price we quoted earlier changed from 1.1200 to 1.1205, this would be a change of five pips.

[Note: Pips are one of the most fundamental concepts to understand when trading currencies, but there are countless other concepts that forex traders need to know to be successful. Investopedia Academy’s Forex Trading course will teach you a proven strategy that you can leverage when trading all currencies. Check it out today!]

To get the value of one pip in a currency pair, an investor has to divide one pip in decimal form (i.e., 0.0001) by the current exchange rate, and then multiply that number by the notional amount of the trade.

Keeping with our earlier example for the EUR/USD currency pair, let’s say the value of one pip is 8.93 euros ((0.0001/1.1200) * 100,000). To convert the value of the pip to U.S. dollars, just multiply the value of the pip by the exchange rate, so the value in U.S. dollars is $10 (8.93 * 1.12).

The value of one pip is always different between currency pairs because of differences between the exchange rates of various currencies. A phenomenon does occur when the U.S. dollar is quoted as the quote currency. When this is the case, for a notional amount of 100,000 currency units, the value of the pip is always equal to US$10.

To learn more, see “Common Questions About Currency Trading,” “A Primer on the Forex Market” and “Forces Behind Exchange Rates.”

What should I look for when choosing a forex trading platform?
A:
A trading platform is a piece of software that acts as a conduit for information between a trader and a broker. A trading platform provides information such as quotes and charts, and includes an interface for entering orders to be executed by the broker. Trading platform software can be locally based, meaning it is installed on the trader’s computer and can be used with Windows, Mac and Linux systems – different brokers offer different options in this respect. Alternatively, some brokers offer software that is web based. These platforms often run using Java, a dynamic web language. The advantage of web-based trading platforms is that they can be used by almost any computer with internet access. Trading platforms are often available free-of-charge, but some brokers allow traders to purchase platforms that have a higher functionality for a fee. Other brokers provide platforms with different levels of functionality for traders who are more active.

Online Forex Trading
Online forex trading requires the same things from a trading platform that are required for trading any other type of security. The platform must act as a go-between for the retail forex broker and the forex trader. Platforms must also provide real-time and historical data to the trader and provide the him or her with access to all of the types of orders that need to be available to trade forex efficiently. (For more on this, read Place Forex Orders Properly.)
Third-party forex trading software is also often used, as many retail forex brokers’ platforms have an application program interface (API), which allows traders to integrate third-party or even proprietary software into the platform.
Some factors to consider when looking for forex software are:

  • Is it free? If there is a nominal charge, what additional features are made available?
  • What technical indicators are available in the charting component?
  • Is the software Windows, Mac or internet (Java or HTML) based?
  • Can you trade from the charts?
  • What is the order interface? What types of orders are available?
  • Is historical data made available through the software?
  • Does the platform allow for backtesting of strategies?
  • Is the graphical user interface (GUI) pleasing to look at?
  • Is the GUI conducive to monitoring a lot of information at once?
  • Does the platform have an API that allows additional software or programming?
Most forex brokers allow customers to open a demo account prior to funding a full account or mini account. Be sure to try out each broker’s software during their trial periods to help determine which forex trading software is best.
For more on this topic, see our Forex Market Tutorial.

What types of accounts are available for forex trading?
A:
There are many different types of forex accounts available to the retail forex trader. Demo accounts are offered by forex brokers as a way to introduce traders to their software and execution methods. After the trader has tried out demo accounts with a few different dealers, a funded trading account would be the next step.
Mini accounts, full accounts, and managed accounts are the most common types of funded accounts. Mini accounts are similar to regular trading accounts; however currency is traded in lots of 10,000 rather than 100,000. This allows for lower mandatory initial deposits, and greater customization of risk management.
It is important that the currency trader consider what they want to get out of their account, before deciding on the type to open. Demo accounts, and mini accounts, are great for the retail forex trader to learn a profitable system, and get used to the execution methods of the broker. For the currency speculator that doesn’t want to trade by themselves, a managed account would be better.
Forex Managed Trading
Forex managed trading involves a money manager that trades a forex account on behalf of a client for a fee. Managed forex accounts are similar to hiring an investment advisor to manage a traditional investment account of equities and bonds. Returns and fees between managed accounts can vary greatly; therefore, it is important to research your options thoroughly before assigning your account to a professional manager.
Managed Forex Account
Some managed forex accounts involve the trader “teaching” the manager what signals to look for and how to interpret them. It is thought that forex managed trading takes the psychology out of managing personal wins and losses.

Another managed forex account type uses the firm’s own proprietary trading systems. However, it is important to note that there is no such thing as the “holy grail” of trading systems. If a system is a perfect money maker, the seller will not want to share it. This is why big financial firms keep their “black box” trading programs under lock and key.

For more, see our Forex Market Tutorial.

When did the U.S. start using paper money?
A:

On February 3, 1690, the Massachusetts Bay Colony was said to have issued the first paper money in the U.S. in order to pay for military action against Canada during King William’s War.

Massachusetts was a truly pioneering colony when it came to money, as they were also the first to mint their own silver coins in 1652, despite a British law against it. The paper money created in 1690 was called a bill of credit, and represented the colony’s obligation to the soldiers. The soldiers could spend or trade the colony’s IOU just like silver and gold coins.

During the revolution of 1775, colonial leaders tried to replicate Massachusetts’ paper experiment on a wider scale, but the newly-christened continentals lacked any backing, such as silver or gold. On a small scale it may have worked, but so much money was printed that rapid inflation stripped them of all their value.

Less than 100 years later, two competing currencies were used to finance the opposing sides of the Civil War. Their values fluctuated with the fortunes of the war. Yet, it wasn’t until the National Banks Act after the civil war that the U.S. government introduced a monetary system where banks could issue paper notes based on their holding of government bonds. These disparate currencies were taxed out of existence in the following decades and replaced with national bank notes, giving the U.S. its first uniform paper currency.

To learn more about monetary policy, see “The Fed’s Tools for Influencing the Economy.”

Where is the central location of the forex market?
A:
There is no central location of the foreign exchange market, often referred to as the forex (FX) market. Transactions in the FX market take place in many different forms, 24 hours a day, through different channels all over the globe; existing wherever one currency is exchanged for another.
The forex market is situated within the following areas:

  • retail forex brokers
  • central banks
  • commercial businesses
  • banks
Retail Forex Brokers
These brokers offer speculative trading to the individual retail trader. This area of the forex market is very small compared to the total volume of currency exchanged worldwide.
Central Banks
By purchasing and selling currencies, central banks try to control their money supply, interest rates and inflation. Whether official or not, nations often have target exchange rates for their currencies, and a nation’s central bank can often use their reserves of national and foreign currency to try and stabilize the market for their currency.
Commercial Businesses
Whenever a company has to purchase from, or sell to a company in a foreign nation, a foreign exchange transaction is likely to occur. For example, a U.S. based company may need to purchase Euros to pay an invoice to a French company; or the French company may have to purchase U.S. dollars to pay a U.S based invoice. In both of these cases a foreign exchange transaction needs to occur. Companies that deal with foreign customers or suppliers often take this one step further, and purchase or sell currencies as a hedge against future exchange rate movement. By locking in today’s exchange rates, companies can take exchange rate risk out of the equation.
Interbank Market
The interbank market makes up the largest portion of the forex market, and is inclusive of the above areas of trading. Customers often turn to the banks to intermediate their foreign exchange transactions, and banks often trade their own accounts as well.
There is no central location that forex trading occurs in. For this reason, there is no central body controlling prices and actions of many players. This is a new and lucrative area for speculation, but investors must heed the risks that are taken when entering it.
To learn more, read Getting Into The Forex Market and our Forex Market Tutorial.

Who determines interest rates?
A:

In countries using a centralized banking model, interest rates are determined by their respective central banks.

In order to determine the interest rate, a government’s economic observers create a policy that helps ensure stable prices and liquidity. This policy is routinely checked so that the supply of money within the economy is neither too large (causing prices to increase) nor too small (causing prices to decrease). In the U.S., interest rates are determined by the Federal Open Market Committee, which consists of the seven governors of the Federal Reserve Board and five Federal Reserve Bank presidents. The FOMC meets eight times a year to determine the near-term direction of monetary policy and interest rates.

For further background on the Federal Reserve’s functions, see our tutorial on The Federal Reserve.

Retail banks are typically the first financial institutions to expose money to the economy, and therefore they are the principal instruments used by the central bank to manipulate the money supply. Put simply, the central bank is able to regulate the supply of money to the end user (individuals and companies) by adjusting interest rates on the money it lends to or borrows from retail banks.

If the monetary policy makers wish to decrease the money supply, they will increase the interest rate, which makes it more attractive to deposit funds and reduce borrowing from the central bank. Conversely, if the central bank wishes to increase the money supply, they will decrease the interest rate, which makes it more attractive to borrow and spend money.

For further reading on interest rates, see “Interest Rates and Your Bond Investments,” “Forces Behind Interest Rates,” and “How Interest Rates Affect The Stock Market.”

Why does the time value of money assume that a dollar today is worth more than a dollar tomorrow?
A:

The time value of money, or TVM, assumes a dollar in the present is worth more than a dollar in the future because of variables such as inflation and interest rates. Inflation is the general increase in prices, which means that the value of money depreciates over time as a result of that change in the general level of prices.

Changes in the price level are reflected in the interest rate. The interest rate is charged by financial institutions on loans (i.e., a mortgage or car loan) to individuals or businesses and TVM is taken into account in setting the rate.

TVM is also described as discounted cash flow (DCF). DCF is a technique used to determine the present value of a certain amount of money when received at a future date. The interest rate is used as the discounting factor, which can be found by using a present value (PV) table.

A PV table shows discount factors from time 0 (i.e., the current day) onward. The later money is received, the less value it holds, and $1 today is worth more than $1 received at a date in the future. At time 0, the discount factor is 1, and as time goes by, the discount factor decreases. A present value calculator is used to obtain the value of $1 or any other sum of money over different time periods.

For example, if an individual has $100 and leaves it in cash rather than investing it, the value of that $100 declines. However, if the money is deposited in a savings account, the bank pays interest, which depending on the rate could keep up with inflation. Therefore, it is best to deposit the money in a savings account or in an asset that appreciates in value over time. A PV calculator can be used to determine the amount of money required in relation to present versus future consumption.

To learn more about the basics of investing, see our Investing for Beginners crash course.