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How many Rupees to a Dollar? - Outside View

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How many Rupees to a Dollar?
Jul 5, 2010

The exchange rate closed at forty-six rupees and sixty-eight paise to the US dollar on 2nd July, 2010. But no, this is not the question I'm going to spend the rest of the article answering. To get to why this was the rate requires different thinking from investing in the stock market, so I shall start with some basics.

First, what is the most active financial market in the world? If you feel tempted to reply, 'the stock markets, of course!', do resist a response. The largest stock market in the world, the New York Stock Exchange, has an average daily trading value of around $150 billion. What may surprise you is that the currency markets dwarf the stock markets, with an average daily trading value of $4 trillion!

Currency markets are so active because they provide excellent opportunities for portfolio diversification and trading profits. The NSE & MCX-SX provide four different currency futures contracts to choose from (USDINR, EURINR, GBPINR, and JPYINR - the Indian rupee relative to the US dollar, the Euro, the Pound and the Yen).

Unlike stocks, currencies are a zero sum game. This is because currencies are measured against one another, so one currency's rise must mean another currency's fall. So, for every winner, there is a loser. Overall, at the end of the trading day, no new net wealth is created.

The stock market works on different principles. If the market rises (falls), the overall value of the market increases (decreases), so investors as a whole become more (less) wealthy - i.e., it is not a zero sum game.

You might ask, as an investor, how can one consistently make money from FX markets when currencies are a zero sum game? (In fact, after spreads and commissions, it will become a negative sum game)

This requires an understanding of the market's participants. So, let's take a step back and look at who are the big players. They consist, first, of banks, whose purpose is to make markets and profit from the spread, much like any broker in any financial market. Next we have companies, which may earn and spend money in currencies other than their home currency, and use the market to make foreign transactions, and hedge against currency movements. Third are the central banks, which either discreetly or openly will intervene to achieve a desired exchange rate for their own currency. (An example is China, which regularly intervenes to keep the Renminbi pegged to the Dollar, but all countries central banks, including the Reserve Bank of India, do this). Fourth, dear reader, is you: the group of investors, traders, and speculators who seek profits from their understanding of currency movements.

Among the major market players, neither companies nor central banks are out specifically to make a profit from changes in rates, while banks are in it for the spread. By analyzing their (often changing) motives - using macroeconomic analysis, short-term interest rate changes and a range of other factors - the investor makes money within the zero sum game that applies to the market as a whole. In practice, therefore much of currency analysis relies on how we expect central banks to behave and where companies are likely to make investments (i.e. examining country fundamentals).

In the coming weeks, we'll discuss trading strategies, market trends, and investment opportunities. Most importantly, my aim is to provide you, the investor, with the right tools to make informed decisions in the currency markets, and of course make a handsome profit!

This column, A Fresh Perspective, is authored by Asad Dossani. Asad is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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