Global Investment in Currency
According to Hubbard & O’Brien (2006) there are two kinds of exchange rate systems: the managed float exchange rate system and the fixed exchange rate system. The latter requires countries to agree on keeping exchange rates among their respective currencies fixed. However, it is the managed float exchange rate system that currently prevails in the international financial system. In this system, the value of a currency must be determined by the free market forces of demand and supply.
All the same, the government is allowed to intervene if it believes that raising or decreasing the value of its currency against another currency or all currencies would help in the management of the economy. As a hypothetical example to illustrate this point, declining value of the U. S. dollar is expected to make it cheaper for foreign nations to import U. S. goods and services. An increase in exports is essential for the United States to balance its current account – presently facing a deficit.
Hence, if the Federal Reserve decides that the value of the dollar must be decreased against other currencies, free market forces of demand and supply are not the only factor to affect the price of the U. S.
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Investors also buy and sell currencies, seeing that the prices of currencies may fluctuate in a managed float exchange rate system. Just as investors rush to purchase common stocks of companies that are expected to rise in value, they flee those currencies that are expected to be devalued in the near future. Zhou (1997) writes that investment in foreign exchange is an accompaniment of international trade (p. 289). International trade concerns the demand and supply of goods and services that are bought and sold through international businesses.
As demand and supply of internationally traded goods and services fluctuate, values of currencies involved in the trade are also expected to fluctuate. If a currency rises in value, investors may rush to purchase it as they purchase highly valued stocks of successful companies. If a currency falls in value, however, investors may decide to sell it off. This affects the value of the currency once again. International trade relations also change with fluctuations in the values of currencies.
Undoubtedly, therefore, global investment in currencies entails the buying and selling of international currencies for profits. As suggested previously, this trade could be compared to investments in the international stock markets. Investors are known to employ their global “currency trade as a hedge against investments in other international securities. ” Global investment in currency is expected by some financial experts to provide continual streams of profit.
While “absolute returns” may not be guaranteed, investors believe in the value of portfolio diversification with this form of trade. Just as investors purchase common stock of various companies at the same time so as to balance the risks of their investments, they may purchase many different currencies at any given time to diversify their investment portfolios. Of course, those currencies which consistently rise in value against other currencies are considered most profitable. According Wayne Bowers, the director of global fixed income for the Northern Trust based in London:
Plan sponsors and other institutional investors have begun to look to currency trading as an active strategy… The returns from currency markets generally are uncorrelated to traditional asset classes, and they can provide an additional source of alpha. That offers an attractive risk-to-return ratio for plan sponsors looking to better manage their liabilities through diversification and the need for additional alpha. Global investments in currencies are not only lucrative for the institutional investor, but also for the individual investor.
As a matter of fact, diversification in currency investment is said to especially benefit those who plan to retire in a country that is different from their own, and those who desire to “hedge themselves against the risk of inflation in their home currency. ” Currency fluctuations are always possible. Hence, currency diversification is advisable. If a single currency fails, global investment in a number of currencies would not lose as much in profits. Moreover, investors cannot depend upon their investments in stocks and bonds alone to make the best possible profits on their invested moneys.
In the present era of globalization, all forms of international trade are accessible to the global investor and quite easily so with the use of the Internet. This is the reason why financial experts are increasingly recommending the currency as an asset class to global investors. In fact, investing in currencies in addition to stocks and bonds is not uncommon for the successful investor nowadays. One of the strategies for global investing in currency is referred to as tri-currency diversification.
In this form of trade, the investor may hold assets that are “denominated across” three different currencies. There are two basic methods of accomplishing the diversification: (1) An investor may “hold cash directly in the underlying foreign currency, for example, cash on account in pounds sterling, US dollars or euros with their bank;” and (2) The investors may maintain “securities such as stocks, bonds or funds which are denominated and quoted in a foreign currency. ” As mentioned before, global investing has been made very easy with advances in technology around the world’s financial centers.
Hence, the global trade in currencies has easily made its mark to include securities in its asset class – despite the fact that global investment in securities is known to be a separate form of international trade altogether. While investing in the Euro in the beginning of the twentieth century has appeared to be a highly profitable form of business, global investing in currency still suffers from mismanaged perceptions of the people that global investments must certainly entail high risk for their moneys.
What is more, financial experts are in no position to advise global investors to buy and sell currency unless they have differentiated among the three different kinds of global currency investment: (1) strategic or long-term diversification of currency; (2) “medium-term tactical currency reallocation;” and (3) “short-term leveraged currency speculation. ” The differences in currency investment have been explained thus: For example, ‘placing a levered bet’ that the Swiss franc will appreciate over
the next two months, because the investor believes in a ‘flight to quality’ story is not an example of strategic long-term investing. This speculative strategy may result in a significant loss if the Swiss franc depreciates over that period of time. The objective of a currency bet, such as the one just mentioned, is to make money if the currency moves in the direction of the bet. This is very different to the objective of long-term currency diversification, which is namely to protect your assets in the event that your country of residence changes, your home currency
devalues or is pegged to the value of another currency (or basket of currencies) at a specific date in the future. Another reason why global investing in currency is not as popular as it is expected to be in the age of globalization is the fact that all financial advisors do not possess “strong working knowledge” of the global political economy. Financial advisors must also be able to explain the interaction of interest rates, monetary policy, and currency fluctuation in order make currency investment an attractive option for their clients.
Even if financial advisors have an understanding of international economics and may easily explain to their clients the interaction of interest rates, monetary policy, and currency fluctuation; experts believe that financial advisors would be neglecting their fiduciary responsibilities if they do not recommend to their clients a certain level of “long-term strategic currency diversification. ” Reilly (2006) writes that “misconceptions continue” in the currency investment market because everybody does not possess sound knowledge about international economics.
While currencies affect prices of the automobiles that we purchase, in addition to the movement of interest rates; the majority of investors in the world tend to overlook the potential of currency to “enhance portfolio returns and lower volatility. ” All the same, currency movements remain “independent of the direction of stock or bond prices,” and therefore “currency exposure” should be looked upon as a wonderful way of diversifying portfolio risk and introducing novel sources of return. Of a certainly, global investing in currency should be made more attractive to “mainstream investors.
” This is the call of globalization, after all, as it eases international trade by removing barriers between the investments of nations. However, given that an international education about currency management is a prerequisite for a successful global currency market; financial experts continue to advise nations to undertake the responsibility of such an education for the mainstream investors. According to a report published by Pensions Week, “Currency management originally developed from pension funds beginning to move from domestic portfolios, typically a mix of bonds and stocks, into assets in foreign capital markets to diversify risk.
” But, now that the global currency market is ‘globalized,’ it is possible to rapidly develop the market and allow the global currency trade to become one of the most important forms of portfolio diversification for institutional as well as individual investors. In point of fact, the report classifies currency management as an “investment masterclass,” most definitely referring to the near future of this trade in the age of globalization. Of course, governments around the world have participated in global currency trade for a much longer period of time.
As an example: in order to keep its currency from appreciating, the government of India purchased more than $2 billion (U. S. dollars) between 8 February and 26 February 2005. Hence, currency trade could help economies during times of economic turbulence. Global investment in currency also helps to balance economies. According to a news report: The Government of India is expected to further open up the currency market to create a dollar demand and curb its fall against the rupee. The Economic Survey
2004-2005 suggests that the Centre may look at raising the $25,000 limit on overseas investments by resident individuals, reduce import duties on gold and encourage domestic companies to go for overseas acquisitions. As compared to investment experiences of the past, the global currency market has “mushroomed” especially in the last few years with a huge increase in the “number of offshore specialist currency brokers” that offer their services to both business and private investors.
The dynamics of the currency market are a given for countries that are nowadays looking forward to increased foreign direct investments. At the same time, however, countries such as India and China are not expected to be well-educated in the art and science of currency management. As mentioned previously, in order to maximize benefits in the currency market, a sound working knowledge of currency management and international economics is a necessity. This knowledge should be accompanied by a new sense of responsibility to allow the currency market to flourish beyond expectations.
International laws must be established and old rules and regulations must be reconsidered in order to simplify global investment in currency. If rules, regulations and laws are not necessary, perhaps international standards need to be established or modified for this form of international trade to be considered lucrative to an increasing number of investors around the world. After all, financial experts are extremely hopeful that this asset class is a unique one and expected to show its full range of brilliant colors (with a variety of popular currencies) in the present era of globalization.
While the recent experience of India in the global currency market is related to the country’s increasing interest in foreign direct investment and the benefits of globalization; another central feature of the currency trade with special importance for developing economies is that this form of investment has the power to bail out economies. The United States has, for example, invested heavily in the economy of Iraq, seeing that the Big Brother Economy is looked upon as the savior of the war-torn nation.
Because the United States government invested in the Iraq currency, other investors were also attracted to the Iraq Dinar, seeing that the U. S. economy was seen as a model for countries around the globe. For this reason, Sebastian River Holding’s Inc. had also purchased 100,000,000 Iraq Dinar. The company believed that this investment would “increase dramatically in the near future. ” As per another business news report of the time, this investment was highly lucrative in monetary terms: “As of [March 28, 2007] 1,000,000 Iraq Dinar is equal to $784.
93 USD, according to the Central Bank of Iraq (CBI). Since it is nearly impossible to purchase directly from CBI, 1,000,000 Iraq Dinar is being sold as high as $1340 USD here in the United States. ” Indeed, such investments were not only expected to help in the development of Iraq after its prolonged war, but also allow other economies to benefit from the reconstruction phase that the country is said to be going through even at present. As a consequence of the increasing interest in the Iraq dinar on the part of global investors in the currency market, the dinar was expected to be revalued.
Daniel Duffy, the Chief Executive Officer and President of Sebastian River Holding’s Inc. described the level of profits that should be expected by the investor in the currency: We are on our way to become large investors in foreign currency… Since Iraq has the largest natural gas reserve in the world and is the 2nd largest proven oil reserves in the world, with over 100,000,000,000 barrels of oil, the company feels that the Dinar reaching 1 Dinar per US dollar is feasible.
If the rate goes 1 Dinar for 1 US Dollar, this would give Sebastian River Holding’s Inc. a profit of well over $99,000,000 from this one investment. While investors from the developed world were expressing an increased amount of interest in the currency of the oil rich country, their counterparts in developing nations continued to look up to the currencies of the strong economies instead. The Euro and the United States dollar remain very popular investment vehicles in the developing nations.
These currencies allow the developing economies to stabilize and maintain themselves, while keeping in close contact with the foreign direct investors of the developed world. Indeed, global investments in currency are expected to benefit all economies at the same time. Isolation is not a rule of the game any longer. Rather, globalization has revealed unlimited possibilities for economies through international cooperation. Currency trade may help to strengthen all economies. At the same time, the requirement of increased education in this area of investment cannot be undermined.
In fact, currency trade could turn out to be one of the most important money making ventures of the globalized world, but only if necessary attention is paid to its prerequisite educational requirement. References Currency as an Asset Class. (2007). Northern Trust. Retrieved Nov 27, 2008, from http://www. northerntrust. com/pointofview/07_April/april07_currencyasset. html Currency Market Rules May Be Eased to Support $. (2005, Feb 26). Asia Africa Intelligence Wire. Edwards, J. (2006, Dec 15). Are currency brokers a safe bet? (2006, Dec 15). Guardian.
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