Handbook of Finance: Investment Management and Financial Management

Chapter 54. Some Considerations in the Use of Currencies

BRUCE COLLINS, PhD

Professor of Finance, Western Connecticut State University

OZGUR KAN, PhD, CFA, FRM

Product Specialist, Moody's Investors Service

Abstract: The market for foreign exchange is the largest and most liquid financial market in the world with almost U.S. $2 trillion in daily traditional transactions. The amount of trading in foreign exchange markets has doubled since 2001 with most of the increased volume attributed to some form of speculation rather than for traditional transactions purposes. The growing search for alternative asset classes on the part of institutional investors has lead to currencies as a separate asset class and to the development of currency investment programs and currency overlay programs in the investment management business. Hedge funds and pension funds in particular have directed investments into currencies. In addition, the arrival of the Internet has led to the creation of competing retail trading platforms for foreign exchange. It all adds up to increased volume and the need for a greater understanding of this important market. Trading foreign exchange involves a position in a currency pair, which means the purchase of one currency is the simultaneous sale of another. Managing a portfolio of currency positions as an investment strategy or a currency overlay program requires an understanding of market mechanics, pricing, and the trading instruments.

Keywords: foreign currency market, currency ...