Important Foreign Exchange Terms

ABA - A 9-digit code used by the American Bankers Association to define a specific bank. Each institution has its own unique number code.

Ask price - The price at which a seller offers or it is willing to sell a currency to a buyer; also known as the offer price.

Annualized - The extrapolation of the behavior of a certain measured factor (such as rate, volatility, etc.) from a given period of time to the expanse of one full year.

Base currency - The currency in relation to which other currencies are quoted; the first currency listed in a currency pair; this is most often the currency of the home market in which the investor is trading.

Basis point (or BPS) - A financial unit of measure that describes the percentage change in value of a security. One basis point is equal to one one-hundredth of one percent, i.e. 0.01%, or as a decimal 0.0001 (see Pip). For example, a change of 4.20 percent to 4.85 percent is a move of 65 basis points.

Bid price - The price at which a buyer offers or is willing to pay to purchase a currency from a seller.

Central bank - A particular country's governmental body that controls the nation's monetary policy and currency creation.

Consumer Price Index (CPI) - A measure of the average price that a typical U.S. consumer pays for a standardized basket of goods and services as compared to the average price paid for that same basket of goods and services in an earlier base year.

Cross rates - The foreign exchange rate between two currencies other than the U.S. dollar, which is the currency in which most exchanges are typically quoted. Thus, the cross rate would be expressed as the ratio of the dollar rates of the two currencies.

Currency - the lawful denominated medium of exchange of a country. In the foreign exchange market, each country's currency is represented by a unique three-character ISO code. For example, United States dollars are identified USD, Euros are designated EUR, etc.

Currency pair - The exchange rate relationship between two currencies whereby one currency is expressed in terms of the other. The first listed currency of the pair is called the base currency, and the second currency is known as the quote or counter currency. For example, USD/EUR is a common currency pair, and is pronounced "U.S. dollars per Euro."

Day Trading - A highly specialized type of investing in which market positions are opened and closed with the same day (or within a few days at most). This type of trading is usually speculative in nature.

Discount Rate - The interest rate that a private banking institution pays for loaned funds received from the U.S. Federal Reserve System.

Exchange rate - The amount of a particular currency needed to buy a standardized amount of another currency.

Exchange rate risk - The potential loss that an investor faces from a movement in bid/ask prices (i.e., exchange rates) that is adverse to the investor's open market position.

Euro - The currency adopted as a result of the European Economic and Monetary Union (EMU); it replaced those of the following member countries: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain.

Exposure - The risk that an investor accepts from any open investment position; the amount that can be lost; also known as market exposure.

Federal Reserve System - The central bank of the United States, which has the responsibility of implementing the country's monetary policy and regulating the system's member banks.

Fixed exchange rate - The official exchange rate set by the monetary authority of a country, typically its central bank.

Floating exchange rates - Exchange rates that are determined by supply and demand.

Foreign exchange - The exchange or trading of foreign currency (also known within the industry as Forex or FX); also, transactions that cause a change in the foreign currency position of a financial institution. Foreign currency is bought and sold on the foreign exchange market either for immediate (known as spot) or forward delivery.

Foreign exchange market - An area (not necessarily confined to physical borders or boundaries) where buyers and sellers are in contact for the purpose of trading foreign currencies.

Forward contract - A purchase contract that locks in the exchange rate for delivery on a specified future date. The buyer is typically required to put up a deposit (or margin) for the privilege of buying the future currency at today's rate of exchange.

Hedging - A strategy used by traders and investors to protect an investment or portfolio against loss. With regard to currency transactions, a current sale or purchase would be offset by the investor contracting to buy or sell another financial instrument at a specified future date in order to the eliminate a profit or loss on the current sale or purchase by balancing it out. In this manner the risk due to price fluctuations is substantially negated.

Interbank prices - Market rates that apply to currency prices for transactions of one million U.S. dollars or more; these prices differ from retail market rates.

ISO - International Standards Organization, a global standard-setting body.

Long position - A market position in which the investor has purchased a financial instrument (stock, commodity, currency, etc.) that he or she did not previously own, with the expectation of an increase in value (also known simply as long); opposite of short position.

Margin - An investor-contributed cash percentage of the market value of securities held in a margin account; a cash deposit provided as collateral by the purchaser of a forward contract position.

Market maker - An individual or financial institution that provides consistent buy and sell quotations for a particular security or securities. A market maker must carry an inventory of the securities quoted or have ready access to the quoted amounts.

Offer price - See Ask price.

Open position - Any market transaction (whether long or short) that has not yet either been settled by physical payment or effectively balanced out by an equal and opposite transaction for the same date.

Overbought - A market circumstance in which the movement of a currency pair price has risen at least 150 percent more violently than normal, overreacting to net buying activity. As a result, a price correction will generally be expected to soon take place; in other words, investors will expect the price of the currency pair to presently fall.

Oversold - A market circumstance in which the movement of a currency pair price has fallen at least 150 percent more violently than normal, overreacting to net selling activity. As a result, a price correction will generally be expected to soon take place; in other words, investors will expect the price of the currency pair to presently rise.

Point (or Pip) - The smallest incremental move that an exchange rate can make. Because most currency pairs are priced to four decimal places, the smallest incremental move possible would be a change of 0.0001, which is equivalent to one Basis point. For example, a currency that has moved from a price of 1.4580 to 1.4583 has risen three points (or pips).

Portfolio - The total selection of securities held by an investor or financial institution. A primary function of the portfolio is to manage and minimize investment risk.

Price movement - The change in price of a particular currency over a given period of time.

Retail prices - Market currency prices that include commissions and other charges which exchange agencies or banking institutions levy in order to convert currencies for non-corporate (i.e., private) clients.

Risk - The chance that an investor's return-on-investment (ROI) will be different from that expected, including the potential for loss of part or all of his or her investment funds.

Settlement - The final stage or culmination of a transaction, identified by the physical exchange of one currency for another.

Short position - A market position in which the investor has sold a financial instrument (stock, commodity, currency, etc.) that he or she did not previously own, with the expectation of a decrease in value (also known simply as short); opposite of long position.

Spot - A transaction that will reach settlement within two days.

Spot price - The current market price of a spot transaction.

Spot rate - A spot transaction's current rate.

Spread - The difference between a currency's bid and ask prices.

Stop-buy - A buy order that is executed when an investor-specified price (which is above the current ask price) is reached; used to enter the market when prices are expected to continue to rise.

Stop-loss (or Stop order) - An order that is executed when an investor-specified price is reached to close the market position by either buying or selling (depending upon whether the position is long or short) to limit the investor's loss from a damaging price move.

Trend - The direction of the market; generally identified as either a major, intermediate, or short-term trend. A trend's direction may be upward, downward, or sideways.

Volatility - A measure by which prices are expected to fluctuate or have fluctuated during a given period of time.