Cross fx rate..
The investor follows the cross forex rate between the Euro and the Japanese yen. He believes that this market is headed for a fall. As he is less confident of this forex market trading, he does not fully use the leverage available on his deposit. He chooses to ask the dealer for a quote in EUR1,000,000. This requires a margin of EUR1,000,000 x 5% = EUR50,000 = approx. USD52,500 (EUR/USD1.05).
The dealer quotes 112.05-10. The investor sells EUR at 112.05.
Day 1: Sell EUR1,000,000 vs JPY 112.05 = Buy JPY112,050,000.
He protects his position with a stop-loss order to buy back the euro at 112.60. Two days later, this stop is triggered as the euro strengthens short term in spite of the investor's expectations.
Day 3: Buy EUR1,000,000 vs JPY 112.60 = Sell JPY112,600,000.
The EUR side involves a credit and a debit of EUR1,000,000. Therefore, the EUR account shows no change. The JPY account is credited JPY112.05m and debited JPY112.6m for a loss of JPY0.55m. Due to the simplicity of the example and the short time horizon of the forex market trading, we have disregarded the interest forex rate swap that would marginally alter the loss calculation.
This results in a loss of JPY0.55m = approx.USD5,300 (USD/JPY 105) = 5.3% loss on the original deposit of USD100,000.
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07-22-2008, 08:56 PM
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