23 October Commemorating Forty-One (41) Years of Fiat Currency October 23, 2017By FX Initiative FX Market Overview, General , Bretton Woods, Brexit, Continuing Professional Education, CPE, Currency, Demand, Exchange Rates, Fiat Currency, Foreign Exchange, Gold Standard, Management, Risk, Supply, Volatility, FX 0 This week marks 41 years since the definition of the U.S. dollar was officially changed through Public Law 94-564 on October 19, 1976. The result was a shift in U.S. monetary policy where the gold standard, which pegged all currencies to the U.S. dollar (USD) and fixed value in terms of gold, was replaced by our current system of freely floating fiat currencies, where currency no longer holds intrinsic value and is established as money by government regulation or law. This was the most notable event during the Nixon Shock, which was a series of economic measures undertaken by United States President Richard Nixon beginning in 1971, and shaped the nature of the foreign exchange market as it exists today. Source: http://uscode.house.gov/statutes/pl/94/564.pdf The free floating system of fiat currencies is best illustrated by the U.S. dollar Index (DXY) that was introduced in March of 1973. The DXY is a measure of the value of the United States dollar (USD) relative to a basket of foreign currencies, which include the euro (EUR), Japanese yen (JPY), Pound Sterling (GBP), Canadian dollar (CAD), Swedish Krona (SEK) and Swiss franc (CHF). At its start, the value of the U.S. Dollar Index was 100.000, and it has since traded as high as 164.7200 in February 1985, and as low as 70.698 on March 16, 2008. The DXY goes up when the U.S. dollar gains value when compared to other currencies, and goes down when the U.S. dollar loses value. The following graph shows the volatility in the value of the U.S. dollar over the last 50 years in relation to various political, economic and other major global events. Source: US Dollar Index from Stooq.com Free floating exchange rates are determined by the balance between supply and demand factors that influence a particular currency, and the intersection point where supply meets demand establishes what is known as the price equilibrium or exchange rate. The graph below of supply and demand shows that when there is an increase in demand and a corresponding shift of the demand curve to the right, a new intersection point where supply meets demand is established, and a new price equilibrium or exchange rate is set. In this case, as demand increases, the value or price of the currency also increases from Exchange Rate 1 to Exchange Rate 2. These fluctuations in currency values underscore the concept of exchange rate risk, or currency risk, which arises from the change in price of one currency against another. Source: FX Initiative FX Market Overview Course Supply and demand with respect to foreign currency valuations is a simple idea in theory. If at a particular exchange rate, demand exceeds supply, the price will rise, and if supply exceeds demand, the price will fall. Supply is influenced by a central bank’s monetary authority through monetary policy, and depending on the specific circumstances and economic goals of a country or region, a monetary authority will influence the money supply through interest rates and other market mechanisms. Demand, on the other hand, comes from a multitude of market forces including, but not limited to, (1) economic business cycles and economic data releases (2) international investment patterns and foreign direct investment (3) the balance of payments as it relates to tradable goods and services (4) government fiscal, monetary, or other policies and political developments and (5) speculation based on any or all of these factors. Source: FX Initiative FX Market Overview Course Over the last 40 years, governments have played a significant role in defining and driving the value of free floating fiat currencies. Since the financial crisis of 2007–2008, exchange rates have been impacted by several major foreign exchange interventions as follows: Venezuela’s introduction of a two-tier official exchange rate system for the Venezuelan bolívar in January 2010 The Bank of Japan’s devaluation of the Japanese yen though quantitative easing and “Abenomics” in April of 2013 The Central Bank of Russia allowing the Russian ruble to float freely in an attempt to stabilize value in November of 2014 The Swiss National Bank (SNB) no longer holding the Swiss franc at a fixed exchange rate with the euro in January 2015 Brexit’s impact on the British pound following the United Kingdom’s referendum to withdraw from the European Union in June 2016 In commemoration of the week that changed the foreign exchange market as we know it, we can look at free floating exchange rates through the lens of history and see how the events of the 1970’s are still impacting the value of more than 180 currencies recognized as legal tender in circulation throughout the world. To learn more about the foreign exchange market and how to manage currency risk, explore FX Initiative’s educational videos, interactive examples, and webinar events. Our currency risk management training illustrates best practices from leading organizations such as Apple to help you efficiently and effectively mitigate foreign exchange risk for your international business. Learn how to assess and optimize your firm's foreign exchange risk profile by taking the FX Initiative today! Ready to conquer currency risk? Click here to get started! Cheers, The FX Initiative Team support@fxinitiative.com Related Posts Comparing Cryptocurrency to Foreign Currency Cryptocurrencies such as Bitcoin have captured headlines in 2017, and the question of how modern cryptocurrencies compare to traditional foreign currencies is often raised. FX Initiative helps global businesses manage foreign exchange (FX) risk, and this article will explore some of the key differences between cryptocurrency and foreign currency from a corporate foreign exchange risk management perspective. It is clear that cryptocurrencies are still in their infancy, but the debate in the financial community over the future growth of this digital asset class remains open. While many articles have focused on areas such as monetary authorities, regulation, costs, timing, and transparency, this article will offer a unique focus specifically on the areas of acceptance, exchange, utilization, obsolescence, and risk management. Acceptance A small but growing number of brand name companies promote their acceptance of Bitcoin, such as Overstock.com, DISH Network, Expedia, Microsoft, and others. In fact, Coinbase claims that 47,000 businesses integrate Bitcoin with their service. However, companies such as Dell and Fiverr announced their acceptance of Bitcoin in 2014 but have since updated their policies to no longer accept Bitcoin. As ... Identifying Direct vs. Indirect Currency Quoting Conventions It is evident that no one single world currency exists. There are over 180 currencies recognized as legal tender in circulation throughout the world. The most widely used list of currencies is known as ISO 4217, which is a standard published by the International Organization for Standardization or the ISO. The ISO is an international standard-setting body composed of representatives from various national standards organizations, and the ISO 4217 currency codes shown in FX Initiative’s Currency Code Locator are used in banking and business globally. The ISO 4217 currency codes are also commonly used when publishing exchange rate quotes in newspapers or banks to help delineate the different currencies instead of translating currency names or using ambiguous currency symbols. The most traded pairs of currencies in the world are called “The Majors”, and they include the euro, British pound sterling, Australian dollar, New Zealand dollar, United States dollar, Canadian dollar, Swiss franc, and Japanese yen. While someone new to the foreign exchange market might view published FX quotes similar to a stock or commodity price quotes, it is important to ... How to Price Cryptocurrency (Bitcoin) Derivatives? Bitcoin (BTC) broke through to a record high of $11,831 over the weekend as volatility in the cryptocurrency continues to rise. Amidst these large and recent price fluctuations, the CME Group (Chicago Mercantile Exchange & Chicago Board of Trade) announced that its new bitcoin futures contract will be available for trading on December 18, 2017. While the valuation of traditional currency and equity derivatives is well established among professionals working in the financial industry, the introduction of the first cryptocurrency bitcoin derivative poses valuation questions as it relates to a new pricing model. Simply put, how are cryptocurrency derivatives priced? Financial engineering is a continuously evolving discipline designed to introduce and test new products, pricing models and hypotheses. Currently, equity futures are typically priced using variables such and the risk free interest rate and dividends, and currency forwards are priced based on the foreign and domestic interest rate differential between the two currencies in the pair. Additionally, equity options are typically priced using the Black–Scholes option pricing model, and currency options are priced using the Garman–Kohlhagen option pricing model. All ... How to Compare Currency Derivatives & Credit Considerations Foreign exchange risk management involves the use of currency derivatives, which are financial contracts between two parties whose value is derived from the exchange rate of one or more underlying currencies. In order to use currency derivatives to achieve foreign exchange risk management objectives, companies must be able to deal or trade with a credit worthy counterparty such as a bank or financial institution. Counterparty credit risk is the risk that the counterparty to a contract does not perform, and is involved in any banking activity, including trading currency derivatives. Therefore, both parties in the transaction need to consider the financial condition of their counterparty by quantifying their creditworthiness. It can be helpful to compare key credit considerations between the three most common currency derivatives, which include forward contracts, vanilla options, and zero cost collars. Forward contracts involve the exchange of two currencies at an agreed upon rate on the date of the contract for settlement on a date more than two business days in the future. A forward contract will almost always finish in either an asset or liability position ... Conquering Currency Risk Management Conquering currency risk management involves identifying, analyzing, and prioritizing various foreign exchange (FX) exposures, and developing and implementing a coordinated and systematic plan that utilizes company resources efficiently and effectively to mitigate and optimize FX risk. An important part of mitigating FX risk is hedging exposures such as revenues, expenses, receivables, payables, assets, liabilities, and equity. The degree to which companies implement adequate foreign exchange risk management practices can vary substantially, from not managing the risk at all to engaging in robust hedging activities. As a result, the FX impact on the bottom line can vary widely across organizations. Global companies face questions including, but not limited to: How to manage currency risk? How to draft a FX risk policy? Where to look for FX risk exposures? What currency risks to hedge and how? Which strategies meet FX hedge objectives? What are the economics? How to do FX accounting? That's a lot of questions! It's time to take the FX Initiative! FX Initiative's foreign exchange risk management training starts with watching our online video series about: Foreign Exchange (FX) Market Overview FX Risk Exposures FX ... Conquering Currency Risk Management Conquering currency risk management involves identifying, analyzing, and prioritizing various foreign exchange (FX) exposures, and developing and implementing a coordinated and systematic plan that utilizes company resources efficiently and effectively to mitigate and optimize FX risk. An important part of mitigating FX risk is hedging exposures such as revenues, expenses, receivables, payables, assets, liabilities, and equity. The degree to which companies implement adequate foreign exchange risk management practices can vary substantially, from not managing the risk at all to engaging in robust hedging activities. As a result, the FX impact on the bottom line can vary widely across organizations. Global companies face questions including, but not limited to: How to manage currency risk? How to draft a FX risk policy? Where to look for FX risk exposures? What currency risks to hedge and how? Which strategies meet FX hedge objectives? What are the economics? How to do FX accounting? That's a lot of questions! It's time to take the FX Initiative! FX Initiative's foreign exchange risk management training starts with watching our online video series about: Foreign Exchange (FX) Market Overview FX Risk Exposures FX ... Comments are closed.