Membership in NFA and CFTC registration are mandatory for futures commission merchants (FCMs), commodity trading advisors (CTAs), commodity pool operators (CPOs), floor brokers, and introducing brokers (IBs) working with customer accounts, as well as floor traders. The CFTC also requires associate membership in NFA and CFTC registration for most associated persons (APs). APs solicit orders, customers, or customer funds for FCMs, IBs, CTAs, or CPOs. Membership is voluntary for futures exchanges.

[Need to include]

The forex market is sensitive to changes in the economy and will react accordingly. As the economy is affected by investment performance, the expected returns may change due to the influence of inflation or deflation. Thus, it’s important to consider foreign economy trends while planning investment strategies.

• Employment
• Consumer Spending
• Income
• Industrial and Inflation Indicators

The value of a country’s exports minus its imports. A nation’s balance of trade is favorable when the exports of goods exceed imports, and is said to be unfavorable if imports exceed exports.

Interbank Funds Transfers & Settlement System

In the United States, payment and securities settlement systems consist of numerous financial intermediaries, financial services firms, and non-bank businesses that create, distribute, and process large-value payments. The bulk of the dollar value of these payments are processed electronically and are generally used to purchase, sell, or finance securities transactions; disburse or repay loans; settle real estate transactions; and make large-value, time-critical payments, such as payments for the settlement of interbank purchases and sales of federal funds, settlement of foreign exchange transactions, or other financial market transactions.

There are two primary networks for interbank, or large-value, domestic, funds transfer payment orders. The first, Fedwire® Funds Service, is operated by the Federal Reserve Banks and is an important participant in providing interbank payment services, as well as safekeeping and transfer services for U.S. government and agency securities and mortgage-backed securities. In addition, Fedwire Funds Service and the Federal Reserve’s National Settlement Service (NSS) are critical components used in other payment systems’ settlement processes. The Clearing House Interbank Payments Company L.L.C. (CHIP Co.) operates the second, the Clearing House Interbank Payments System (CHIPS).

Processing large-value funds transfers involves two key elements: clearing and settlement. Clearing is the transfer and confirmation of information between the payer (sending financial institution) and payee (receiving financial institution). Settlement is the actual transfer of funds between the payer’s financial institution and the payee’s financial institution. Settlement discharges the obligation of the payer financial institution to the payee financial institution with respect to the payment order. Final settlement is irrevocable and unconditional. The finality of the payment is determined by that system’s rules and applicable law.

In general, payment messages may be credit transfers or debit transfers. Most large-value funds transfer systems are credit transfer systems in which both payment messages and funds move from the payer financial institution to the payee financial institution. An institution initiates a funds transfer by transmitting a payment order (a message that requests the transfer of funds to the payee). Payment order processing follows the predefined rules and operating procedures of the large-value payment system used. Typically, large-value payment system operating procedures include identification, reconciliation, and confirmation procedures necessary to process the payment orders. In some systems, financial institutions may contract with one or more third parties to help perform clearing and settlement activities on behalf of the institution.

The legal framework governing payment activity and the regulatory structure for financial institutions that provide payment services is complex. There are rules for large-value payments that are distinct from retail payments. Large-value funds transfer systems differ from retail electronic funds transfer (EFT) systems, which generally handle a large volume of low value payments including automated clearinghouse (ACH) and debit and credit card transactions at the point of sale.

Source: www.ffiec.gov

An economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries’ nominal interest rates for that time.

The rational for the IFE is that a country with a higher interest rate will also tend to have a higher inflation rate. This increased amount of inflation should cause the currency in the country with the high interest rate to depreciate against a country with lower interest rates.

The IMF promotes international monetary cooperation and exchange rate stability, facilitates the balanced growth of international trade, and provides resources to help members in balance of payments difficulties or to assist with poverty reduction.

Through its economic surveillance, the IMF keeps track of the economic health of its member countries, alerting them to risks on the horizon and providing policy advice. It also lends to countries in difficulty, and provides technical assistance and training to help countries improve economic management. This work is backed by IMF research and statistics.

The IMF supports its membership by providing:

• policy advice to governments and central banks based on analysis of economic trends and cross-country experiences;
• research, statistics, forecasts, and analysis based on tracking of global, regional, and individual economies and markets;
• loans to help countries overcome economic difficulties;
• concessional loans to fight poverty in developing countries; and
• technical assistance and training to help countries improve the management of their economies.

One of the problems stock investors have is losing their balance in an investment portfolio spread. This balancing problem can occur in a rising market or in a falling market. The balance is the ratio in your portfolio of stocks, bonds and cash. Investors should have a ratio in mind (some leave out cash) of how they want their investments to be in proportion to their total portfolio.

The role of central banks in microfinance is related to their broader role in the financial system and in the economy more generally.

Central banks have a number of objectives:

• tactical or macroeconomic objectives (relating primarily to the domestic price level and the exchange rate);
• long-term strategic objectives of financial sector development (including the development of an effective payments system and other forms of financial infrastructure); and
• sectoral or microeconomic objectives (such as prudential supervision and deposit insurance).

A central bank, reserve bank, or monetary authority is the entity responsible for the monetary policy of a country or of a group of member states. It is a bank that can lend money to other banks in times of need. Its primary responsibility is to maintain the stability of the national currency and money supply, but more active duties include controlling subsidized-loan interest rates, and acting as a lender of last resort to the banking sector during times of financial crisis (private banks often being integral to the national financial system). It may also have supervisory powers, to ensure that banks and other financial institutions do not behave recklessly or fraudulently.

Intervention

Official intervention in the foreign exchange market means that the central bank or other agent of the government buys or sells foreign currency in an attempt to influence the exchange rate value. Purchases of foreign exchange usually are intended to push down the home currency value of the exchange rate, and sales usually are intended to push it up.

Sterilized Intervention

In a sterilized intervention, the central bank offsets the purchase or sale of foreign exchange by selling or purchasing domestic securities so as to keep the domestic interest rate at its target. Since the domestic interest rate usually is considered the main determinant of the value of the domestic currency, many argue, it must change in order to influence the exchange rate. Sterilized intervention may be especially useful when the exchange rate is under speculative attack (that is, when a change in the exchange rate is not justified by fundamentals) or to help coordinate private sector expectations

The theory of elasticities holds that the exchange rate is simply the price of foreign exchange that maintains the balance of payments in equilibrium. In other words, the degree to which the exchange rate responds to a change in the trade balance depends entirely on the elasticity of demand to a change in price.

For instance, if the imports of country A are strong, then the trade balance is weak. Consequently, the exchange rate rises, leading to the growth of country A’s exports, and triggers in turn a rise in its domestic income, along with a decrease in its foreign income.

Whereas a rise in the domestic income (in country A) will trigger an increase in the domestic consumption of both domestic and foreign goods and, therefore, more demand for foreign currencies, a decrease in the foreign income (in country B) will trigger a decrease in the domestic consumption of both country B’s domestic and foreign goods, and therefore less demand for its own currency. The elasticities approach is not problem-free because in the short term the exchange rate is more inelastic than it is in the long term and additional forex rate variables arise continuously, changing the rules of the game.

Source: http://www.iforex.org

The World Trade Organization (WTO) is an international organization designed by its founders to supervise and liberalize international trade. The organization officially commenced on January 1, 1995 under the Marrakesh Agreement, succeeding the 1947 General Agreement on Tariffs and Trade (GATT).

The World Trade Organization deals with regulation of trade between participating countries; it provides a framework for negotiating and formalizing trade agreements, and a dispute resolution process aimed at enforcing participants’ adherence to WTO agreements which are signed by representatives of member governments and ratified by their parliaments.

Among the various functions of the WTO, these are regarded by analysts as the most important:

• It oversees the implementation, administration and operation of the covered agreements.
• It provides a forum for negotiations and for settling disputes.
• Additionally, it is the WTO’s duty to review and propagate the national trade policies, and to ensure the coherence and transparency of trade policies through surveillance in global economic policy-making.
• Another priority of the WTO is the assistance of developing, least-developed and low-income countries in transition to adjust to WTO rules and disciplines through technical cooperation and training.
• The WTO is also a center of economic research and analysis: regular assessments of the global trade picture in its annual publications and research reports on specific topics are produced by the organization.
• Finally, the WTO cooperates closely with the two other components of the Bretton Woods system, the IMF and the World Bank.

The market value of all goods and services produced by US residents in the US or abroad (i.e. regardless of where they were produced) over a period of time (typically a year).

Study Guide >> Forex Market Concepts >>  Gross National Product (GNP)

Supervisory employee responsible for reviewing FDM promotional materials must be under the ultimate supervision of a principal of the FDM who is also an AP (means that an individual principal of a FDM will ultimately be held liable for fraudulent or midleading promotional materials)

FDM must have policies on reviewing the activities of non-Members with which they do business, including:

• Regular review of trading
• Procedures for customer complaints
• Review of promotional materials
• Review of activites of non-Members must also be done by an AP under the ultimate supervision of an FDM principal/AP

Study Guide >>Forex Regulations >>  NFA Notice to Members: Supervision of Forex Promotional Materials

→ See NFA Bylaw 306 at: www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=BYLAW%20306&Section=3

Forex Dealer Member (FDM) is an NFA member who acts a counterparty to forex transaction. It is a self-executing title, meaning that an NFA member is an FDM solely by nature of acting as a counterparty to forex transactions. No applications or approvals are required to be considered an FDM. If you do not act as a counterparty to a forex transaction (IB, CTA, or CPO), then you are not considered an FDM, but you may be subject to parts of NFA Rule 2-36 pursuant to NFA Rule 2-39.

The following are not FDMs and not subject to NFA Rule 2-36:

• financial institutions (e.g., banks and savings associations);
• certain insurance companies and their regulated subsidiaries or affiliates;
• financial holding companies;
• investment bank holding companies;
• registered broker-dealers that are members of FINRA; and
• Material Associated Persons of registered broker-dealers that are members of FINRA.

→ General Disclosures:

• Disclosure of characteristics and risks of forex transactions (members and associates should know what information has been provided to the customer)

→ Specific Disclosures:

• disclaimer regarding non-protection under the Bankruptcy Code
• manner in which member will be compensated for services
• 2 paragraph uppercase disclaimer re: trading not conducted on exchange, conflict of interest, trading exposure
• disclose bid and offer when customer enters an order
• duty to update information if a material change would make prior information misleading (member)

Reporting: NFA is concerned that the customer receives timely and accurate notice of account status:

• Confirmations: Written confirmation must be submitted within one business day of any account activity (including offsetting transactions, rollovers, deliveries, etc.). Information should include all costs, fees, commission, third party fees, etc.
• Monthly/Quarterly Summaries: If (1) there has been activity in an account during the month or (2) there are any open positions in the account at the end of the month, the FDM will need to provide a monthly summary of all forex transactions and other account activity to the customer. For customer accounts not fitting within the above, summaries should be provided quarterly.
• Delivery:  both confirmation and summaries may be transmitted by electronic means.

Supervision:

Study Guide >>Forex Regulations >>  NFA Interpretive Notice - Forex Transactions

This is quite a nebulous topic which is explored in greater depth elsewhere in the materials.  I provide an overview below.

See generally NFA rule 2-36(h) Filing Promotional Materials with NFA:

The Compliance Director may require any Forex Dealer Member for any specified period to file copies of all promotional material with NFA for its review and approval at least 10 days prior to its first use or such shorter period as NFA may allow. The Compliance Director may also require a Forex Dealer Member to file for review and approval copies of promotional material prepared or used by some or all of the non-Members it is responsible for under Section (d).

The Forex Transactions Guide states:

Communications with the Public and Promotional Material - No Member or Associate shall make any communication with potential or current customers that operates as a fraud or deceit; uses a high-pressure approach; or implies that forex transactions are appropriate for all persons.

Promotional material used by the Member or Associate shall not:

• Deceive the public or contain any material misstatement of fact or omit a fact that makes the promotional material misleading;
• Include any statements of opinion unless they are clearly identified as such and have a reasonable basis in fact;
• Mention the possibility of profit unless accompanied by an equally prominent statement of the risk of loss;
• Include any reference to actual past trading profits without mentioning that past results are not necessarily indicative of future results;
• Include any statistical or numerical information about past performance of actual accounts unless the Member can demonstrate that the performance is representative of actual performance of all reasonably comparable accounts for the same period (calculated in accordance with the formula in CFTC Regulation 4.35(a)(6) and NFA Compliance Rule 2-34); or
• Include testimonials unless they are representative of all reasonably comparable accounts, the material prominently states that the testimonial is not indicative of future performance or success, and the material prominently states that they are paid testimonials (if applicable).

No Member or Associate may represent that forex funds deposited with a Forex Dealer Member are given special protection under the bankruptcy laws. No Member or Associate may represent or imply that any assets necessary to satisfy its obligations to customers are more secure because the Member keeps some or all of those assets at a regulated entity in the United States or a money center country.

No Member or Associate may represent that its services are commission free without prominently disclosing how it is compensated in near proximity to that representation.

No Member or Associate may represent that it offers trading with “no-slippage” or that it guarantees the price at which a transaction will be executed or filled, unless:

• It can demonstrate that all orders for all customers have been executed and fulfilled at the price initially quoted on the trading platform when the order was placed;9 and
• No authority exists, pursuant to a contract, agreement, or otherwise, to adjust customer accounts in a manner that would have the direct or indirect effect of changing the price at which an order was executed.

Members and Associates may not solicit customers based on the leverage available unless they balance any discussion regarding the advantages of leverage with an equally prominent contemporaneous disclosure that increasing leverage increases risk.

No Member shall use or directly benefit from any radio or television advertisement that recommends specific forex transactions or describes the extent of any profit obtained in the past or that can be obtained in the future unless the member submits the advertisement to NFA’s Promotional Material Review Team for its review and approval at least 10 days prior to its first use or such shorter period as NFA may allow.

Every Member should adopt and enforce written procedures to supervise communications with potential and current customers and promotional material. A supervisory employee that is, or is under the ultimate supervision of, a listed principal who is also an NFA Associate should review and approve all promotional material and make a written record of such review and approval.12

All promotional material should be maintained by each Member and be available for examination for the periods specified in the recordkeeping section of this notice, measured from the date of last use.

See also Notice I-08-15:

(i) Hypothetical Results

Any Member who uses promotional material that includes a measurement or description or makes any reference to hypothetical forex transaction performance results that could have been achieved had a particular trading system of the Member or Associate been employed in the past must comply with Compliance Rule 2-29(c) and the related Interpretive Notice as if the performance results were for transactions in on-exchange futures contracts.

Solicitation

See NFA Rule 2-39 at www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=RULE%202-    39&Section=4

Study Guide >>Forex Regulations >>  Promotional Material and Solicitation

See generally Rule 2-44 Forex Customer statements here: www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=RULE%202-44&Section=4.

Written confirmation provided to customers within one business day of activity.

Written confirmation must include the following information:

1. Date;
2. Transaction type (e.g., new position, offsetting position, rollover, adjustment);
3. Currency pair;
4. Buy or sell (if a new or offsetting position);
5. Size;
6. Price or premium (for new or offsetting positions or price adjustments);
7. Price or premium change (for price adjustments);
8. Monetary adjustments (debit or credit);
9. Net profit or loss for offsetting positions; and
10. Charges for each transaction (e.g., rollover interest and/or fees).

Daily statements must be provided to customers on a daily basis and must show account equity as of the end of the previous day. They can be provided electronically and can be combined with confirmations and provided electronically with the customers consents

Monthly statements are required for all accounts that have open positions at the end of the month or changes in the account balance or equity since the prior statement. Quarterly statements are required for all other open accounts. The monthly or quarterly statements must contain the following information regarding the transactions during the reporting period and the funds in the account:

• The account equity at the beginning of the reporting period;
• All initiating or offsetting transactions, deliveries, option exercises, or option expirations that occurred during the reporting period, with the following information for each: date, currency pair, buy or sell, size, and price or premium (with any price or premium adjustment noted);
• All open positions in the account, with the following information for each position: date initiated, currency pair, long or short, size, price or premium at which it was initiated (with any price or premium adjustment noted), and the unrealized profit or loss;
• All deposits and withdrawals during the reporting period;
• All other monetary adjustments (debits and credits) to the account;
• The amount of cash in the account (excluding non-cash collateral and unrealized profits and losses);
• A breakdown by type of all fees and charges during the period, including commissions and interest expense or rollover fees; and
• The account equity at the end of the reporting period.

Study Guide >>Forex Regulations >>  Reports to Customers, Confirmations, Monthly Summaries

The following is the text of Section 12 of NFA’s Financial Requirements from NFA’s Rules Manual:

Two general security deposit requirements are 1% or 4%. Between the FDM and customer (who is not an Eligible Contract Participant (ECP):

• 1% (British pound, the Swiss franc, the Canadian dollar, the Japanese yen, the Euro, the Australian dollar, the New Zealand dollar, the Swedish krona, the Norwegian krone, and the Danish krone);
• 4% (All other currencies);
• For short options, the above amount plus the premium received; and
• For long options, the entire premium.
• FDMs complying with the 150% rule (pursuant to Section 11(a)(i) or (ii)), can have lower security deposits
• Acceptable Collateral – cash and other items pursuant to CFTC Rule 1.25, subject to haircuts

Study Guide >>Forex Regulations >>  Security Deposit Rules

Generally customer funds are not held in segregated customer accounts separate from the FDM.  Accordingly, in the event of a bankruptcy at a FDM, the customer funds would be administered by a trustee according to the US bankruptcy laws (if based in the US).  Customers would be entitled to a pro rate distribution of available assets.  There is no guarantee they would be able to recover all of the customer funds.

Study Guide >>Forex Regulations >>  Security of Customer Funds, No Segregation

Forex managers and solicitors generally will need to make sure that both the firm and the individual (associated person or AP) are registered with the CFTC.  The firm will also need to be a member of the NFA.

Firms must complete and submit Form 7R through the NFA’s online registration system.  The cost for firm registration is likely to be $200 for Forex CPOs, Forex CTAs, and Forex IBs.  These firms will also need to become members of the NFA which costs $750 on an annual basis. These firms will also need to become members of the NFA which costs $750 on an annual basis. Guaranteed forex IBs need a guarantee form signed by the FDM [Form 1-FR-IB (Part B)].

Individuals must complete and submit Form 8-R through the NFA’s online registration system. Each individual (whether a principal or an AP) will need to have passed both the Series 3 exam and the Series 34 exam. Individuals will need to submit a fingerprint card as well.

→ NOTE:  Individuals who were APs of a registered firm as of May 22, 2008 may be “grandfathered” in and may not need to take the Series 34 exam.

Forex CPOs and forex CTAs will need to have their disclosure documents reviewed by the NFA prior to soliciting clients with those documents.

Study Guide >>Forex Regulations >>  Registration Requirements

Members and Associates have a duty to acquaint themselves sufficiently with the personal and financial circumstances of each forex customer to determine what further facts, explanations and disclosures are needed in order for the customer to make an informed decision on whether to enter into forex transactions.

Every Member should determine what information it will obtain from a prospective forex customer. At a minimum, the Member soliciting the customer to engage in forex transactions should obtain the customer’s name, address, principal occupation or business, current estimated annual income and net worth, approximate age, and an indication of the customer’s previous investment and trading experience. Members and their Associates need to ensure that each customer they solicit has received adequate information concerning the risks of forex transactions so that the customer can make an informed decision as to whether forex transactions are appropriate for the customer. These obligations fall on the Forex Dealer Member when a non-Member solicits the customer.

Members and APs have a duty to make sure customer makes informed decision with regard to forex transactions (FDMs have this duty if non-member solicits customer):

• Should consider personal and financial circumstances
• Should provide additional facts, explanations, disclosures if necessary
• Members must decide what information to request from a customer
• Minimumum information –  customer’s name, address, principal occupation or business, current estimated annual income and net worth, approximate age, and an indication of the customer’s previous investment and trading experience
• Minimum information: customer’s name, address, principal occupation or business, current estimated annual income and net worth, approximate age, and an indication of the customer’s previous investment and trading experience.

Study Guide >>Forex Regulations >>  Know Your Customer

General: this part of the rule applies generally to FDMs and, inc certain instances, the APs of the FDM.  It will also apply to Members which solicit, introduce, or manage customer accounts (those parts applicable to FDMs will also apply to these members if the customer deals with a counterparty that is not a FDM).

Issues for white labelers: if the firm providing the white label product is a FDM, the member may rely on the FDM.  If the firm providing the product is not a FDM then the Member is ultimately liable.  In the former situation the Member must (i) Provide required notifications and disclosures to customers; (ii) Maintain records; and (iii) Respond to situations where it has reason to believe the white labeler is not complying with the Notice.

Focus on the following areas: the security, capacity, credit and risk-management controls, and records provided by the firm’s electronic trading systems.

Rule 2-36(e) provides:

Supervision.  Each Forex Dealer Member shall diligently supervise its employees and agents in the conduct of their forex activities for or on behalf of the Forex Dealer Member. Each Associate of a Forex Dealer Member who has supervisory duties shall diligently exercise such duties in the conduct of that Associate’s forex activities for or on behalf of the Forex Dealer Member.

Specific Items Discussed in Interpretive Notice

Security

• Authentication & Encryption. User should be authenticated when logging on (passwords, secured, digital certificates, etc) and this information should be appropriately encrypted; firewalls should be used when and if appropriate
• Customers should be able to tell the Member about access issues
• Periodic testing. Annual independent internal audit or qualified outside audit; report docemented and provided to senior management; if any deficiency there should be follow up
• Electronic trading system should be monitored by appropriate personnel; procedures in place for updating the system as needed

Capacity

• Adopt and enforce written procedures to evaluate capacity of ETS
• ETS should go through initial stress test; subject to periodic reviews thereafter by independent inside pary or qualified outside party; audits documented and reviewed by management
• ETS should be tested for both capacity and performance; system should be designed to provide adequate capacity to meet estimated peak volume needs
• Firm should also have procedures for following up on customer compliancts regarding these issues
• Disaster recovery. Contingency plan should be in place should the system go down or abnormal volume; backup systems can include telephone
• If operational issues, these should be relayed to the customers through the website, email, im, or through the phone
• Firm should disclose that there may be system issues in advance and what customers can do.  This can be in the customer agreement
• Credit and risk-management controls
• Procedures should be in place to make sure there is not undue financial risk on the firm or the other customers from a customer trade
• ETS should be designed to allow the firm to limit the customers trading; ETS should block order the exceed pre-set limits
• ETS should be designed so that if stop-losses are exceeded positions will be closed out prior to a position becoming a deficit; there is a greater duty to make sure this is the case if the fdm states that the customer cannot lose more than they invest
• If ETS does not automatically liquidate a position, the ETS should generate an aler to the customer
• Periodic review of the system to make sure proper credit and risk management

Recordkeeping

• Written procedures to record and maintain essential information re: customer order and account activity
• Records should include: Date and time the order is received by the system; Price (or premium for an option) at which the order is placed; Price (or premium for an option) quoted on the trading platform when the order was placed (if the system is a trading platform); Account identification; Currency pair; Size; Buy or sell; Type of order (if not a straight market order); Date and time the order is transmitted to the trading platform (if the system is an AORS); Date and time of execution (if the system is a trading platform); Size and price (or premium) at which the order is executed; Date and time the execution information is received (if the system is an AORS); andDate and time the execution information is reported by the system.
• Options also need: Put or call; Strike price; and Expiration date.
• Time recorded to nearest second
• Rollover information should include: Account identification; Currency pair; Size; Long or short; Date and time of the rollover; Price of the position after the rollover; Bid and ask prices quoted on the platform when the rollover occurred; Amount of interest credited or debited to the account, if any; Any other fees charged for the rollover.
• ETS should be designed so that it is searchable for any one of a number of different items
• Daily account records should include the following items: Account identification; Funds in the account (net of any commissions and fees); Open trade equity (the net profits and losses on open trades); and Account balance (funds in the account plus or minus open trade equity).  Options should also include: Long option value; Short option value; and Net option value.
• ETS must have dynamic information on price changes, to the nearest second.
• Daily exception reports. Those trades which fill outside the price range at the time order was entered into; these reports should be reviewed by management on a daily basis for suspicious or unjustifiable activity
• Month end assessment fee reports – number and size of forex transactions for the month
• Record retention. 5 years, first 2 in an accessable place

Trade Integrity

• Written procedures to maintain integreity of the ETS
• ETS should be designed to provide bids and officers related to current market activity
• If firm advertises a particular spread (x pip) then the ETS should be able to handle this
• ETS designed for minimal slippage, and only then based on market conditions
• Price adjustments should be done pursuant to objective criteria identified in written procedures; otherwise management approval needed for an adjustment
• APs should be prohibited from adjustinc prices for any reason once the order hits the ETS
• If automatic rollover, the ETS should be designed to follow the procedures detailed in the written agreement

Annual Certification

• By all FDMs
• AP who is also a principal, filed with the NFA
• Also members who are involved with counterparties which are not FDMs

Futures requirements:

Study Guide >>Forex Regulations >> NFA Interpretive Notice Compliance Rule 2-36(e): Supervision of the Use of Electronic Trading Systems

[Need to include] See NFA Interpretive Notice on Rule 2-36(e).

Study Guide >>Forex Regulations >> Disclosures to Customers

I am not sure what they are getting at here.  In general, all conflicts of interest would need to be disclosed.  The interpretive notices to Rule 2-29 and Rule 2-9 give us some insight into this general principal.

Interpretive notice to Rule 2-29: Disclosing conflicts of interest for securities futures products.

Firms must make sure they:

• disclose all conflicts of interest
• review promotional material; firms must make sure that promotional material is accurate and does not gloss over any conflicts of interest

Interpretive notice to Rule 2-9: Ethics training.

Ethics program should address: avoidance of conflicts of interest and proper disclosure and handling of conflicts of interest.

Study Guide >>Forex Regulations >> Conflicts of Interest

CFTC:

The Commodities Futures Trading Commission (CFTC) is a government agency which is charged with enforcing the laws under the Commodities Exchange Act, as amended (CEA).  The CFTC, with regard to the CEA, is functionally equivalent to the SEC.  With regard to off-exchange foreign currency transactions, Congress has provided a mandate to the CFTC to propose rules which will require the registration of forex managers and solicitors.  Once a registration structure is enacted the CFTC will ultimately be in charge of making sure that these maangers and solicitors are operating pursuant to the regulations promulgated by the CFTC.  The CFTC will provide the NFA with the authority to monitor these managers and solicitors and oversee the registration process.

CFTC Jurisdiction:

On May 22, 2008, the Congress passed H.R. 6124, the Food, Conservation, and Energy Act of 2008 (also known as “the Farm Bill”) which contains several amendments to the Commodity Exchange Act (“CEA”).  In particular, Title XIII of the FarmBill (1) clarifies that the CFTC’s anti-fraud authority applies to certain retail off-exchange foreign currency transactions, (2) creates a new registration category for retail foreign exchange dealers, (3) requires registration for those who solicit orders, exercise discretionary trading authority and operate pools with respect to retail off-exchange foreign currency transactions, and (4) imposes minimum capital requirements for futures commission merchants and retail foreign exchange dealers that act as counterparties to such transactions.  Parts of the legislation, particularly those confirming the Commission’s anti-fraud authority, were effective upon passage.  Other parts of the legislation, such as those requiring the registration of parties engaged in these transactions and minimum capital requirements, will only be effective upon the Commission’s issuance of final regulations.  Any such changes to the information below will be accomplished through notice and comment rulemaking and will be made available in the Federal Register section of CFTC.gov.

A complete description of the amendments to the CEA effected by Title XIII of the Farm Bill can be found in the Joint Statement of Managers, pp. 291-299, which can be accessed through the House Agriculture Committee’s Farm Bill Homepage.  Interested parties should monitor the Commission’s website as well as the National Futures Association’s website, for developments.

The CFTC has witnessed increasing numbers, and a growing complexity, of financial investment opportunities in recent years, including a sharp rise in foreign currency (forex) trading scams.

The Commodity Futures Modernization Act of 2000 (CFMA) made clear that the CFTC has jurisdiction and authority to investigate and take legal action to close down a wide assortment of unregulated firms offering or selling foreign currency futures and options contracts to the general public. The CFTC also has jurisdiction to investigate and prosecute foreign currency fraud occuring in its registered firms and their affiliates. The CFTC issued an advisory in 2001 that discussed these CFMA amendments to the Commodity Exchange Act (CEA), 7 USC 1, et seq.

The Division of Trading and Markets (now Division of Clearing and Intermediary Oversight, or DCIO) issued an advisory in 2002 concerning foreign currency trading by retail customers (PDF). The advisory affirms that off-exchange trading of foreign currency futures and options contracts with retail customers by a counterparty that is not a regulated financial entity as set forth in the CFMA is unlawful. The advisory further states that, if there is a lawful counterparty to the transaction, such as a person registered as a futures commission merchant, the persons acting as intermediaries to such a transaction, that is, in the manner of an introducing broker, commodity trading advisor or commodity pool operator, would not need to register under the CEA if that is their only involvement in futures or option transactions.

DCIO issued an additional advisory in 2007 concerning foreign currency trading by retail customers (PDF). The DCIO Advisory addresses the following issues: (1) registration requirements for associated persons of firms registered as introducing brokers (IBs), commodity trading advisors, and commodity pool operators that are involved in forex transactions; (2) the permissibility of certain unregistered affiliates of a futures commission merchant (FCM) to act as proper counterparties in forex transactions; (3) claims that forex customer funds are segregated; (4) introducing entities acting as FCMs; (5) the applicability of the IB guarantee agreement to forex transactions and prohibiting guaranteed IBs from introducing forex transactions to an FCM that is not its guarantor FCM; (6) prohibiting forex account statements of an FCM’s unregistered affiliate from being included in the FCM’s account statements to its customers; and (7) prohibiting retail customers from acting as counterparties to each other in forex transactions.

CFTC Jurisdictional Limitations:

CFTC Chairman Gary Gensler addressed the following limitations to the authority of the CFTC in his address to the U.S. Senate:

Retail Fraud: In the 2008 Farm Bill the Congress clarified the CFTC’s jurisdiction over fraud in retail foreign currency transactions. Since the passage of the Farm Bill, unscrupulous firms have been offering the same type of fraudulent “rolling spot” commodity contracts that were prohibited in the Farm Bill, but in other commodities that were not covered by the bill. Since the enactment of the Farm Bill, the CFTC has received more than 50 complaints from the public relating to potential fraud from such contracts. The regulatory reform package should include a provision to expand the CFTC’s jurisdiction over this type of retail fraud to all types of commodities.

Foreign Boards of Trade: As part of regulatory reform legislation, the Congress should also provide the CFTC with clear statutory authority to ensure that traders that are trading on a foreign board of trade through trading terminals in the U.S. comply with the same U.S. position limits and reporting requirements when trading a foreign contract that settles against any price of a contract traded on a U.S. exchange.

Source: CFTC Chairman Gary Gensler Address to the US Senate

http://www.cftc.gov/customerprotection/fraudawarenessandprevention/forex/index.htm

Study Guide >>Forex Regulations >>  CFTC jurisdiction and jurisdictional limitations

Because of the time differences involved in the forex trading markets, there was the possibility that there would be differences in the time of the settlement of the forex contracts.  This meant that it was possible that the counter party would not pay the trader (i.e. you would send them your currency and they would not send you their currency).  This has been mitigated through the CLS system.  Herstatt risk refers to a situation in 1974 when a German bank called Herstatt was shut down by German banking regulators prior to paying off its counterparties; this left the counterparties with substantial losses.

Study Guide >> Forex Trading Risks >>Settlement Risk

Risk inherent in the trader’s operational structure.  For instance if a trader’s decision making skills are spread out and decisions are dependant on a number of different systems, any thing that happens to one part of the system could affect the whole.  This may affect the trader’s ability to enter and exit trades as it would normally do.

Additionally, forex dealers typically have operational risk related to their quoting and execution systems.

Study Guide >> Forex Trading Risks >>Operational Risk

Risk that the general forex market may cause the value of a position to change.

Study Guide >> Forex Trading Risks >> Market Risk

Options are a great tool for traders during anticipated periods of market volatility.  During these periods of volatility it is expected that huge drawdowns could occur.  It is also during this time that prices can gap up or down so slippage during these times is expected to increase.

Forex options are not traded on an exchange so they are usually privately negotiated contracts between the FDM and the trader.

→ NOTE:

Managers who utilize these types of instruments may be subject to regulation under state investment advisory laws.  Many state securities laws are written broadly so as to include “investment contacts” in the definition of “security.”  While I have not personally heard of a state making a claim like this, it is not hard to see a state making such a claim.]

Barrier Forex Option

In its most basic form, the barrier option is an option which is triggered upon the happening of an event (the barrier) (i.e. a currency pair reaching a previously determined exchange rate).  A double barrier option has a barrier both above and below the current market price.  There are two central ways to play barrier options: knock-in or knock out.

These pay off if an asset reaches a certain price. Knock-in options are created with predetermined characteristics when the underlying reaches a certain price. Knock-out options are options that terminate if the underlying reaches a certain price. Since the option ceases to exist, there is no payoff even if the price moves back within the knock-out barrier before the original expiration. Thus, an option with a knock-out barrier has a maximum specified value and payoff.

Because the option may either not come into existence or pass out of existence, barrier options are generally cheaper the standard options, with the double-barrier option being cheapest. Most exotic FX options are barrier options.

Knock-in Barrier Option

The knock-in triggers an option contract upon a certain price which is hit by the currency pair.  This means that there is no option contract in existence until a barrier is hit.  [What does this mean for long and short?] The knock in can be structured so it is triggered upon a price increase (the up and in option) or upon a price decrease (the down and in option).

Knock-out Barrier Option

The knock-out cancels an existing option contract which will be effective unless a certain price is hit by the currency pair.  Unlike a knock-in option, the knock-out option is currently in existence; it will cease to be once the barrier is hit.  [What does this mean for long and short?] Like the knock-in, the knock-out can be structured to be triggered upon a price increase (the up and out) or upon a price decrease (the down and out).

Single-Barrier Options

These have a single trigger price that is either above or below the strike price, and double-barrier options have trigger prices that are above and below the strike price.

Double Barrier Options

[Need to include]

Compound Options

This is an option to purchase an existing option. This has two potential premiums: the first to purchase the compound option and the second to purchase the underlying option.  Because there are two premiums compound options are more expensive than vanilla options.  Advantage is that they provide the opportunity for large amounts of leverage and that they are cheaper (initially) than vanilla options.

→ NOTE:

http://en.wikipedia.org/wiki/Barrier_option
http://www.financial-spread-betting.com/exotic-options.html
http://www.traderslog.com/forex-options.htm
http://www.forexdirectory.net/exover.html

Study Guide >> Definitions and Terminology >> Forex Exotic Options

There is a risk that it may be impossible to liquidate a position.  This can happen when a currency is deregulated or fixed trading bands are widened.  Some potential currencies include (but are not limited to): Thai Baht, South Korean Won, Malaysian Ringitt, Brazilian Real, Hong Kong Dollar.

Study Guide >> Forex Trading Risks >> Liquidity Risk

The value of a foreign currency investment can be affected negatively by a number of factors related to the interest rate or one or other of the currencies traded.

Study Guide >> Forex Trading Risks >>  Interest Rate Risk

Exchange rate risk is the currency fluctuations on the worldwide currency market, fluctuation of demand and supply for a particular currency. The most effective way to control the risk of exchange rate is to get rid of the positions that lose too much, and to increase the number of those who keeps the lose limits taken into account; essentially, limit the position and the limit loss. Maintaining a limit position allowed for a particular investor’s currency, in each transaction, during the transaction will be determined by it. The loss limit is also an instrument of the investor that may set the limit to which it is admitted to lose in the foreign exchange transactions, the limit above which the loss will be automatically stopped.

The exchange rates between currencies can change quickly and by a significant amount.  These changes could produce large losses for the trader.  Some traders utilize stop losses or limit orders in order to mitigate this risk.

Study Guide >> Forex Trading Risks >>  Exchange Rate Risk

The risk that the counterparty defaults.  The counterparty to an off-exchange transaction may not, for a variety of reasons, be able to complete a transaction.  Such non completion of any portion of a transaction may be to the detriment to the other party.  In such cases, the other party will be subject to all or partial loss.

In the event of bankruptcy of the counterparty the trader may be unable to recover assets held at the counterparty (for example, the Refco scandal).  Generally there is no segregated customer protection in the event of a bankruptcy.  However, in many cases, credit risk for many forex transactions is restricted because of the short term contract execution.

Study Guide >> Forex Trading Risks >>  Credit Risk

Some countries still interfere (i.e. limit supply of currency available) with the natural market mechanisms of the forex markets.  Such interference could affect a currency in a number of different ways including the liquidity of the currency.  If significant enough the trader may not be able to receive a rightful payment.  Country risk is most acute with the so called “exotics.”

Study Guide >> Forex Trading Risks >> Country Risk

Most FDMs do not have separate commissions or other fees per transaction, but this will be decided at each FDM.  Instead FDMs make money through the spread that they make on each side of the transaction (i.e. they buy the currency for less than they sell it to you).  The pip spread actually works as a kind of transaction cost, for more on this see http://www.babypips.com/school/how_leverage_affects_transacti.html.

Transaction costs vary from FDM to FDM. You should consider:

1. Commissions. If there is a commission, add it to the spread to determine total cost. Also, you need to determine whether the commission is calculated on a per side or round trip basis.
2. Spread on currency pairs. This is the value of the pip multiplied by the spread (pip X spread). The spread may fluctuate throughout day, based on the FDM.
3. Rollover rates. These are important for longer term strategies (and are not necessarily important for day traders).
4. Quality of execution, including slippage and the consistency of rates versus other platforms.

→ NOTE:

http://www.aboutcurrency.com/university/fxvideocourse/how_to_evaluate_forex_transaction_costs.shtml

Study Guide >> Forex Trading Calculations >>  Transaction Costs

Leverage allows the trader to increase the possible ROI on an investment.  The amount of the ROI is expressed as a percentage of the margin amount.  For instance, if you gain $200 on a trade which was initiated with $1,000 on margin, your return on margin is 20%.

Example:

The Trader buys 100,000 GBP at 1.9505 USD (using US$1000 as the margin amount).

• The Trader calculates a potential profit and places a limit order of 1.9620 (Potential profit of US$1,115.00)
• The Trader calculates a potential loss and places a stop at 1.9475 (Potential loss of US$300)
• Within the next hour the GBP rallies to 1.9592, stalls and begins to reverse.
• The Trader decides the limit will not be reached, so he closes his position by selling the GBP at 1.9558 and locks in a profit of US$530.00
• The Trader made a profit of US$530 on a margin amount of $1000 = 53% return on margin in an hour.

Source:

http://209.85.173.132/search?q=cache:F1AKfPCKJVEJ:www.silversandcapital.com/investinginforex.aspx+forex+return+on+margin&cd=7&hl=en&ct=clnk&gl=us&client=firefox-a

Study Guide >> Forex Trading Calculations >>  Return on Collateral

Buying an Option

You pay the premium (quoted in pips).  If at expiration the option is in the money then the profit equals the difference between the strike price and the current market price (closing spot price) less the amount of the premium paid.   Profit potential is unlimited and the potential loss is limited to the amount paid for the premium

Exotic Option P&L Calculation - [Need to include]

→ NOTE:

Using options: http://www.forexcapital.com/options.htm
Exotic options: http://www.elitetrading.de/forum/forex/exotic_forex_options_1865.html

Study Guide >> Forex Trading Calculations >>  Option and Exotic Option P & L Calculation

Forex pip value refers to the amount of money gained/lost for each pip that is gained/lost in currency trading. The easiest way to find out pip value of a currency pair is by observing how much money you gain/lose for each pip you gain/lose when you are in-trading. To do the manual calculation, you need to know what ‘1 pip’ is for the related currency pair. The pip value for each currency pair is different and the value can be determined according to the following formula:

→ FORMULA: Pip Value = 1 pip x Trade Size

Price After Pips

I am not sure what they are trying to get at…maybe the fact that there are spreads and that when you initiate a position you are automatically starting with a loss the size of the spread….

Example:

USD/JPY at an exchange rate of 119.90

(.01 / 119.80) x $100,000 = $8.34 per pip

USD/CHF at an exchange rate of 1.4555

(.0001 / 1.4555) x $100,000 = $6.87 per pip

In cases where the US Dollar is not quoted first, the formula is slightly different.

EUR/USD at an exchange rate of 1.1930

(.0001 / 1.1930) X EUR 100,000 = EUR 8.38 x 1.1930 = $9.99734 rounded up will be $10 per pip

GBP/USD at an exchange rate or 1.8040

(.0001 / 1.8040) x GBP 100,000 = 5.54 x 1.8040 = 9.99416 rounded up will be $10 per pip.

Good Website:

http://www.babypips.com/school/know_your_ps_and_ls.html

Study Guide >> Forex Trading Calculations >>  Pip Values and Price After Pips

Example:

USD is base currency
Profit = Price Change in Pips x Units Traded
USD is secondary currency
Profit = Price Change in Pips x Units Traded / Exit Price

Good Websites:

http://www.forex.com/calculating_forex_pl.html
http://www.streetdirectory.com/travel_guide/148460/foreign_exchange/forex_trading___profit_and_loss_calculations.html

Study Guide >> Forex Trading Calculations >> Profit and Loss Calculations

[Need to include]

Study Guide >> Forex Trading Calculations >>  Open Trade Variation

At the end of the day institutions will net their long and short positions between one another so that they do not have to settle every single transaction – only the net positions are settled.  This can save on fees and commissions.

Study Guide >> Forex Trading Calculations >>  Netting of Positions

Leverage calculations allow you to see basically how much equity is in your account so you will not be subject to a margin call. Most forex brokers allow a very high leverage ratio, or, to put it differently, have very low margin requirements. The margin in a forex account is a performance bond, the amount of equity needed to ensure that you can cover your losses.

If you have 100:1 leverage, then the margin in your account must be at least 1% of the contract value. If you have 200:1 leverage, then the margin in your account must be at least 0.5% of the contract value. To calculate margin, you take the price of the currency X the number of units X the margin requirement.

→ EXAMPLE: EUR/USD = 1.35

1.35 x 100,000 x 1% = 1,350 USD that must be used as margin to control the 100,000 units of EUR

Study Guide >> Forex Trading Calculations >>  Effects of Leverage Calculations

Cross-rate transactions occur when two currencies are equal which follows from their forex currency exchange rate according to a forex rate of the third currency. There are a couple of ways that cross rate transactions can be executed. First, some FDMs will actually offer these pairs. Second you can buy EUR/USD and then USD/JPY to affect a EUR/JPY cross.

Currency pairs that do not involve the USD are referred to as cross rates. Even though the USD is not represented in the quote, the USD rate is usually used in the quote calculation. An example of a cross rate is the EUR/GBP.

Study Guide >> Forex Trading Calculations >> Cross rate transactions

• Cross rate transactions
• Effects of leverage calculations
• Netting of positions
• Open trade variation
• Profit & loss calculations
• Pip values, price after pips
• Option and exotic option profit & loss calculations
• Return on collateral, security deposit, margin
• Transaction costs

Study Guide >> Definitions and Terminology >> Forex Trading Calculations

Also called the law of one price, the theory that the price of a currency (as defined by the exchange rate with another currency) is determined by the relative level of prices of the two countries.  Basically the theory says that the price of a basket of goods should be the same in two countries.  If 10 HC buys 15 FC then PPP says that the same basket of goods which cost 10HC should also cost 15FC.  Essentially, the  prices of currencies tend to move toward equilibrium.

The problem with the theory is that it does not accurately predict variations in exchange rates.  PPP cannot be used along as a decision making tool with regard to forex transactions.  PPP often does not take into account issues such as transportation costs, demand within the country, etc.

→ EXAMPLE:

Big Mac Index, see http://www.actionforex.com/financial-glossary/financial-glossary/big-mac-index-20041204335/

Study Guide >> Forex Market Concepts >>  Theory of Purchasing Power Parity

The rise in level of prices of goods and services in an economy over time (the decline in the real value of money over time).  The supply of money and inflation are linked.  Inflation has a large effect on interest rates, which in turn effect exchange rates.  Over the long term inflation means that the value of a currency will drop.

Inflation numbers influenced by GDP numbers, PPI (produce price index), CPI (consumer price index)

→ NOTE:

http://en.wikipedia.org/wiki/Inflation
http://www.forexfloor.com/inflation-indicators.html

Study Guide >> Forex Market Concepts >> Inflation

The market value of goods and services produced in the US by US residents or non residents over a period of time (typically a year).  Increasing GDP is better than decreasing GDP.

Study Guide >> Forex Market Concepts >>  GNP and GDP

The effect proposes that if the real interest rate is equal to the nominal interest rate minus the expected inflation rate, and if the real interest rate were to be held constant, that the nominal rate and the inflation rate have to be adjusted on a one-for-one basis.

→ NOTE: Real interest rate = nominal interest rate - inflation rate

→ EXAMPLE: In simple terms: an increase in inflation will result in an increase in the nominal interest rate. For example, if the real interest rate is held at a constant 5.5% and inflation increased from 2% to 3%, the Fisher Effect indicates that the nominal interest rate would have to increase from 7.5% (5.5% real rate + 2% inflation rate) to 8.5% (5.5% real rate + 3% inflation rate).

Source: http://www.investorwords.com/6519/Fisher_effect.htm

Study Guide >> Forex Market Concepts >>  Fisher Effect

A government’s decisions regarding spending and revenue collection (taxation).  Fiscal policy influences the economy.  It is to be contrasted with monetary polcy which focuses centrally on the supply of money. the following are types of fiscal policy:

Neutral: spending equals taxation

Expansionary: spending is greater than tax revenue; usually associated with budget deficit

Contractionary: tax revenue is greater than spending; usually associated with a budget surplus

Study Guide >> Forex Market Concepts >>  Fiscal Policy