World of currency trading `a bit like playing chess'

Exchanges are often complex, with millions of dollars, many risks

February 09, 2002|By Eileen Ambrose | Eileen Ambrose,SUN STAFF

To understand John M. Rusnak's arcane world of currency trading, a good way to start is to think about taking a trip overseas and exchanging your dollars for, say, yen.

Currency values change by the second and are influenced by a country's economy, politics, interest rates and stock market ups and downs.

So if you exchange your dollars for yen Monday morning, you might receive 135 yen for every $1. But if the Japanese stock market plummets on bad economic news that day - or if the American stock market soars - you might get 137 yen for each dollar Monday night.

That works to your advantage heading to Japan, but a weakening yen works against you when, on the way home, you exchange what yen you have left for dollars. The 135 yen that cost you $1 might only bring you 95 cents.

"When holding these yen, you take the risk of it going up or down. You are a position holder," said Gary Feder, president of the International Currency Association.

This is sort of the risk currency traders deal with.

Traders may buy and sell dollars, pounds, yen, ringgit and baht for the bank's customers or in the bank's own account. Trades are done at a minimum of $1 million, and sometimes for much more, so slight fluctuations in prices mean sizable profits or losses.

"It's a bit like playing chess. The rules are simple. But to be a chess master, you have to use your head," said Peter Wadkins, vice president of Tullett & Tokyo Liberty, a New York money broker.

In a very basic example, say a bank's corporate customer needs yen to complete a transaction with a Japanese company, and agrees to a price of 135 yen for $1 with the bank. The bank's foreign exchange trader then goes into the market, called the interbank foreign exchange, consisting of other banks, looking to see if he or she can find a better price.

If the U.S. bank's trader can get, say, 135.05 yen for each dollar, then the bank makes a profit on the transaction, said Russell Wasendorf, co-author of Foreign Currency Trading. If the trader can only get 134.95 yen, however, then the bank would take a loss.

Transactions are generally done quickly - often within minutes - so the risk is passed on.

Trading on behalf of corporate customers is usually done by junior staff, and the bank's most experienced traders are allowed to do proprietary trading for the bank's own account, said John Drohan, a commodities attorney with Drohan & Drohan in New York.

Rusnak was doing proprietary trading for Allfirst Financial Inc.

In proprietary trading, which can involve elaborate strategies and sophisticated financial instruments, a bank may hold a position for a half-hour or even a week or two, trying to profit from longer-term price changes, Drohan said.

The foreign exchange trading done between banks is essentially unregulated. Individual banks, though, have risk managers who determine a trader's risk parameters, based on the trader's experience, said Wadkins, the New York broker. Traders will be told how much revenue they are expected to bring in each day, how much loss they can incur and the size of the position they can hold.

Sometimes banks take on risk to make a profit, and other times they hedge - a strategy that lowers the possibility of a big loss, but also reduces potential profit.

The bank may sell a "call" option to a corporate client, giving the customer the right to purchase a currency at a certain price within a certain time. If the currency price rises and the client exercises its right, the bank must make up the difference from the price the client is paying for the currency and the higher current price.

But the bank may hedge its risk by also buying a call option similar to the one it sold, so that if the currency does rise, the bank is protected against a loss.

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