The most remarkable performances in the investment world in recent years have been achieved by people, or .funds, operating in the .futures markets –and increasingly in financial. futures. George Soros* was a pioneer in what me might call “The New Investment Way. “ The currencies markets have been central to the investment approach of Soros’ Quantum* Fund, in which James Rogers was a partner for a time, and which grew from a few million to over $2bn. Currencies are the most important market for Bruce Kovner’s Caxton Corporation, which has overtaken the Mint group in size. The success of these .funds should have changed the way people think about currencies. But the change is coming about very slowly.

A freight agent in the Persian Gulf was chartering planes to bring in electrical equipment. The agent paid his charter cost in dollars but agreed to accept payment for the freight in Belgian francs. On one occasion, a sharp rise in the dollar cost him all of his profit margin plus about the same amount again. He resolved never to expose himself to a comparable currency risk again. Moreover as he pondered the way a move in the dollar had amounted to twice the profit margin on the freight, he further resolved to study the currency markets in depth; and in due course, perceiving that there could be no half measures with currency risks, he left the freight agency business to devote all his time to the analysis and trading of currencies.

The first thing we have to decide in currencies is once and for all to separate occupational risk from performance aims. Occupational risk is exposure incurred as a by-product of your situation –whether it be the commercial’s problem of currency receivables and payables or the investor’s risk in holding foreign assets or liabilities. Performance is to do with making money .Bankers usually blur the difference. But you and I should have no truck with fuzzy thinking which encourages one to muddle risk– perception and performance: you end up muddling fear and greed.

It’s up to you to decide what occupational risk you can stand: what you can’t stand you should eliminate by hedging, taking into account the costs involved. Having done that, you are free to pursue performance any way you like. This book is about the pursuit of performance in the currency markets; and this chapter is about how to set about it in practice. It’s

addressed to investors, to fund managers including treasurers, to other speculators, and to commercials concerned with the timing of currency purchases and sales. You’re already on your way to being knowledgeable analyst and a keen forecaster .

You can deal in the currency markets in 3 ways – cash*, forward* or futures*. The cash (or “spot”, as in cash-on-the-spot) and forward markets are made by banks: they decide the rates at which they will deal. They have no currency “exchange”, in the way you have a stock exchange, or a futures exchange. The equivalent of a quotations board is the video screen where the buying and selling rates of specific banks in specific financial centres are purveyed through the agency of Reuters, Knight-Ridder and others. This is the so-called “inter-bank” market.

Interbank Market.

The banks provide a very competitive service to large clients who are able to pick and choose between their quotations, as multinationals are and as brokers are; and they provide the only service for the “spot” market, and for all currencies other than the main “reserve*” currencies. But for centuries, people have wanted to settle their commercial dealings at a future date –to pay for the goods “ after the ship comes in”, for example. However they often wished to settle the rate for conversion between two currencies now. This is just the kind of thing bankers are happy to do if they are handsomely remunerated.

So for centuries bankers have been quoting rates for forward dates. This is the forward* currency market, in which rates are quoted for almost any date in the future. The way forward rates differ from spot rates has been described in Chapter IV .It is determined mathematically by the difference in interest yields on the currencies in question: if 6-month interest rates on the two currencies happened to be exactly the same, the 6-month forward rate would be the same as the spot rate.

In the early 1970s, after currencies had begun to float, some luminaries in the futures markets of Chicago said “Hey! Why don’t we start up a futures markets in these currencies, just like in corn and hogs.” There was no reason why not. To Chicagoans, and Texans and Californians et al, foreign currencies were not that different from corn and hogs and copper and gold, and few Americans knew much about the interbank market in currencies. So they went ahead and the first financial futures were born – to be followed by futures in T-Bonds and stock indices and Eurodollars and the rest.

The currency futures markets in Chicago thrived, partly because of the thinness of the interbank currency markets in North

America. Of course they quoted the foreign currencies in dollars and cents, just as they quoted hogs and corn in dollars and cents. So their method was to quote the D-Mark as, say , l DM = 29.5c or $0.2950, rather than the European way of $1 = DM 3.390. And the future settlement dates were fixed at specific quarterly dates in March, June, September and December. But in other respects, the “future” was much the same as the forward. And if the price of mid-June D-Marks got too high in relation to the forward interbank rate, someone would arbitrage* the difference by selling the future in the IMM* (International Money Market) exchange and buying the forward in the interbank market.

Contrary to the conventional wisdom prevailing in Europe, I suggest you don’t deal in the forward interbank market, unless you deal in very large size, through a broker or through a fair selection of banks, who will accommodate you through most of your normal waking day (see Chapter One). If you deal in the futures market, one broker should suffice. The one essential you seek in your broker is immaculate execution. That’s all. But it does include always answering the telephone instantly; being available from 7.30 am – 8.30 p.m. London time; offering 24 hour execution of stops; and complete honesty in all things, notably in the matter of the price at which your trades are executed.

In addition to the big US brokers, such as Merrill Lynch, Prudential Securities, Shearson-Lehman, there are many smaller outfits which can offer a more personal service at competitive commission rates. See “broker*” in the Glossary. Some of these advertise from time to time in the financial papers.

The 24-hour day covers Singapore’s Simex* futures market as well as Chicago’s IMM: the currency contracts at Simex are interchangeable (“fungible” is the technical term) with the IMM’s. But in addition, the so-called EFP* market offers IMM quotations at most times when an active interbank market exists somewhere in the world. EFP stands for “exchange for physical”: the EFP market consists of a number of specialist market-makers, who are in the business of arbitraging between futures contracts and the “physical” interbank forward markets. Like the banks, they make their turn on the “spread” between offer and bid prices: the spread is usually 3 to 5 points (as opposed to 1 point in the IMM) – i.e. $37.50 to $62.50, on contracts of $70,000-$120,000 –which is very competitive with the spreads quoted by banks for such amounts.

The amount of currency exposure a bank will allow you to run is a matter for negotiation. The IMM operates a “margin*” system, as do all futures markets – margin being money you have to ante up to cover the risk in a