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LM01 Alternative Investment Features, Methods, and Structures

LM01 Categories, Characteristics, and Compensation Structures of Alternative Investments

LM01 Corporate Structures and Ownership

LM01 Derivative Instrument and Derivative Market Features

LM01 Ethics and Trust in the Investment Profession

LM01 Fixed-Income Instrument Features

LM01 Fixed-Income Securities: Defining Elements

LM01 Introduction to Financial Statement Analysis

LM01 Market Organization & Structure

LM01 Market Organization and Structure

LM01 Organizational Forms, Corporate Issuer Features, and Ownership

LM01 Portfolio Management Overview

LM01 Portfolio Management: An Overview

LM01 Rates and Returns

LM01 The Firm & Market Structures

LM01 Time Value of Money

LM01 Topics in Demand and Supply Analysis

LM02 Alternative Investment Performance and Returns

LM02 Analyzing Income Statements

LM02 Code of Ethics and Standards of Professional Conduct

LM02 Code of Ethics and Standards of Professional Conduct Profession

LM02 Financial Reporting Standards

LM02 Fixed Income Markets - Issuance Trading and Funding

LM02 Fixed-Income Cash Flows and Types

LM02 Forward Commitment and Contingent Claim Features and Instruments

LM02 Introduction to Corporate Governance and Other ESG Considerations

LM02 Investors and Other Stakeholders

LM02 Organizing, Visualizing, and Describing Data

LM02 Performance Calculation and Appraisal of Alternative Investments

LM02 Portfolio Risk & Return: Part I

LM02 Portfolio Risk and Return Part I

LM02 Security Market Indexes

LM02 The Firm and Market Structures

LM02 Time Value of Money in Finance

LM02 Understanding Business Cycles

LM03 Aggregate Output, Prices and Economic Growth

LM03 Analyzing Balance Sheets

LM03 Business Models & Risks

LM03 Corporate Governance: Conflicts, Mechanisms, Risks, and Benefits

LM03 Derivative Benefits, Risks, and Issuer and Investor Uses

LM03 Fiscal Policy

LM03 Fixed-Income Issuance and Trading

LM03 Guidance for Standards I-VII

LM03 Guidance for Standards I–VII

LM03 Introduction to Fixed Income Valuation

LM03 Investments in Private Capital: Equity and Debt

LM03 Market Efficiency

LM03 Portfolio Risk & Return: Part II

LM03 Portfolio Risk and Return Part II

LM03 Private Capital, Real Estate, Infrastructure, Natural Resources, and Hedge Funds

LM03 Probability Concepts

LM03 Statistical Measures of Asset Returns

LM03 Understanding Income Statements

LM04 An Introduction to Asset-Backed Securities

LM04 Analyzing Statements of Cash Flows I

LM04 Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives

LM04 Basics of Portfolio Planning & Construction

LM04 Basics of Portfolio Planning and Construction

LM04 Capital Investments

LM04 Common Probability Distributions

LM04 Fixed-Income Markets for Corporate Issuers

LM04 Introduction to the Global Investment Performance Standards (GIPS)

LM04 Monetary Policy

LM04 Overview of Equity Securities

LM04 Probability Trees and Conditional Expectations

LM04 Real Estate and Infrastructure

LM04 Understanding Balance Sheets

LM04 Understanding Business Cycles

LM04 Working Capital and Liquidity.

LM05 Analyzing Statements of Cash Flows II

LM05 Capital Investments and Capital Allocation

LM05 Company Analysis: Past and Present

LM05 Fixed-Income Markets for Government Issuers

LM05 Introduction to Geopolitics

LM05 Introduction to Industry and Company Analysis

LM05 Monetary and Fiscal Policy

LM05 Natural Resources

LM05 Portfolio Mathematics

LM05 Pricing and Valuation of Forward Contracts and for an Underlying with Varying Maturities

LM05 Pricing and Valuation of Forward Contracts.

LM05 Sampling and Estimation

LM05 The Behavioral Biases of Individuals

LM05 Understanding Cash Flow Statements

LM05 Understanding Fixed-Income Risk and Return

LM05 Working Capital & Liquidity

LM06 Analysis of Inventories

LM06 Capital Structure

LM06 Cost of Capital-Foundational Topics

LM06 Equity Valuation: Concepts and Basic Tools

LM06 Financial Analysis Techniques

LM06 Fixed-Income Bond Valuation: Prices and Yields

LM06 Fundamentals of Credit Analysis

LM06 Hedge Funds

LM06 Hypothesis Testing

LM06 Industry and Competitive Analysis

LM06 International Trade

LM06 Introduction to Geopolitics

LM06 Introduction to Risk Management

LM06 Pricing and Valuation of Futures Contracts

LM06 Simulation Methods

LM07 Analysis of Long-Term Assets

LM07 Business Models

LM07 Capital Flows and the FX Market

LM07 Capital Structure

LM07 Company Analysis: Forecasting

LM07 Estimation and Inference

LM07 International Trade and Capital Flows

LM07 Introduction to Digital Assets

LM07 Introduction to Linear Regression

LM07 Inventories

LM07 Pricing and Valuation of Interest Rate and Other Swaps

LM07 Pricing and Valuation of Interest Rates and Other Swaps

LM07 Technical Analysis

LM07 Yield and Yield Spread Measures for Fixed-Rate Bonds.

LM08 Currency Exchange Rates

LM08 Equity Valuation: Concepts and Basic Tools

LM08 Exchange Rate Calculations

LM08 Fintech in Investment Management

LM08 Hypothesis Testing

LM08 Long Lived Assets

LM08 Measures of Leverage

LM08 Pricing and Valuation of Options

LM08 Topics in Long-Term Liabilities and Equity

LM08 Yield and Yield Spread Measures for Floating-Rate Instruments

LM09 Analysis of Income Taxes

LM09 Income Taxes

LM09 Option Replication Using Put-Call Parity

LM09 Option Replication Using Put–Call Parity

LM09 Parametric and Non-Parametric Tests of Independence

LM09 The Term Structure of Interest Rates: Spot, Par, and Forward Curves

LM10 Financial Reporting Quality

LM10 Interest Rate Risk and Return

LM10 Non-current (Long-Term) Liabilities

LM10 Simple Linear Regression

LM10 Valuing a Derivative Using a One-Period Binomial Model

LM11 Financial Analysis Techniques

LM11 Financial Reporting Quality

LM11 Introduction to Big Data Techniques

LM11 Yield-Based Bond Duration Measures and Properties

LM12 Applications of Financial Statement Analysis

LM12 Introduction to Financial Statement Modeling

LM12 Yield-Based Bond Convexity and Portfolio Properties

LM13 Curve-Based and Empirical Fixed-Income Risk Measures

LM14 Credit Risk

LM15 Credit Analysis for Government Issuers

LM16 Credit Analysis for Corporate Issuers

LM17 Fixed-Income Securitization

LM18 Asset-Backed Security (ABS) Instrument and Market Features

LM19 Mortgage-Backed Security (MBS) Instrument and Market Features

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IFT Notes for Level I CFA^® Program

LM08 Currency Exchange Rates

Part 2

2. Market Functions

There are several motivations for foreign exchange transactions such as:
- International trade: Companies buying and selling products/services across geographies.
- Capital market transactions such as investors buying fixed assets in other countries, investing in stocks/bonds denominated in foreign currencies.
- The growth of international tourism. Tourists buy the currency of the country they are visiting.

Hedging versus Speculating

Hedging is engaging in a transaction to mitigate foreign exchange risk.
- For example: A Chinese food products company imports canned peaches, Maple syrup, and various types of vinegar from the United States. It makes the payment in dollars. The company can engage in a forex transaction to buy a certain amount of dollars at a specified rate. This removes the risk (uncertainty) of the U.S. dollar becoming too expensive in the future. This is an example of hedging.
- For example: Take another example of a software services exporter in Pakistan who gets paid in dollars. But the revenues are reported in Pakistani rupee (PKR). To remove the uncertainty of how much the U.S. dollar translates into PKR, the company may engage in forex transaction to receive a certain amount of PKR for every dollar at a certain date.
Speculating: This means that unlike in the examples above, the person engaging in the transaction has no intention of taking delivery of the currency. They seek to profit from exchange rate changes. They were merely anticipating a movement in a certain direction (currency appreciating / depreciating) and trading on that view.
At times the difference between hedging and speculation is blurred.

Spot Transactions

Spot transactions involve the exchange of currencies for immediate delivery. For most currencies, this corresponds to “T+2” delivery, meaning that the exchange of currencies is settled two business days after the trade is agreed to by the two sides of the deal.
- The exchange rate used for such transactions is called the spot exchange rate.

Forward Contracts
- Forward contracts are agreements to deliver foreign exchange at a future date at an exchange rate agreed upon today. As such, they are any exchange rate transactions that occur with currency settlement longer than T+2 days.
- In the hedging examples we saw earlier a forward contract may be used. For example, the Chinese company may enter into a contract on Jan 13, 2014 to pay $500,000 on Apr 13, 2014 at the rate of 6.21 CNY ( $\frac{CNY}{USD} = 6.2100)$
- Two factors are defined in each forward contract:
  - The date at which the currencies are to be exchanged.
  - The exchange rate applicable on the settlement date. This exchange rate is defined now and is called the forward exchange rate; it is different from the spot rate.
- Forward contracts can be of any size the counterparties agree upon, however the liquidity in forward market decreases as the trade size and term to maturity increases.

3. Market Participants, Size and Composition

The forex market has a diverse range of participants. One way of classifying them is to group them based on buy side and sell side players.

Sell side:

Large FX trading banks such as Deutsche bank, Citigroup, UBS, and HSBC.
Other banks fall into the second and third tier of the FX market.

Buy side:

Clients who use banks to undertake FX transactions.
Corporate accounts: Corporations using forex transactions for cross-border trade of goods and services.
Real money accounts: restricted use of leverage. Investment funds managed by mutual funds, ETFs, pension funds, endowments etc.
Leveraged accounts: Hedge funds, high-frequency algorithmic traders.
Retail accounts: Individuals trading for their own accounts, tourists exchanging currency during international travel.
Governments.
Central banks: Intervene in the forex market to control their domestic exchange rate. For instance, during 2012-13, the Reserve Bank of India bought billions of U.S. dollars to strengthen the depreciating Indian rupee.
Sovereign wealth funds: Countries with current account surpluses like Norway, UAE, Kuwait, and China direct international capital inflows into SWFs instead of holding them as foreign exchange reserves. SWF then invests these funds internationally in natural resources, infrastructure projects and real estate to earn higher returns and exert more influence.

3.1 Market Size and Composition

Exhibit 3 in the curriculum (reproduced below) lists FX turnover by instrument.

FX Turnover by Instrument

Spot	36%
OTC forwards	12
Exchange-traded derivatives	4
Swaps^a	44
OTC Options^b	4
Total	100%
a Includes both FX and currency swaps.
b Includes what the BIS categorizes as ‘’other FX products.’’

The largest turnover is in the swaps market, followed by the spot market.

Note: You need not memorize the numbers.

Exhibit 4 in the curriculum (reproduced below) lists FX flows by counterparty. Average daily FX flow between financial clients is higher than that between the sell-side banks (interbank market).

FX Flows by Counterparty.