How To Invest In Currency?
People invest in currencies because of various reasons. Unlike the stock market, currency markets are way bigger and government bodies, like the RBI, banks, also trade in the currency. The reasons for trading differ, for example, RBI trades to provide a hassle-free and timely flow of credit into the markets, or to improve the balance of trade of their country or to control inflation, the reasons are plenty.
There are two ways in which we can invest in a currency as investors:
1. OTC (Over the Counter) Markets: An over-the-counter market is a market that is not regulated by an authority. In these types of markets, dealers act as market makers by quoting the buy and sell prices. These markets are generally very illiquid, meaning an investor has to be compensated with a liquidity premium in their investments.
OTC markets are also generally very less transparent and are subject to fewer regulations. Lower entry costs are an added advantage of the OTC markets.
There are two subcategories of OTC markets:
a) Interbank Market- The interbank market is a global market for financial institutions to trade currencies between themselves.
b) Merchant Market- Merchants help businessmen to start a business and help to raise finance. They provide consultancy to its clients for financial services.
2. Derivative Exchanges: Currency derivatives are futures and options contracts that trade on the exchange. Derivative contracts are generally more transparent and are traded on a real-time basis. Currency derivative exchanges are similar to stock exchanges. We can trade currencies at NSE and BSE exchanges.
Currency derivatives are useful in the following ways:
- Hedging: Traders and Investors face risk associated with the prices of underlying assets and use derivatives to reduce their risk.
- Arbitrage: Traders try to find a mispriced security in two different markets and profit from it.
- Speculating: Traders try to predict the future movements in the price of underlying assets and based on the view, take positions.
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