Trade Forex - Forex Market

Interest Rates and Forex Rates

There is a basic fact of life which we must bear in mind: You never get anything for nothing. When you acquire a house you have to give money in exchange. When you acquire a Treasury bill, you must also give money in exchange. When you operate in the money and foreign exchange money market, you are always giving and taking every time that you enters into a transaction. In this article we shall discuss how the price or rate of exchange in this giving and taking is expressed.
As in any other market, prices in the money market and the foreign exchange market depend on whether one is buying or selling. Traders in these markets always provide two prices: the one at which they are willing to buy and the one at which they are willing to sell. Actually, this is one of the ways in which traders in these markets make a profit. However in this chapter we shall talk about market rates in general, leaving our discussion of the complications involved in bid and offer rates.

Rates in the Money Market

Prices in the money market are usually expressed in terms of percentage rates of interest. These rates measure the cost or return associated with the use of money for a specified period of time. For example, in a loan of $100 if the lender receives $108 at the end of the year the $8 represents an 8 percent annual interest rate on the money. In physical terms the lender gives up currency in Forex exchange for a piece of financial paper that establishes that the borrower will return the principal of the loan, $100, plus the specified rate of interest, 8 percent per annum.1

Interest Rate Quotations

In reading interest rate quotations of forex institute, one must be careful to understand the period of time involved. The figure 8 percent alone does not convey the necessary information to evaluate the cost of money. Usually, these rates are expressed on a per annum basis. However, sometimes a rate will apply to a period of time different from a year. For example, in countries with high interest rate levels, interest rates are often quoted on a per month basis, say, 2 percent per month. Obviously, any rate applicable for any period of time can be converted to a per annum basis. Thus, a 2 percent per month rate is equivalent to 24 percent (2 percent X 12 months) per annum. Whatever the unit of time involved, the important fact to remember is that if one wants to compare interest rates among themselves or with other percentage returns, all the numbers must be based on the same unit of time, usually per annum. Otherwise, one will reach erroneous conclusions.
The alternative to forex trading interest rates quoted for a specific period of time, such as per annum, per quarter, or per month, is a flat interest rate. For example, 4 percent flat of $100 is $4. In this calculation the time factor does not playa role. The 4 percent flat is always simply 4 percent of the amount in question. Of course, it is possible to convert a flat interest rate into a per annum interest rate. For example, if the flat charge of 4 percent covers a two-month period, then 4 percent flat would be equal to 24 percent per annum. On the other hand, per annum interest rates may be converted into flat interest rates. A charge of 10 percent per annum covering two years word is equal to a 20 percent flat rate.