Basic Terms

• "Pip" is the smallest price increment in a currency, which is 0.0001 for forex rates quoted to four decimal places and 0.01 for Japanese yen-based currency pairs. For example, a CAD/USD exchange rate move from 0.9755 to 0.9756 is one pip, while a USD/JPY move from 100.23 to 100.24 is one pip. "CAD," "USD" and "JPY" refer to the Canadian dollar, U.S. dollar and Japanese yen, respectively. The terms "ask" and "bid" refer to prices at which the currency dealer is willing to sell and buy, respectively. "Bid/ask spread" is the difference between bid and ask, usually expressed in pips. "Spot" rates mean current exchange rates.
  
  

Currency Pairs

• Exchange rates are quoted for several currency pairs, the most common being GBP/USD, EUR/USD, USD/CHF and USD/JPY. "GBP," "EUR" and "CHF" refer to the British pound, euro and the Swiss franc, respectively. "Cross rates" refer to exchange rates not involving the U.S. dollar, such as EUR/CHF and CAD/JPY. The first currency in a pair is the "base" currency and the second is the "counter" currency. The exchange rates show how much of the counter currency is required to buy one unit of the base currency.
  
  

Trading

• A "market" order is an order to buy or sell at the current ask or bid price, respectively, while a "limit" order is executed at the specified price or better. "Margin" is the minimum level of funds required in an account to trade currency pairs. The "cost of carry" is the interest cost on the funds borrowed from the broker to hold open currency positions. A "margin call" takes place when the margin drops below the minimum level, usually as a result of changes in the exchange rates of open positions. "Fundamental" analysis involves assessing the direction of exchange rates based on monetary policy and overall economic conditions. "Technical" analysis is based on price charts and statistical measures.
  
  

Derivatives

• Derivatives derive their values from underlying assets, such as stocks, bonds, commodities and currencies. Currency derivatives include "futures," "forwards," "options" and "swaps." Derivatives are used by businesses to hedge against currency fluctuations. Forwards and futures are agreements between two parties to fix future exchange rates. Futures contracts trade on derivatives exchanges, such as the Chicago Mercantile Exchange. Options give investors the right but not the obligation to buy (call option) or sell (put option) the underlying asset by an expiration date. In swaps, principal currency amounts are exchanged at spot rates with an agreement to swap them back at an exchange rate at a predetermined point in the future.