Mechanics of Margin FX

When trading margin foreign exchange, investors are quoted a dealing spread that offers a buying and selling level for the trade. When the investor accepts the offered price and receives a confirmation, the trade is done. For example if the AUD/USD quote is 0.7000 (bid) to 0.7005 (ask-offer), this would mean selling AUD dollars against the US dollar at 0.7000 and buying at 0.7005.

*The term bid (willing buyers) is the available price to sell at and the term offer or ask (willing sellers) is the available price to buy at.

Buying a foreign currency (either spot or forward) to open creates an asset. The position is said to be long the foreign currency. If the foreign currency appreciates, there will be an exchange gain. If the currency depreciates, there will be an exchange loss. Selling a foreign currency (either spot or forward) to open creates a liability. The position is said to be short the foreign currency. If the foreign currency depreciates, there will be an exchange gain. If the currency appreciates, there will be an exchange loss.

The execution of an equal and opposite transaction will give rise to a “closed” forward position, namely a bought and a sold position for an identical amount of the commodity currency in the same terms currency for settlement on the same settlement date. Accordingly, upon settlement, the amount payable on the settlement date will be the net value of the opening and the closing transaction in the terms currency. In this situation, initial margins for the positions will not be required as no positions will be open. However, we note that the profits from such transactions cannot be paid until the settlement date and that the losses (if any) must be fully covered by variation margins pending settlement.

The margin FX products offered are either spot FX, forward FX and FX options:

1. Spot and Forward Contracts:
a) Spot Contract
A Spot transaction is a margin foreign exchange contract where the settlement date is within two business days after the date of entering the transaction. Please note that this settlement period will be impacted by public holidays in the relevant market.

b) Forward Contract
A forward contract is an agreement to buy or sell a specified amount of a commodity or financial instrument at a fixed price to be settled at some future date (ie greater than two (2) business days). Please note that, at the settlement date, the forward contract will continue as a spot transaction with automatic rolling of the position until the position is closed by you.

A forward contract (also referred to as a forward outright on the trading platform) is a currency rate deal where the settlement date is later than two working days after the date of entering the transaction starting the day the deal is made until it ends. An open margin foreign exchange position for a forward date may be closed out or liquidated by the execution of an equal and opposite position. Accordingly, the deal ends in one of the following events:

1. Termination initiated by you.
2. The currency rate has reached the stop loss or profit target rate you specified or predefined.

2. Leverage
The use of Margin Forex involves a high degree of leverage. These contracts enable a
user to outlay a relatively small amount (in the form of initial margin) to secure an exposure to the underlying share. This leverage can work against you as well as for you. The use of leverage can lead to large losses as well as large gains. For example, if you have a positive view about the prospects of the AUD strengthening to the USD, you could  buy 100,000 worth of the AUD at say the ask (offer) quoted at 0.7000 and use an initial margin of $2,000. For the experienced investor, this leverage provides an attractive means of gaining exposure to the performance of the underlying currency without the need to invest in the physical currency.

3. Margins
The entry into Margin Forex involves the payment of margins. There are two components of the margin, which you are required to pay in connection with  Margin Forex. These are initial margin and variation margin.

The Initial Margin (IM) is an amount of money that will be debited from your account at the time the Forex transaction is entered into. The initial margin represents the security deposit value that you are required to hold when you first open a Forex position. The initial margin is typically 2% of the contract value for majors or will represent the assessed risk value that the principal determines should apply.  An initial margin is a form of risk control based on the volatility in the market if the market moved adversely against you overnight, initial margins are returned when positions are closed. The initial margin value is expressed in the first currency.

Initial margin obligations will be as follows:
• In the case of Spot and Forward contracts, the initial margin immediately payable will be a percentage of the face value of the contract currency pairs. (For more details on Forex sprecifications see last page of manual.)

• In the case of bought Option contracts, the initial margin immediately payable is the full
amount of the premium value. In the case of sold Option contracts, the initial margin
payable will be dependent upon the specific characteristics of the contract (eg strike
price, volatility of underlying instrument, time to expiry).

The Variation Margin (VM) is the unrealised profit or loss on your open position. This amount is equal to the dollar value movement in your open position when compared against the current market price. The profit or loss is realised when positions are closed.
The variation margin value is expressed in the second currency.

The Gross Liquidation Value (GLV) is the amount of money you would have in your account were you to close out all positions (ie realising variation margin) at the current market price (less any transaction charges or adjustments).

The Free Equity (FE) balance is defined as Gross Liquidation Value less Initial Margin.
Free equity can be utilised to enter into further Forex positions or can be withdrawn from your account, subject to account minimum balance being maintained.

Example:
In this example, say we bought $100 000 worth of AUDUSD, which requires an initial margin of $2 000 (ie 2% of purchase value) and the price has moved favourably from the bought price by $1 000 (VM) at the close of the market. Hence the GLV is $21 000 ($20 000 +$1 000) and the Free Equity is $19 400USD ($21 000USD-$2 000AUD). Note: Starting account balance was USD$20 000 and is the nominated currency base by the client.

Account Balance	Initial Margin	Variation Margin	GLV	Free Equity *
$20 000USD	-$2 000 AUD	+$1 000USD	$21 000USD	$19 400USD

4. Margin Calls
Margin calls occur when your free equity falls into negative territory, positions are monitored on a mark to market basis. You are provided with notice of the margin deficit by making a “margin call” via e-mail, fax, sms message, telephone, pop ups through the platform or via post. When we make a margin call you must deposit the amount of funds that we request into your account. Margin calls must normally be met within 24 hours of making a margin call. In some situations you may require payment within a shorter time period (for example where there is unusual volatility). If you fail to make margin payments we may reduce or close all your open positions without further notice. You must be in a position to fund such requirements at all times and ensure that you are always contactable.

5. Daily payment of differences
a) Sold Open Positions
If the contract value at the close of business is, in monetary terms, greater than your sold contract value determined for the previous day, and you hold a “short” position, you will pay the difference. Conversely, if the new contract value in monetary terms is less than your sold contract value, you will receive the difference. This difference is treated as the variation margin.

b) Bought Open Positions
If the contract value at the close of business is, in monetary terms, greater than your bought contract value determined for the previous day, and you hold a “long” position,  you will receive the difference. Conversely, if the new contract value in monetary terms is less than your sold contract value, you will pay the difference. This difference is treated as the variation margin.

6. Closing a Margin Forex
To close a  Margin Forex position, you place the order, either electronically or by telephone, to determine the current market price, with the view to close the position (or part of it). The profit or loss from a transaction is calculated by keeping the units of one of the currencies constant (the “base” currency) and determining the difference in the number of units of the other currency (the “terms” currency). The profit or loss will be expressed in the units of the currency which is not kept constant. Profits and losses are converted to your base currency that you have nominated for your account.

Profits and/or losses are realised if both the buy and the sell side of the transaction are complete and have been matched against each other or closed out. Profits and/or losses are unrealised if only one side of the transaction has been completed. In other words, if you do not instruct the system to match selected trades against previous trades then it will default to matching trades on a First In First Out (“FIFO”) basis. This will result in the transactions remaining open and only being matched at settlement date.

7. Price Quotations
The principal calculates foreign exchange rates taking into consideration the current spot “inter bank” exchange rates and the amount of currency that you wish to buy or sell. The calculation of the price to be paid (or the payout to be received) for margin foreign exchange products offered by the principal, at the time the contract is purchased or sold, will be based on the best estimate of market prices and the expected level of interest rates, implied volatilities and other market conditions during the life of the financial contract and is based on a complex arithmetic calculation.

The contract prices (or the payout amounts) offered to clients hedging, trading or speculating on market prices may differ from prices available in the primary or underlying markets where contracts are traded. This is due to the spread favouring the principal in the price calculation. The principal acts as a market maker and not a broker and make their earnings from the spreads that are embedded in the currency rates. Different spreads are used depending on the currency pair traded. The spread is the difference between the rate at which we buy and sell (bid and offer) the financial instruments (i.e. between the wholesale price achieved by the principal and your trade price). This spread is incorporated into the rates quoted to you and is not an additional charge or fee payable to you.

It is arbitrary how many significant figures are used in an exchange rate quotation. The last decimal place to which a particular exchange rate is usually quoted is referred to as a “point” or “pip”, all points (or pips) are not of equal value. For example:

• In the quotation USD 1=AUD 0.7250, one point or one pip means AUD 0.0001.
• In the quotation USD 1=JPY 102.50, one point or one pip means JPY 0.01.