REPUBLIQUE DU CAMEROUN

REPUBLIC OF CAMEROON
Paix-Travail-Patrie
Peace-Work-Fatherland
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NISTERE DE L’ENSEIGNEMENT
MINISTRY OF HIGHER EDUCATION
SUPERIEUR
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BILINGUAL INSTITUTE OF APPLIED SCIENCES
TITUT UNIVERSITAIRE BILINGUE DES
AND TECHNOLOGY (BIAST)
NCES APPLIQUÉES ET TECHNOLOGIE
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(BIAST)
**********AUTORISATION N°19 /00/649 /MINESUP/SG/DDES/ESUP DU 10 JUILLET 2019
BP: 1026 Tel: (237) 674784870 / 695998714 Bafoussam-Cameroun
Email: [email protected] Site web: http://www.biast.cm

Department: Banking and Finance

Course Title: Finance II Course Code: BFI 125
Semester: First, Course Instructor: NEBA Alphonse A.

COURSE OUTLINE:
Part One: Decentralized Financial Systems II: CEMAC Regulations on MFIs
Chapter 1: The approval, prior authorization, statement, and prohibitions.
 The Approval:
 Approval of establishments;
 Approval of leaders and auditors.
 Prior authorizations and declarations: - the prior authorization; - the simple statement;
- Limits of MFI activities.
Chapter 2: Regulatory standards for the surveillance and control of the establishments.
Part Two: Islamic Finance II
Chapter 3: Main techniques of Islamic finance
Part Three: Financial Markets II
Chapter 4: The foreign exchange market and determinants of currencies exchange rates;
Chapter 5: The main transactions on the foreign exchange market.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 1

PART ONE: DECENTRALIZED FINANCIAL SYSTEMS: CEMAC REGULATIONS
OF THE MFI

CHAPTER 1: THE APPROVAL, PRIOR AUTHORIZATION, STATEMENT, AND

PROHIBITIONS

1.1) General Regulatory Framework

Before 1998, microfinance institutions in Cameroon were supervised and placed under the control of
the Ministry of Agriculture. During the period the activities of these institutions were seen as essentially
suited for the promotion of rural and agricultural activities. However, as a result of many irregularities in the
field and due to little or no supervision and control expertise at the level of personnel working in the
Ministry of Agriculture the was an urgent need to protect the public and guard depositors’ funds. This
resulted into a Prime Ministerial decree that puts the granting of licenses, supervision, and control of all
MFIs under the Ministry of Finance and COBAC.

In Cameroon, MFIs are regulated by three different laws: (1) the national law, (2) the Economic and
Monetary Community of Central Africa (CEMAC) law instituted through COBAC, (3) the Pan African
Organization for Harmonization of Business Law in Africa (OHADA). Each institution is compelled to
comply with these frameworks paying attention to the basic prudential norms as stated by COBAC.
However, despite the existence and clear definitions of these laws and regulations, dissemination among
major stakeholders remains relatively poor. Again, the fact that many government bodies and ministries are
involved in the provision of microcredit supposedly as a way of alleviating poverty and fighting
unemployment from different dimensions complicate matters further. This is because through various
memorandums the activities are carefully regulated.

The master text prepared by COBAC for the regulation and control of MFIs focuses on the nature of
activities of these institutions and not their legal form. In article one of the text, microfinance is referred to
as activities undertaken by authorized entities without the status of either a bank nor a financial institution,
but do accept savings and offer credits in addition to other financial products to mostly those left out of the
traditional banking system. The same text categorized these institutions under three categories:
A) Category one: are institutions that collect savings and deposits and lend them to their members. This
category includes associations, cooperatives and credit unions. There is no stipulated capital for category
one institutions, instead COBAC text required the capital to be sufficient to cover and meet up with
stipulated prudential norms.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 2

B) Category two: are institutions that collect savings and deposits and lend them on to third parties. This
category groups limited liability companies that function more like micro-banks. The minimum capital
for category two institutions as stipulated by the text is FCFA50million. Proof of this amount must be
shown in the form of a bank statement from any of the commercial banks.
C) Category three: is made of lending institutions that do not collect savings and deposits. They include
micro credit and project financing institutions. The minimum capital requirement for a category three
institution is FCFA25millions. This amount must be fully paid with evidence shown in the form of a
bank statement from a commercial bank as at the time of application for accreditation.

Prudential and non-prudential requirements are more stringent for MFIs that mobilize public savings,
and this follows good practice. As part of the 2002 regulation, COBAC also established 21 regulations
defining prudential ratios, and existing MFIs were compelled to comply with these ratios by the end of April
2007

According to article eight, all intermediation operations carried out by a microfinance institution is
limited to the country where it is implanted. For any intermediation operations with the rest of the world, all
MFIs must pass through a commercial bank, or other financial institutions within the country of operations.
At inception, each category is expected to receive accreditation and license before commencing operations.
The COBAC text also recommends each MFI to be part of the national association of MFIs. Their
membership will serve as a liaison between policy makers, the government and provide members the
opportunities to chip in their inputs for the development of better microfinance policies.

1.2) Registration Approval

More than 80% of MFIs in Cameroon are registered as association or cooperative savings and credit
institutions. These MFIs are consequently governed by the law No. 90/053 of 19 December 1990 on
freedom of Association, and law No. 92/006 of 14 August 1992 relating to cooperative societies and
common initiative groups. The other two categories of MFIs are registered either as limited companies or
project financing institutions. After obtaining their legal form as it pertains to the various categories, each
MFI must request for accreditation from the Ministry of Finance. This is in accordance to Prime Ministerial
Decree of 1998 (No. 94 of 98/300/PM laying down the procedures governing credit unions, cooperatives).

To submit an application, there must be a promoter or manager in place, as well as a general

assembly or list of members. A certain amount of minimum capital, depending on the category of
microfinance institution, must be already raised and an institution file must be created and submitted. This
file, which passes through the Monetary Authority (the minister of finance) to COBAC, must include the
following documents:

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 3

  A stamped application specifying the requested category
 A registration Certificate
 The minutes of the general meeting for the creation of the institution,
 The Articles of Association of the Institution
 A list of founding members or shareholders
 The members of the Board of Directors or of the organ considered as such
 Where necessary, documents testifying that payments have been made in connection with the
liberation of subscribed shares, supported by bank statements or any other documents serving as such
 A three year forecast of the activity, expansion and organization
 A detail of technical and financial means to be used as well as any element likely to enlighten the
competent authorities.

For Managers For External Auditors

 Copy of birth certificate  Copy of birth certificate
 Two passport size identical photos  Two passport size identical photos
 A curriculum vitae dated and signed ;  Copies of certificates obtained
 Copies of certificates obtained  Minutes of the general assembly meeting delegating
 Minutes of the general assembly their appointments
meeting delegating their appointments  Copies of police report-non conviction for all members
 Copies of police report-non conviction of management
for all members of management  A certificate of residence ;
 A certificate of residence ;  Current resident permit in case of a foreigner in the
 Current resident permit in case of a Board
foreigner in the Board  Agreement as a certified accountant in CEMAC
 A copy of the CEMAC certificate of approval as an
accountant or chartered accountant ;

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 4

CHAPTER 2: REGULATORY STANDARDS FOR THE SURVEILLANCE AND
CONTROL OF THE ESTABLISHMENTS.

In the late eighties, as a result of the commercial banking sector in Cameroon experiencing a serious
crisis, with many major banks becoming illiquid and/or insolvent that Microfinance and MFIs really gained
ground. Unfortunately, the late 1990s witnessed some of the biggest losses incurred by the MFIs in
Cameroon. These losses were the result of a range of errors by the MFIs under-pricing the risk of the
uncollaterised loans they give to the poor and directly competing for customers by opening offices around
the country. The MFIs experienced high arrears in loan repayment and bad debts which amounted to around
a quarter of the overall total loan portfolio and losses registered in the sector (Elle, 2012). This situation thus
prompted changes in the regulation, supervision, monitoring, control and governance of MFIs in Cameroon.

Prudential norms for the control and supervision of microfinance institutions’ activities as stipulated
by COBAC are recapitulated in the table below
Norms Description Requirement
Solidarity funds as a percentage of Capital ≥ 40%
Obligatory reserves norms ≥ 40%
Risk coverage ratio ≥ 10%
Ratio of highest debtor-Highest debtor as a percentage of total debt ≤ 15%
Assets coverage ratio ≥ 100%
Administrators, management and employees engagement ≤ 30%
Credit /resource ratio or transformation ratio ≤ 70%
Ratio relative to line of financing received ≥ 50%
Liquidity Ratio ≥ 100%
Limit of other activities carried out ≤ 20%
Biggest Shareholder ratio ≤ 20%
Norme de prise de participation ≤ 15%

Due to their direct involvement and collection of public savings, category two microfinance institutions are
subjected to stringent regulations. Within this context, the Banking Commission published 21 additional
prudential norms that became mandatory in April 2007 and which provide the possibility of the supervisory
and control authorities to revoke the license/ authorization of MFIs not complying.

These regulations and prudential norms establish prudential standards with respect to liquidity and
solvency of the institutions, the minimum capital (no minimum for the first category, FCFA50million for the

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 5

second category and FCFA25million for the third category. Attention is also shifted to the distribution of
risk, resource processing (transformation ratio) while at the same time cautioning the use of external
financing which should not exceed 50% of equity.

Again, with the existent of a law requiring all MFIs to transmit monthly report to COBAC, just end
of year audited financial statement are currently being submitted and most often they are submitted late with
less than 60% of MFIs are submitting. Supervision and control remain weak at the level of COBAC, due to
lack of resources and man power to frequently carry out spot checks and discipline. Prudential regulation
requires large financial, human, technological and legal resources. COBAC and other supervisory authorities
charged with these responsibilities are poorly equipped in terms of enforcement resources and generally
unable to carry out control on the operations of financial institutions.

According to existing COBAC text, MFIs in each member country are recommended to create a
single professional association for all microfinance operators. COBAC expect these professional
associations to serve as a doorway between policy makers, donors and MFIs and also contribute to the
development of microfinance policies, rules and developmental plans. COBAC also expects these
professional associations to facilitate the prudential role of regulators by fostering transparency and
sustainability in the sector through innovation and professionalism.

Regulators in the CEMAC favour the grouping of microfinance institutions into networks. The
regulators have laid down the rules for representation within these networks as well as control and
management procedures. Networks apply for accreditation on behalf of their members, vet the management
team and develop internal control and reporting mechanisms. CAMCCUL is a very good example of an MFI
operating in a network. This choice is strongly motivated by the shortage of resources and manpower. This
can be an easy pathway for small cooperative wishing to seek accreditation.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 6

 PART TWO: ISLAMIC FINANCE
2.1) What is Islamic Finance?
Islamic finance is a type of financing activity that must comply with Sharia (Islamic Law). The
concept can also refer to the investments that are permissible under Sharia.
The common practices of Islamic finance and banking came into existence along with the
foundation of Islam. However, the establishment of formal Islamic finance occurred only in the 20th
century. The main difference between conventional finance and Islamic finance is that some of the
practices and principles that are used in conventional finance are strictly prohibited under Sharia
laws.

2.2) Principles of Islamic Finance

Islamic finance strictly complies with Sharia law. Contemporary Islamic finance is based on a
number of prohibitions that are not always illegal in the countries where Islamic financial
institutions are operating:

1. Paying or charging an interest

Islam considers lending with interest payments as an exploitative practice that favors the lender at
the expense of the borrower. According to Sharia law, interest is usury (riba), which is strictly
prohibited.
2. Investing in businesses involved in prohibited activities
Some activities, such as producing and selling alcohol or pork, are prohibited in Islam. The
activities are considered haram or forbidden. Therefore, investing in such activities is likewise
forbidden.
3. Speculation (maisir)
Sharia strictly prohibits any form of speculation or gambling, which is called maisir. Thus, Islamic
financial institutions cannot be involved in contracts where the ownership of goods depends on an
uncertain event in the future.
4. Uncertainty and risk (gharar)
The rules of Islamic finance ban participation in contracts with excessive risk and/or uncertainty.
The term gharar measures the legitimacy of risk or uncertainty in investments. Gharar is observed
with derivative contracts and short-selling, which are forbidden in Islamic finance.

In addition to the above prohibitions, Islamic finance is based on two other crucial principles:
Material finality of the transaction: Each transaction must be related to a real underlying
economic transaction.
Profit/loss sharing: Parties entering into the contracts in Islamic finance share profit/loss and risks
associated with the transaction. No one can benefit from the transaction more than the other party.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 7

2.3) Types of Financing Arrangements
Since Islamic finance is based on several restrictions and principles that do not exist in conventional
banking, special types of financing arrangements were developed to comply with the following
principles:

1. Profit-and-loss sharing partnership (mudarabah)

Mudarabah is a profit-and-loss sharing partnership agreement where one partner (financier or rab-ul
mal) provides the capital to another partner (labor provider or mudarib) who is responsible for the
management and investment of the capital. The profits are shared between the parties according to a
pre-agreed ratio.

2. Profit-and-loss sharing joint venture (musharakah)

Musharakah is a form of a joint venture where all partners contribute capital and share the profit and
loss on a pro-rata basis. The major types of these joint ventures are:

 Diminishing partnership: This type of venture is commonly used to acquire properties. The
bank and investor jointly purchase a property. Subsequently, the bank gradually transfers its portion
of equity in the property to the investor in exchange for payments.
 Permanent musharkah: This type of joint venture does not have a specific end date and
continues operating as long as the participating parties agree to continue operations. Generally, it is
used to finance long-term projects.

3. Leasing (Ijarah)
In this type of financing arrangement, the lessor (who must own the property) leases the property to
the lessee in exchange for a stream of rental and purchase payments, ending with the transfer of
property ownership to the lessee.

2.4) Investment Vehicles

Due to the number of prohibitions set by Sharia, many conventional investment vehicles such as
bonds, options, and derivatives are forbidden in Islamic finance. The two major investment vehicles
in Islamic finance are:
1. Equities
Sharia allows investment in company shares. However, the companies must not be involved in the
activities prohibited by Islamic laws, such as lending at interest, gambling, production of alcohol or
pork. Islamic finance also allows private equity investments.
2. Fixed-income instruments
Since lending with interest payments is forbidden by Sharia, there are no conventional bonds in
Islamic finance. However, there is an equivalent of bonds called sukuk or “Sharia-compliant
bonds.” The bonds represent partial ownership in an asset, not a debt obligation.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 8

THERE are a wide variety of Islamic financing tools, but most derive from a limited number of
prototypes.

Murabaha - A bank buys goods on behalf of a customer who then buys them at a mark-up from the
bank at a later date or by instalment. The bank rather than the customer has title to the goods until
the money is paid, and makes its profit from the mark-up. Commonly used for shortterm trade
finance.

Musharaka - Partners invest in a project and manage it jointly, having decided in advance in what
proportion the profits and losses will be split. A bank may become a partner by supplying capital to
a venture. Equivalent to venture capital.

Mudaraba - Two parties come together in an enterprise, one with money and another with an asset
such as land, machinery or expertise. They agree the split of profits beforehand. Any losses are
borne by the lender as the borrower is considered to have paid their share in work time. Fund
management can come under this category, with the investor providing the capital and the fund
manager the expertise.

Ijara - The bank buys an asset and leases it to someone, who pays the bank a fixed fee. The bank
retains title to the asset, which must be used productively.

One version, Ijara wa'l-Iqtina', gives the asset to the leassee at the end of the lease period. This is
used for leasing ships, aircraft and factory machinery.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 9

 PART THREE: FINANCIAL MARKETS
CHAPTER 4: THE FOREIGN EXCHANGE MARKET AND DETERMINANTS OF
CURRENCIES EXCHANGE RATES
4.1- Definition of Foreign Exchange Market: The foreign exchange market (also known
as forex, FX, or the currencies market) is an over-the-counter (OTC) global marketplace that determines the
exchange rate for currencies around the world. Participants in these markets can buy, sell, exchange, and
speculate on the relative exchange rates of various currency pairs. The foreign exchange market or forex
market is the market where currencies are traded. The forex market is the world’s largest financial market
where trillions are traded daily. It is the most liquid among all the markets in the financial world. Moreover,
there is no central marketplace for the exchange of currency in the forex market. It is an OTC market. The
currency market is open 24 hours a day, five days a week, with all major currencies traded in all major
financial centers. Trading of currency in the forex market involves the simultaneous purchase and sale of
two currencies. In this process the value of one currency (base currency) is determined by its comparison to
another currency (counter currency). The price at which one currency can be exchanged for another currency
is called the foreign exchange rate. The major currency pairs that are traded include the EUR/USD,
USD/JPY, GBP/USD, and USD/CHF.6 The most popular forex market is the euro to US dollar exchange
rate (EUR to USD), which trades the value of euros in US dollars.

Foreign exchange markets can be considered as a linkage of banks, nonbank dealers, and forex dealers and
brokers who all are connected via a network of telephones, computer terminals, and automated dealing
systems. Electronic Broking Services and Reuters are the largest vendors of quote screen monitors used in
trading currencies.

The forex market consists of three major segments: Australasia, Europe, and North America. Australasia
includes the major trading centers of Bahrain, Sydney, Tokyo, Hong Kong, and Singapore. Europe includes
Zürich, Frankfurt, Paris, Brussels, London, and Amsterdam. The North America region includes New York,
Montreal, Toronto, Chicago, San Francisco, and Los Angeles.
Foreign exchange markets are made up of banks, forex dealers, commercial companies, central banks,
investment management firms, hedge funds, retail forex dealers, and investors.
Foreign exchange is the action of converting one currency into another. The rate that is agreed upon by the
two parties in the exchange is called exchange rate, which may fluctuate widely, creating the foreign
exchange risk. As will be seen in the case of Japan Airlines (JAL) below, the risk can be high.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 10

There are two types of exchange rates that are commonly used in the foreign exchange market. The spot
exchange rate is the exchange rate used on a direct exchange between two currencies “on the spot,” with the
shortest time frame such as on a particular day. For example, a traveler exchanges some Japanese yen using
US dollars upon arriving at the Tokyo airport. The forward exchange rate is a rate agreed by two parties to
exchange currencies for a future date, such as 6 months or 1 year from now. A main purpose of using the
forward exchange rate is to manage the foreign exchange risk, as shown in the case below.

The main functions of the market are to (1) facilitate currency conversion, (2) provide instruments to
manage foreign exchange risk (such as forward exchange), and (3) allow investors to speculate in the
market for profit.

4.2) Exchange rate quotation

The two basic quotations are direct and indirect quotes. In direct quotation, the cost of one unit of foreign
currency is given in units of local or home currency. In indirect quotations the cost of one unit of local or
home currency is given in units of foreign currency.

For example, consider EUR as the local currency. Then

Direct Quote: 1 USD = 0.773407 EUR
Indirect Quote: 1 EUR = 1.29303 USD

4.3) Foreign Exchange Rates

Exchange rate movements affect a nation's trading relationships with other nations. A higher-valued
currency makes a country's imports less expensive and its exports more expensive in foreign markets. A
lower-valued currency makes a country's imports more expensive and its exports less expensive in foreign
markets. A higher exchange rate can be expected to worsen a country's balance of trade, while a lower
exchange rate can be expected to improve it.

DETERMINANTS OF EXCHANGE RATES

Numerous factors determine exchange rates. Many of these factors are related to the trading relationship
between the two countries. Remember, exchange rates are relative, and are expressed as a comparison of the
currencies of two countries. The following are some of the principal determinants of the exchange rate
between two countries.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 11

1) Differentials in Inflation
Typically, a country with a consistently lower inflation rate exhibits a rising currency value, as its
purchasing power increases relative to other currencies. During the last half of the 20th century, the
countries with low inflation included Japan, Germany, and Switzerland, while the U.S. and Canada achieved
low inflation only later. Those countries with higher inflation typically see depreciation in their currency
about the currencies of their trading partners. This is also usually accompanied by higher interest rates.

2) Differentials in Interest Rates

Interest rates, inflation, and exchange rates are all highly correlated. By manipulating interest rates, central
banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and
currency values. Higher interest rates offer lenders in an economy a higher return relative to other countries.
Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise. The impact of
higher interest rates is mitigated, however, if inflation in the country is much higher than in others, or if
additional factors serve to drive the currency down. The opposite relationship exists for decreasing interest
rates – that is, lower interest rates tend to decrease exchange rates.

3) Current Account Deficits

The current account is the balance of trade between a country and its trading partners, reflecting all
payments between countries for goods, services, interest, and dividends. A deficit in the current account
shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from
foreign sources to make up the deficit.

4) Public Debt
Countries will engage in large-scale deficit financing to pay for public sector projects and governmental
funding. While such activity stimulates the domestic economy, nations with large public deficits and debts
are less attractive to foreign investors. A large debt encourages inflation, and if inflation is high, the debt
will be serviced and ultimately paid off with cheaper real dollars in the future.

In the worst case scenario, a government may print money to pay part of a large debt, but increasing
the money supply inevitably causes inflation. Moreover, if a government is not able to service its deficit
through domestic means (selling domestic bonds, increasing the money supply), then it must increase the
supply of securities for sale to foreigners, thereby lowering their prices. Finally, a large debt may prove
worrisome to foreigners if they believe the country risks defaulting on its obligations. Foreigners will be less
willing to own securities denominated in that currency if the risk of default is great. For this reason, the

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 12

country's debt rating (as determined by Moody's or Standard & Poor's, for example) is a crucial determinant
of its exchange rate.

5) Terms of Trade
A ratio comparing export prices to import prices, the terms of trade is related to current accounts and the
balance of payments. If the price of a country's exports rises by a greater rate than that of its imports, its
terms of trade have favorably improved. Increasing terms of trade shows' greater demand for the country's
exports. This, in turn, results in rising revenues from exports, which provides increased demand for the
country's currency (and an increase in the currency's value). If the price of exports rises by a smaller rate
than that of its imports, the currency's value will decrease in relation to its trading partners.

6) Strong Economic Performance

Foreign investors inevitably seek out stable countries with strong economic performance in which to invest
their capital. A country with such positive attributes will draw investment funds away from other countries
perceived to have more political and economic risk. Political turmoil, for example, can cause a loss of
confidence in a currency and a movement of capital to the currencies of more stable countries.

7) Market Speculation: Speculative activities by traders can lead to substantial short run fluctuations
in exchange rates.
8) Political News and Events: Adverse political incidents or important news can trigger volatility in
the short run foreign exchange rates.

It's important to remember that these factors do not operate in isolation but rather intermingle in complex
ways to influence exchange rates in the economy. Additionally, these influences can change over time as an
economy develops and evolves.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 13

CHAPTER 5: THE MAIN TRANSACTIONS ON THE FOREIGN EXCHANGE
MARKET.

Forex Market vs. Other Markets

There are some fundamental differences between foreign exchange and other markets. First of all,
there are fewer rules, which means investors aren't held to strict standards or regulations like those in the
stock, futures, and options markets. There are no clearing houses and no central bodies that oversee the forex
market.

Second, since trades don't take place on a traditional exchange, there are fewer fees or commissions
like those on other markets.

Next, there's no cutoff as to when you can and cannot trade. Because the market is open 24 hours a
day, you can trade at any time.

Finally, because it's such a liquid market, you can get in and out whenever you want and you can buy
as much currency as you can afford.

Types of Forex Transactions

Forex traders transact in one of three distinct marketplaces: the spot, the forward, or the futures market. To
find the best entry and exit point for a trade, they will use a variety of analysis techniques.

1) The Forex Spot Market

The spot market is the most straightforward of the Forex markets. The spot rate is the current exchange rate.
A transaction in the spot market is an agreement to trade one currency for another currency at the prevailing
spot rate. Spot transactions for most currencies are finalized in two business days. The major exception is
the U.S. dollar versus the Canadian dollar, which settles on the next business day. The price is established on
the trade date, but money is exchanged on the value date.

Role of the U.S. Dollar

The U.S. dollar is the most actively traded currency. The most common pairs are the USD versus the euro,
Japanese yen, British pound, and Australian dollar. Trading pairs that do not include the dollar are referred
to as crosses. The most common crosses are the euro versus the pound and the euro versus the yen.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 14

The spot market can be very volatile. Movement in the short term is dominated by technical trading, which
bases trading decisions on a currency's direction and speed of movement. Longer-term changes in a
currency's value are driven by fundamental factors such as a nation's interest rates and economic growth.

2) The Forex Forward Market

A forward trade is any trade that settles further in the future than a spot transaction. The forward price is a
combination of the spot rate plus or minus forward points that represent the interest rate differential between
the two currencies. Most forward trades have a maturity of less than a year in the future but a longer term is
possible. As in the spot market, the price is set on the transaction date but money is exchanged on the
maturity date. A forward contract is tailor-made to the requirements of the counterparties. They can be for
any amount and settle on any date that is not a weekend or holiday in one of the countries.

3) Forex Futures
Unlike the rest of the foreign exchange market, forex futures are traded on an established exchange,
primarily the Chicago Mercantile Exchange. Forex futures are derivative contracts in which a buyer and a
seller agree to a transaction at a set date and price. This type of transaction is often used by companies that
do much of their business abroad and therefore want to hedge against a severe hit from currency
fluctuations. It also is subject to speculative trading.

RISK MANAGEMENT IN FOREX

1) HEDGING

Hedging is a risk management strategy employed to offset losses in investments by taking an opposite
position in a related asset.

The reduction in risk provided by hedging also typically results in a reduction in potential profits.

Hedging requires one to pay money for the protection it provides, known as the premium.

Hedging strategies typically involve derivatives, such as options and futures contracts.

BY NEBA ALPHONSE AMABO, PLET/M.SC ACCOUNTING 15