Exchange Rate Risk
Exchange rate risk is the most substantial risk where if the high-interest-rate currency depreciates against the low-interest-rate currency, the capital loss from the exchange rate movement can easily outweigh the interest earned.
Forex Market
The foreign exchange (forex) market is a decentralized network of banks, institutions, and individual traders.
Forward Premium Puzzle
The forward premium puzzle refers to the empirical observation that currencies with higher interest rates tend to appreciate, rather than depreciate as predicted by the Uncovered Interest Parity (UIP) theory.
Funding Currency
A funding currency is the low-interest-rate currency that a trader effectively ‘borrows’ or sells to finance the purchase of a higher-interest-rate currency.
Hawkish
A term describing central bank language that favors tighter monetary policy or higher interest rates.
Negative Correlation
Conversely, a negative correlation means two currency pairs typically move in opposite directions.
Positive Correlation
When two currency pairs exhibit a positive correlation, they tend to move in the same direction.
Quote Currency
This is the second currency listed in the pair.
Rollover (Swap)
When you hold a forex position overnight, your broker adjusts your account to reflect the interest rate differential between the two currencies in the pair, and this adjustment is known as a ‘rollover’ or ‘swap’ fee/credit.
Tom-Next Rate
This is the interest rate paid or received for rolling an open spot foreign exchange position from one trading day to the next.