Currency Strategy, Second Edition develops new techniques
and explains classic tools available for predicting, managing, and
optimizing fluctuations in the currency markets. Author Callum
Henderson shows readers ho to use mathematical models to assist in
the prediction of crises and gives practical advice on how to use
these and other tools successfully.

Given there such huge focus on China at the moment, the timing
of this new edition is particularly important. The new edition will
feature a thorough update on the key developments in the past 3
years, new chapters on emerging markets, an in-depth review of the
markets of China and India and their currencies and much more.

CALLUM HENDERSON is Head of FX Strategy for a leading international bank, based in Singapore. A wide-quoted authority of both emerging and currency markets, Mr Henderson has spent the past 16 years in the financial markets in various capacities and has written articles for many leading financial journals and given seminars around the world on global currency markets.
Mr Henderson is the author of three previous books covering the Asian economic story: the bestseller Asia Falling, China on the Brink (awarded Best Business Book of 1999 by the Library Journal of the US) and Asian Dawn.

The global foreign exchange market continues to go from strength to strength, defying those who predicted its demise after the launch of the Euro. However, within this, new Emerging Markets show the greatest potential for growth. This second edition examines in detail the very latest trends in this field, providing important insights for currency market practitioners on regions such as Asia, which may hold the key to the market's development in years to come.

John Maynard Keynes' reference to the 'animal spirits', that elemental force which drives financial markets in herd-like fashion, was applied to the stock market. However, he might as well have been referring to the currency market, for the term sums up no other more perfectly. A market that is volatile and unpredictable, a market that epitomizes such a concept as the 'animal spirits', surely requires a very specific discipline by which to study it.

This is precisely what Callum Henderson does in this eminently practical and readable book. He provides an analytical framework for currency analysis and forecasting, combining long-term economic valuation models with market-based valuation techniques to produce a more accurate and use-friendly analytical tool for the currency market practitioners themselves.

Given there such huge focus on China at the moment, the timing of this new edition is particularly important. The new edition will feature a thorough update on the key developments in the past 3 years, new chapters on emerging markets, an in-depth review of the markets of China and India and their currencies and much more.

Preface to the Second Edition xi

Acknowledgements xvii

About the Author xix

Introduction 1

Part One Theory and Practice 15

1 Fundamental Analysis: The Strengths and Weaknesses of Traditional Exchange Rate Models 17

1.1 Purchasing Power Parity 17

1.1.1 Reasons for "Misalignments" 19

1.1.2 Tradable and Non-Tradable Goods 20

1.1.3 PPP and Corporate Pricing Strategy 20

Example 1 20

Example 2 22

1.1.4 PPP and the Real Exchange Rate 24

1.2 The Monetary Approach 25

1.2.1 Mundell-Fleming 27

1.2.2 Theory vs. Practice 29

1.2.3 A Multi-Polar rather than a Bi-Polar Investment World 30

1.2.4 Two Legs but not Three 30

1.2.5 Implications for New EU Member States 31

1.3 The Interest Rate Approach 32

1.3.1 Real Interest Rate Differentials and Exchange Rates 34

1.4 The Balance of Payments Approach 34

1.4.1 A Fixed Exchange Rate Regime 35

1.4.2 A Floating Exchange Rate Regime 36

1.4.3 The External Balance and the Real Exchange Rate 37

1.4.4 REER and FEER 38

1.4.5 Terms of Trade 39

1.4.6 Productivity 40

1.5 The Portfolio Balance Approach 42

Example 42

1.6 Summary 44

2 Currency Economics: A More Focused Framework 47

2.1 Currencies are Different 48

2.1.1 (In)Efficient Markets 48

2.1.2 Speculation and Exchange Rates: Cause, Effect and the Cycle 49

Example 50

2.1.3 Risk Appetite Indicators and Exchange Rates 53

2.2 Currency Economics 58

2.2.1 The Standard Accounting Identity for Economic Adjustment 58

Example 1 59

Example 2 60

2.2.2 The J-Curve 62

Example 63

2.2.3 The Real Effective Exchange Rate 63

2.3 Summary 64

3 Flow: Tracking the Animal Spirits 65

3.1 Some Examples of Flow Models 69

3.1.1 Short-Term Flow Models 70

3.1.2 Medium-Term Flow Models 77

3.1.3 Option Flow/Sentiment Models 81

3.2 Speculative and Non-Speculative Flows 82

3.3 Summary 84

4 Technical Analysis: The Art of Charting 85

4.1 Origins and Basic Concepts 85

4.2 The Challenge of Technical Analysis 86

4.3 The Art of Charting 87

4.3.1 Currency Order Dynamics and Technical Levels 87

4.3.2 The Study of Trends 90

4.3.3 Psychological Levels 90

4.4 Schools of (Technical) Thought 100

4.5 Technical Analysis and Currency Market Practitioners 102

Part Two Regimes and Crises 105

5 Exchange Rate Regimes: Fixed or Floating? 107

5.1 An Emerging World 108

5.2 A Brief History of Emerging Market Exchange Rates 109

5.2.1 The Rise of Capital Flows 110

5.2.2 Openness to Trade 111

5.3 Fixed and Pegged Exchange Rate Regimes 111

5.3.1 The Currency Board 112

5.3.2 Fear and Floating 112

5.3.3 The Monetary Anchor of Credibility 113

5.4 Exchange Rate Regime Sustainability - A Bi-Polar World? 114

5.5 The Realworld Relevance of the Exchange Rate Regime 116

5.6 Summary 118

6 Model Analysis: Can Currency Crises be Predicted? 119

6.1 A Model for Pegged Exchange Rates 120

6.1.1 Phase I: Capital Inflows and Real Exchange Rate Appreciation 120

6.1.2 Phase II: The Irresistible Force and the Moveable Object 121

6.1.3 Phase III: The Liquidity Rally 123

6.1.4 Phase IV: The Economy Hits Bottom 124

6.1.5 Phase V: The Fundamental Rally 125

6.2 A Model for Freely Floating Exchange Rates 128

6.2.1 Phase I: Capital Inflows and Real Exchange Rate Appreciation 128

6.2.2 Phase II: Speculators Join the Crowd - The Local Currency Continues to Rally 128

6.2.3 Phase III: Fundamental Deterioration - The Local Currency Becomes Volatile 129

6.2.4 Phase IV: Speculative Flow Reverses - The Local Currency Collapses 130

6.3 Summary 133

Part Three The Real World of the Currency Market Practitioner 135

7 Managing Currency Risk I - The Corporation: Advanced Approaches to Corporate Treas…