INTRODUCTION. This program should serve as just one element of your due diligence.

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1 FOREX ONLINE LEARNING PROGRAM INTRODUCTION Welcome to our Forex Online Learning Program. We ve always believed that one of the best ways to protect investors is to provide them with the materials they need to make informed trading decisions. The off-exchange foreign currency, or forex, market is a large, growing and liquid financial market that operates 24 hours a day. It has no central trading location or exchange with many buyers and sellers. Most of the trading is conducted by telephone or through electronic trading networks. Banks, insurance companies, large corporations and other large financial institutions all use the forex markets to manage the risks associated with fluctuations in currency rates. In recent years, however, a number of firms have begun offering forex contracts to individual investors. NFA regulates some, but not all, of these forex firms. Before you open an account with a forex firm, you should ask the firm if NFA regulates its forex activities. If the answer is no, find out who does regulate them. Like many other investments, forex trading carries a high level of risk and may not be suitable for all investors. Forex trading requires constant monitoring and an understanding of the relationship between currencies, as well as what factors influence the currencies' value. If you are a retail investor considering trading in this market, you need to understand fully the market and some of its unique features. One final note before we begin. This program does not suggest that you should or should not trade in the retail off-exchange foreign currency market. You should make that decision after consulting with your financial advisor and considering your own financial situation and objectives. This program should serve as just one element of your due diligence. We have divided this program into six modules: 1. The fundamentals of foreign currency exchange rates; 2. How foreign currencies are quoted and priced; 3. How much it costs to trade foreign currencies; 4. How to calculate profits and losses; 5. How leverage works; and 6. The risks of forex trading. You can view any module at any time by clicking on the module number in the right-hand column. We estimate that it will take you approximately 45 minutes to complete the program. To help you understand the language of forex trading, we have developed a complete Forex Glossary of Terms. You can view this glossary at any time during the program by simply clicking on the Glossary of Terms button in the upper right portion of the screen.

2 We have also prepared three short quizzes throughout the program to help you review what you have learned. Each quiz consists of three questions with multiple choice answers. Just read the question, identify the correct answer and click the Next button. WHAT ARE FOREIGN CURRENCY EXCHANGE RATES? Let s start with a definition of foreign currency exchange rates. Simply put, foreign currency exchange rates are what it costs to exchange one country s currency for another country s currency. For example, if you go to England on vacation, you will have to pay for your hotel, meals, admissions fees, souvenirs and other expenses in British pounds. Since your money is all in US dollars, you will have to sell some of your dollars to buy British pounds. Let s assume that you have decided to take a trip to England. Before you leave, you go to your bank and buy $1,000 worth of British pounds. If you get British pounds ( ) for your $1,000, each dollar is worth British pounds. This is the exchange rate for converting dollars to pounds. After spending a few days in England, you realize that won t be enough to cover all of your expenses. So you go to a bank in England and buy another $1,000 worth of British pounds. This time, however, you get only for your $1,000. The exchange rate for converting dollars to pounds has dropped from to This means that US dollars are worth less compared to the British pound than they were before you left on vacation. When you arrive home, you still have some British pounds left. So you go to your bank and use your remaining 100 to buy US dollars. If the bank gives you $179.31, each British pound is worth dollars. This is the exchange rate for converting pounds to dollars. But what if you were traveling to France? The currency used in France is the Euro. If you go to your bank and buy $1,000 worth of Euros with an exchange rate of , how many Euros will you get? Exchanging $1,000 for Euros with an exchange rate of means you will receive Euros. Conversely, if you were living in France and planned a vacation in the United States, you would go to your bank to buy US dollars with Euros. If the exchange rate was , how many U.S. dollars would you get for your 1,000 Euros? You would receive $1, for your 1,000 Euros. Theoretically, you can convert the exchange rate for buying a currency to the exchange rate for selling a currency, and vice versa, by dividing 1 by the known rate. For example, if the exchange rate for buying British pounds with US dollars is.56011, the exchange rate for buying US dollars with British pounds is In other words, one divided by equals Similarly, if the exchange rate for buying US dollars with British pounds is , the exchange rate for buying British pounds with US dollars is (or one divided by equals.56011). This is how newspapers often report currency exchange rates. You should know, however, that you will not receive the price quoted in the newspaper if you trade forex. That s because banks and other market participants make money by selling the currency to customers for more than they paid to buy it and by buying the currency from

3 customers for less than they will receive when they sell it. This difference is called a spread and we ll talk more about spreads later in this program. As you can see, currency exchange rates fluctuate. Retail customers who trade in the forex market hope to profit from those fluctuations. HOW ARE FOREIGN CURRENCIES QUOTED AND PRICED? Now let s take a look at how foreign currencies are quoted and priced. Currencies are designated by three-letter symbols. The standard symbols for some of the most commonly traded currencies are shown below. EUR USD CAD GBP JPY AUD CHF Euro United States dollar Canadian dollar British pound Japanese yen Australian dollar Swiss franc Currency pairs are often quoted as bid-ask spreads. The first part of the quote is the amount of the quote currency you will receive in exchange for one unit of the base currency (the bid price). The second part of the quote is the amount of the quote currency you must spend for one unit of the base currency (the ask or offer price). For example, a EUR/USD spread of / means that you can sell one Euro for $ and buy one Euro for $ This spread could also be quoted as /78. At first glance, the bid and ask prices may seem backwards to you. That is because they are listed from the dealer s point of view, not from your point of view. The first part of the spread, or the bid, is what the dealer is willing to pay to buy the base currency. So this is the price you will get if you SELL the base currency. In the same way, the second part of the spread, or the ask, is what the dealer is willing to sell the base currency at, so this is the price you will get if you BUY the base currency. Let s look at another example. If the USD/CHF spread is listed as /1.2443, you can sell one US dollar for Swiss francs and buy one US dollar for Swiss francs. Remember that the forex market has no central marketplace. The forex dealer determines the execution price, so you are relying on the dealer s integrity for a fair price.

4 QUIZ #1 In this currency pair, which is the base currency? CAD/USD The correct answer is the Canadian dollar, or CAD. Remember, the first currency in a currency pair is the base currency and the second currency is the quote currency. Using this USD/JPY spread (110.45/55), how many Japanese yen would it take to buy one US dollar? It would take yen to purchase one US dollar. Who determines the execution price the trader, the dealer or the exchange? The correct answer is the dealer. Remember that the forex markets we are discussing have no central exchange on which the contracts are traded, and you as the trader have no control over the execution price. HOW MUCH DOES IT COST TO TRADE FOREX? Before trading forex, you will have to open a trading account with a forex dealer. There are no rules about how a dealer charges a customer for the services the dealer provides or that limit how much the dealer can charge. Before opening an account, you should check with several dealers and compare their charges as well as their services. Some firms charge a per trade commission, while other firms make their money on the spread between the bid and ask prices they give their customers. In the earlier example, the amount of the Euro spread is.0008 (the ask price minus the bid price). This means that if you bought (or sold) the Euro and immediately turned around and sold (or bought) it before the prices changed, you would have a $.0008 loss on each Euro, or an $80 loss on a 100,000 Euro transaction. The wider the spread, the more the price has to move before you break even. While some forex firms advertise commission free trading, they are still making money from your trades through the bid/ask spread. Before opening a trading account, be sure you know how all the parties involved are being compensated. Retail forex transactions are normally closed out by entering into an equal but opposite transaction with the dealer. For example, if you bought Euros with US dollars, you would close out the trade by selling Euros for US dollars. This also is called an offsetting or liquidating transaction. Many retail forex transactions have a settlement date when the currencies are due to be delivered. If you want to keep your position open beyond the settlement date, you must roll the position over to the next settlement date. Some dealers roll open positions over automatically, while other dealers may require you to request the rollover. Some dealers charge a rollover fee based upon the interest rate differential between the two currencies in the pair. You should check your

5 agreement with the dealer to see what, if anything, you must do to roll a position over and what fees you will pay for the rollover. HOW DO I CALCULATE PROFITS AND LOSSES? Now that you know how forex is traded, it s time to learn how to calculate your profits and losses. When you close out a trade, take the price (exchange rate) when selling the base currency and subtract the price when buying the base currency, then multiply the difference by the transaction size. That will give you your profit or loss. Price (exchange rate) when selling the base currency price when buying the base currency X transaction size = profit or loss Let s look at an example. Assume you buy Euros at $ per Euro and sell Euros at $ per Euro. The transaction size is 100,000 Euros. To calculate your profit or loss, you take the selling price of $1.2188, subtract the buying price of $ and multiply the difference by the transaction size of 100,000. ($ ) X 100,000 = $100 In this example, you would have a $100 profit from this transaction. Let s try it again using a different currency. Assume you buy British pounds at $ and sell them at $ The transaction size is 10,000. What is your profit or loss? When you think you know the answer, advance to the next screen. By following the formula we discussed earlier, you should be able to determine that you would see a $5.00 gain from this transaction. ($ $1.8384) X 10,000 = $5.00 Now you try it. If you sell 100,000 Euros at $ per Euro and buy 100,000 Euros at per Euro, would you have a profit or loss on the transaction and how much would it be? Take the selling price of $ and subtract the buying price of $ and then multiply the difference by 100,000. ($ $1.2180) X 100,000 = $100 If you calculated a loss of $100, you calculated correctly.

6 You can also calculate your unrealized profits and losses on open positions. Just substitute the current bid or ask rate for the action you will take when closing out the position. For example, if you bought 100,000 Euros at and the current bid rate is , you have an unrealized loss of $50. ($ $1.2178) X 100,000 = $50 Similarly, if you sold 100,000 Euros at and the current ask rate is , you have an unrealized profit of $50. ($ $1.2165) X 100,000 = $50 If the quote currency is not in US dollars, you will have to convert the profit or loss to US dollars at the dealer s rate. Let s look at an example using a USD/JPY spread. If you lost 50,000 Japanese yen on the transaction and the dealer s rate is $.0091 for each yen, what is your loss in dollars? By multiplying the transaction size (50,000) by the dealer's rate ($.0091), you will find that your loss is $ ,000 X $.0091 = $455 Remember that you must also subtract any dealer commissions or other fees from your profits or add them to your losses to determine your true profits and losses. Also, remember that the dealer makes money from the spread. If you immediately liquidate your position using the same spread, you will automatically lose money. Quiz 2 A speculator believes that the Swiss Franc will appreciate against the US Dollar and enters into a forex transaction when the USD/CHF spread is / In this situation, what will the speculator do? A. Sell US dollars and buy Swiss francs at B. Sell US dollars and buy Swiss francs at C. Sell Swiss francs and buy US dollars at D. Sell Swiss francs and buy US dollars at The correct answer is B. In this case, the speculator needs to buy Swiss Francs and sell US Dollars. That eliminates C and D as possible answers. In order to identify the correct answer, it is helpful to review the concept of the bid/ask spread. When you sell dollars to a dealer, the dealer wants to buy the currency at the bid price. In this case, when you sell dollars to the dealer, you will receive only Swiss francs for every dollar you sell.

7 If a speculator buys a EUR/USD spread when the spread is /24 and immediately sells it back to the dealer at the same spread, what will be the end result? A. 4 point gain B. 4 point loss C. No gain or loss D. There is not enough information in the problem to answer the question. The correct answer is B. When the dealer quotes a spread, the dealer is seeking to buy at the low price and sell at the high price. If a speculator enters this spread, she will have bought the currency at and when she sells the currency back, she will have sold it for , giving her an immediate four point loss. A speculator with $500,000 wants to buy Canadian dollars when the spread is /62. The position is offset when the spread is /66. What will be the result? A. US $5,000 gain B. US $5,000 loss C. US $3,834 gain D. US $3,834 loss The correct answer is C. In this case, our speculator sold US dollars and received Canadian dollars. As a result, the speculator received Canadian dollars for each US dollar (the bid price, or the price at which the dealer would be willing to sell Canadian dollars for US dollars). The speculator received 597,850 Canadian dollars ( X 500,000). Subsequently, the value of the US dollar depreciated against the Canadian dollar. The speculator bought 500,000 US dollars and sold Canadian dollars for (the dealer ask price) and paid 593,300 Canadian dollars. The speculator still had 4,550 Canadian dollars, which represents his profit. However, before you can answer the question, you must convert Canadian dollars into US dollars. To solve this problem, you need to find out how many US dollars it takes to buy 4,550 Canadian dollars. When the speculator reversed the long Canadian dollar position, it took him Canadian dollars to buy one US dollar; so to find his profit, the speculator can simply divide the Canadian dollar profit (Canadian 4,550) by Canadian dollars per US dollar. The result is $3,834 US dollars. How does leverage impact Forex Trading As stated at the beginning of this program, off-exchange foreign currency trading carries a high level of risk and may not be suitable for all customers. The only funds that should ever be used to speculate in foreign currency trading, or any type of highly speculative investment, are funds that represent risk capital; in other words, funds you can afford to lose without affecting your financial situation.

8 Let s proceed on the assumption that you have risk capital you would like to use in trading forex. The next question is how much you need to open an account. Forex dealers can set their own minimum account sizes, so you will have to ask the dealer how much money you must put up to begin trading. Most dealers will also require you to have a certain amount of money in your account for each transaction. This security deposit, sometimes called margin, is a percentage of the transaction value and may be different for different currencies. Keep in mind that a security deposit acts as a performance bond and is not a down payment or partial payment for the transaction. Let s use an example of a dealer requiring a 1% security deposit. The formula for calculating the security deposit is: The current price of the base currency X transaction size X security deposit % = security deposit requirement given in quote currency Looking at the Euro example we used earlier, multiply the current price of the base currency ($1.2178) times the transaction size of 100,000 times 1%. Your security deposit would be $1, $ X 100,000 X.01 = $1, Security deposits allow customers to control transactions with a value many times larger than the funds in their accounts. In the previous example, $1, would control $121,780 worth of Euros. This ability to control a large amount of one currency using a very small percentage of its value is called leverage. In our example, the leverage is 100:1 because the security deposit controls Euros worth 100 times the amount of the deposit. Since leverage allows you to control large amounts of currency for a very small amount, it magnifies the percentage amount of your profits and losses. A profit or loss of $1, on the euro transaction is 1% of the full price but is 100% of the 1% security deposit. The higher the leverage, the more likely you are to lose your entire investment if exchange rates go down when you expect them to go up or go up when you expect them to go down. Leverage of 100:1 means that you will lose your security deposit when the currency loses or gains 1% of its value, and you will lose more than your security deposit if the currency loses or gains more than 1% of its value. If you want to keep the position open, you may have to deposit additional funds to maintain a 1% security deposit. For example, assume you buy or sell a contract worth $100,000 and it moves against you by $2,000. No matter how much money you put up, your dollar loss will always be the same $2,000 but the percentage loss varies with the amount of leverage. At 100:4 leverage, you will have lost half of your investment. At 100:2 leverage, you will have lost your entire investment. And at 100:1 leverage, you will have lost twice your investment and owe the dealer $1,000. Notional value = $100,000 Loss = $2,000

9 Original Investment Leverage Remaining Funds Loss $4, :4 $2,000 50% $2, :2 $0 100% $1, :1 -$1, % You should check your Account Agreement with the dealer to see if the Agreement limits your losses. Some dealers guarantee that you will not lose more than you invest, which includes both the initial deposit and any subsequent deposits to keep the position open. Other dealers may charge you for losses that are greater than your investment. Your Account Agreement with your dealer is crucial. Just as you wouldn t consider buying a house or a car without carefully reading and understanding the terms of the sale, neither should you establish a forex account without first reading and understanding the Account Agreement and all other documents supplied by your dealer. You should know your rights and responsibilities, as well as the firm s obligations before you enter into any forex transaction. For example, if you are not willing or able to pay the full price and take delivery of the currency, make sure the Agreement gives you the right to enter into an offsetting transaction with the dealer. In other words, the Agreement should require the dealer to buy back any currencies you previously bought or to sell you any currencies you previously sold. Otherwise, you may be responsible for paying the value of the entire forex contract and accepting the foreign currency. A number of firms are presently offering options on off-exchange foreign currency contracts. Buying and selling forex options present additional risks, many of which are similar to those inherent in buying options on exchange-traded futures contracts. NFA publishes a brochure called Buying Options on Futures Contracts: A Guide to Their Uses and Risks which discusses the mechanics and risks of options trading. The brochure can be downloaded from NFA s Web site. Most exchange-traded options can be exercised at any time before they expire. These are called American-style options. Many forex options are European-style options, which can be exercised only on or near the expiration date. In other words, you can t take advantage of a favorable price move that occurs before the expiration date unless you can offset your position. You should understand which type of option you are purchasing. Quiz 3 If a forex dealer charges a 1% security deposit, how much will a speculator be required to post as a security deposit to trade an Australian dollar/us dollar spread if the speculator bought 1,250,000 Australian dollars at.7707 US dollars? A. $7,707 B. $1,250 C. $9,634 D. $3,760 The correct answer is C.

10 The formula for calculating the security deposit required is the current price of the base currency times the transaction size times the security deposit percentage. In this case, the price of the base currency is $ The transaction size is 1,250,000 and the security deposit percentage is 1% X 1,250,000 X.01 = 9,634 US dollars A 1% security deposit is what type of leverage? A. 50:1 B. 100:1 C. 25:1 D. 10:1 The correct answer is B 100:1 In an account with a $100,000 position in Japanese yen with 100:1 leverage, what would be the impact of a $1,000 decline in the value of the position? A. 10% loss B. 50% loss C. 100% loss D. 25% loss The correct answer is C. In the case of a $100,000 position with 100:1 leverage, the customer would have been required to post a security deposit equal to 1% of the position value. In this case, the security deposit would have been $1,000 ($100,000 X.01). A 1,000 US dollar decline in the value of the position would have completely wiped out the security deposit. THE RISKS OF FOREX TRADING We ve mentioned throughout the program that forex trading carries a high level of risk. We d like to take a minute to highlight some of those risks. The market could move against you. Fluctuations in the foreign exchange rate between the time you place a trade and the time you close it out will affect the price of your forex contract and the potential profit and losses relating to it. You could lose your entire investment. As mentioned earlier, leverage allows you to hold a large forex position with a relatively small amount of money. If the price moves in an unfavorable direction, high leverage can produce large losses in relation to your initial deposit. In fact, even a small move against your position may result in a large loss, including the loss of your entire deposit. Depending on your agreement with your dealer, you may also be required to pay additional losses.

11 Retail off-exchange forex trades are not guaranteed by a clearing organization. Furthermore, funds that you have deposited to trade forex contracts are not insured and may not receive a priority in bankruptcy. Even customer funds deposited by a dealer in an FDIC-insured bank account may not be protected if the dealer goes bankrupt. Be wary of firms that say Your investment is protected or Your funds are segregated. Unlike regulated futures exchanges, in the retail off-exchange forex market there is no central marketplace. The forex dealer determines the execution price, so you are relying on the dealer to give you a fair price. If you are using an Internet-based or other electronic system to place trades, some part of the system could fail. In the event of a system failure, it is possible that, for a certain time period, you may not be able to enter new orders, execute existing orders, or modify or cancel orders that were previously entered. A system failure may also result in loss of orders or order priority. As with any investment, you should protect yourself against fraud. Over the last few years, there has been a sharp rise in foreign currency scams, and you should do as much due diligence as you can before trading forex. Here are some tips to help you avoid becoming a victim of a forex scam. Stay away from opportunities that sound too good to be true. In general, get-richquick schemes tend to be frauds. For example, avoid any forex company that predicts or guarantees large profits. If a company says that they will double or triple your money in one month or will guarantee a monthly return, walk away. Stay away from forex companies that promise little or no financial risk. There is no doubt that trading forex is risky, so if someone is telling you the opposite, they are not being truthful. Beware of forex companies that make the following types of statements: Whichever way the market moves, you can t lose or While there is risk, it is substantially outweighed by the reward. Check the background of everyone you will be dealing with. If you cannot satisfy yourself that the persons are completely legitimate and above-board, the wisest course of action is to avoid trading through those companies. The program has been prepared by the National Futures Association (NFA).