The foreign currency market is the largest, most liquid market in the world. Trillions of dollars change hands ¿ 24 hours a day, five and a half days a week. When residents or businesses operating here wish to travel, buy foreign goods, open an investment account here (or elsewhere), send funds to onshore relatives such as college students, and other related activities, they must convert existing Bermuda dollars into a global currency that is recognised and accepted as "real" tender for goods and services.

In general, native country currencies (let us call them all dollars for sake of clarity, even though there are pounds, yuans, yen, euro, and many others) are classified as "soft" or "hard" currencies. Years ago, hard and soft currency meant the difference between gold (as a hard metal) and paper dollars created by machines.

While gold is still the ultimate monetary value, the Nixon Administration dropped the gold standard system in the United States in the 1970's. Hard currency (with the US as the number one source) became synonymous with highly liquid, politically and economically stable industrialised countries' currency.

The phrase soft dollar is another connotation for "weak currency" because soft currency values tend to fluctuate more due to political or economic uncertainty within the country, particularly those emerging markets with relatively new market economies. Since Bermuda has been around since the 1600s, it certainly is not newly developed, but it has no real hard assets to back its currency. As a country, it is also too insignificant in the overall global economy to command hard dollar respect.

For a real currency lesson in perceived value, walk into any small town bank (say around 50,000 in population) in the United States and ask to exchange US dollars for Bermuda dollars. The request is usually met with amusement, especially if you display actual Bermuda dollars with one of the inevitable questions being: "Is this real money? It looks like a playcheck!"

Soft dollar economies have tended to link their currency to a hard dollar exchange in a number of ways. Some governments adopted "dollarisation"; in effect, making the US dollar their national currency, easy for the public but less control for a central bank if one exists. Others have pegged their currency exchange rate to a very strong hard currency to provide stability rather than letting their currency value float freely. The third system is called a managed floating rate that is subject to supply, demand and other market forces. Government's responsibility then is to monitor volatility and use other interventions, such as raising interest rates to stabilise the floating rate currency value.

At the present time, US currency is still most frequently the base currency in the world markets, although there are total of eight currencies traded actively more than any other: US dollar, euros, sterling, yen, Swiss francs, and to a lesser extent Canadian, Australian and New Zealand dollars. The reasons for the popularity and dominance by these nations is so obvious, it really needs no explanation. Once and when China is allowed (or decides) to trade currency on world markets, these categories may be ranked somewhat differently.

Foreign holdings of US Securities. Along with the US dollar, US government debt securities are still highly desired even though the US dollar has weakened against the other major currencies in the last few years. If there is such a thing as a guaranteed guarantee, owning US Treasuries today is as good as cash in your pocket, provided you hold the bond to maturity. A review of the amount of US securities (including US debt or as we know it, US Treasuries and Agency bonds) held by foreign nations is staggering ¿ in the trillions!

Taking a 2006 report directly from the US Department of the Treasury, we see total combined US securities held by some of the following foreign countries in their banks and government agencies: Japan ¿ $1 trillion, China - $698 billion, Australia ¿ $109 billion, United Kingdom ¿ $640 billion, Germany ¿ $211 billion.

But, the most astonishing of all (I had to read it twice) tiny little Bermuda ¿ $205 billion, of which $75 billion is US Treasury/Agency bonds! This statistic probably more than anything else seen, legitimises our crowning jewel, the international finance centre global reputation.

How does one buy/sell currency in the Forex exchange trading market? In one of three ways: spot, forward or futures markets. The spot market, which is the largest market, is where currencies are bought and sold according to current prices. These prices are reflections of many market indicators, interest rates, trends, economic activities, political risk, future performance and so. There is a massive industry just built around charting currency trends and capital market activity.

Currency prices are quoted in pairs with the value of one unit (US dollars say) being the base currency quote of 1.00 and the other currency euro reflected through its value of .7275. Looking like this and taken as a quote directly from Bloomberg on July 26, it means that USD/EUR = .7275 that $1 is the equivalent of .7275 euros. If the euro is listed as the base currency, the wording is reversed EUR/USD = 1.3746 and it is an indication that 1 unit of euro is equivalent to $1.3746.

Maths quiz: And this is where understanding quotes becomes a bit trickier. Clients often say, why are the quotes so far apart, i.e .7275 and 1.3746. It depends upon the base currency that you are converting from. Bermudians probably operate most in US dollars ¿ since Bermuda dollars have to be changed to US dollars first before a currency transaction can be effected. A European is going to approach it from his/her perspective ¿ they have euros and want US dollars. It is always easy to find the opposing or equivalent value when you only know one of them. Remember reciprocals from elementary maths? 1.3746 is the reciprocal of .7275 and is arrived at by dividing .7275 into the base currency of 1.00 = 1.3746 ¿ voila.

Tip or Trap. Clients tend to think that they should receive the same price on a currency deal as a Bloomberg quote. Not so and that's enough of a dissertation for one week. Stay tuned, but it won't be next week for Currency Part 3.

Martha Harris Myron CPA CFP® is a Wealth Manager at Argus Financial Limited. She specializes in objective investment advisory services with realistic comprehensive financial solutions for private clients. DirectLine: 294 5709 Confidential email can be directed to marthamyron@northrock.bm

The article expresses the opinion of the author alone. Under no circumstances is the content of this article to be taken as specific individual investment advice, nor as a recommendation to buy/ sell any investment product. The Editor of the Royal Gazette has final right of approval over headlines, content, and length/brevity of article.