Reduce your small business debt and increase your cash flow using Financial Leverage

May 24, 2010 - PRLog -- Derivatives
In financial terms, a derivative is a financial instrument - or more simply, an agreement between two parties - that has a value determined by the price of something else (called the underlying). It is a financial contract with a value linked to the expected future price movements of the asset it is linked to - such as a currency. A Foreign exchange (Forex) derivative is a financial derivative where the underlying is a particular currency.

Derivatives allow leverage without borrowing explicitly, though the "effect" of borrowing is implicit in the cost of the derivative.

In forex, investors use leverage to profit from the fluctuations in exchange rates between two different currencies. The leverage that is achievable in the forex market is one of the highest that investors can obtain.

Leverage is a loan that is provided to an investor by the broker that is handling his or her forex account. When an investor decides to invest in the forex market, he or she must first open up a margin account with a broker. Usually, the amount of leverage provided is either 50:1, 100:1 or 200:1, depending on the broker and the size of the position the investor is trading. Standard trading is done on 100,000 units of currency, so for a trade of this size, the leverage provided is usually 50:1 or 100:1. Leverage of 200:1 is usually used for positions of $50,000 or less.

To trade $100,000 of currency, with a margin of 1%, an investor will only have to deposit $1,000 into his or her margin account. The leverage provided on a trade like this is 100:1.

Although 100:1 leverage may seem extremely risky, the risk is significantly less when you consider that currency prices usually change by less than 1% during intraday trading.

Although the ability to earn significant profits by using leverage is substantial, leverage can also work against investors. For example, if the currency underlying one of your trades’ moves in the opposite direction of what you believed would happen, leverage will greatly amplify the potential losses. To avoid such a catastrophe, forex traders usually implement a strict trading style that includes the use of stop and limit orders.

Risk and over leverage
Employing leverage amplifies the potential gain from an investment, but also increases the potential loss. Interest and principal payments may be higher than the investment returns.

This increased risk may still lead to the optimal outcome for the entity or person making the investment. In fact, precisely managing risk utilizing strategies including leverage and security purchases is the subject of a discipline known as financial engineering.

Calculating Profit and Loss
A small business owner strapped for cash may have very little capital available for investment and no credit available from which to borrow from banks. Therefore, taking a risk investing in the forex market which offers very high returns can be minimized by employing an experienced forex trader to do the day-to-day trading of their account.

However, it is still useful for the small business owner to understand how profit and losses are calculated:

To illustrate an FX trade, consider the following two examples.

Let's say that the current bid/ask for EUR/USD is 1.4616/19, meaning you can buy 1 euro for 1.4619 or sell 1 euro for 1.4616.

Suppose you decide that the Euro is undervalued against the US dollar. To execute this strategy, you would buy Euros (simultaneously selling dollars), and then wait for the exchange rate to rise.

So you make the trade: to buy 100,000 Euros you pay 146,190 dollars (100,000 x 1.4619). Remember, at 1% margin, your initial margin deposit would be approximately $1,461 for this trade.

As you expected, Euro strengthens to 1.4623/26. Now, to realize your profits, you sell 100,000 Euros at the current rate of 1.4623, and receive $146,230.

You bought 100k Euros at 1.4619, paying $146,190. Then you sold 100k Euros at 1.4623, receiving $146,230. That's a difference of 4 pips, or in dollar terms ($146,190 - 146,230 = $40).

Total profit = US $40.

Going further, let’s look at another forex trading profit example with a higher days’ profit:

Forex trading profit is simple enough to calculate. Just keep two formulas in mind.

Where the quote currency is the USD meaning the second currency in a pair, here is the formula:

Profit = Price Change in Pips X Units Traded

Given that USD is now the base currency or the first currency in a pair, the formula becomes:

Profit = Price Change in Pips X Units Traded / Exit Price

To facilitate your understanding here is another example:

In this example, the quote currency is the USD. In the interest of simplicity, assume the broker’s margin requirement is again only 1% thus your $1000 will allow you to trade $100,000.

You plan to trade on the EUR/USD with a current trade value of 1.2518/9. Based on your analysis, the USD will weaken against the euro so you send an order to buy euros which also includes concurrent sale of USD.

So at the 1.2519 mark you are able to buy $100, 000. However buying requires taking the second number in the quote or the ask price.

The price rises reaching 1.2532/3 proving the accuracy of your system. Now you proceed to set in motion selling EUR and buying USD. In this case the bid price is used, which is 1.2532.

So your buying price is 1.2519 and your selling was 1.2532 giving you a trading profit of 17 pips or 0.0017. Let us now transform to real money terms. Given the formula earlier:

Profit = Price Change in Pips X Units Traded
Or,
Profit = 0.0017 X 100,000 = $170.00

Remember this simple rule of the thumb that given a standard trading lot of 100,000 where the USD is the quote currency in the pair, the pip will be equal to $10. So, 17 pips x 10 equals $170.

On a monthly basis an experienced forex trader may have the conservative potential to generate ten profitable trades per month or $1,700 (10 X $170.00 using the above example) with an investment of only $1,000.

With more investment capital, say $4,000 the potential profit may be quadrupled.

Decision Time
You can avoid answering your phone, throw the billing statements in the Cuisinart blender, or chuck them into a garbage can, but that won't make the debts go away. Debt hovers like a buzzard over a dying beast, with annual rates of 20% or more compounded monthly, month in and month out. You can't wish it away. But you can be proactive and try something you have not tried before to relieve your debt burden.

Look at your options to get out of debt:
1. Pay more than the minimum towards your monthly debt payments;
2. Snowball your debt payments by transferring a higher-interest bill to a lower interest bill if you have the available credit;
3. Cash out your savings account;
4. Borrow against your life insurance;
5. Finagle family and friends;
6. Get a home equity loan;
7. Borrow from your 401(k);
8. Debt Settlement by Renegotiate terms with your creditors;
9. file bankruptcy;
10. Increase your cash flow – try our method of Financial Leverage, invest as little as $1,000 in a Forex Trading Account and see what a difference a day trader can make.

If you are still undecided and you qualify, open a demo account for thirty days and let us trade this practice account for you. You risk no investment and you get to see for yourself if our method of generating cash flow for your business really works.

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Kemosabe provides Investment Advisory services to help large and small companies get out of debt.

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Kemosabe Ltd. manages segregated accounts for financial institutions and high net worth individuals. No mandates are accepted unless Kemosabe Ltd. has met the client and clearly established their investment objective.

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