Dollars deposited in Europe Were increasingly lent to borrowers in Europe, and the Eurodollar market grew. The supply and demand were increased by the US balance of trade deficit in the late s and early s, which created a flow of dollars into the hands of non-US residents. US banks used their European branches to move dollars into the Euromarkets, thereby circumventing restrictive US domestic banking regulations.

Although restrictive regulations in the US were eased in the early s, the Eurodollar market was sufficiently well established by then to survive and compete with the domestic US markets. Large dollar loans were made to countries suffering a balance of payments deficit as a consequence of the large increase in oil prices at that time. However, there is a very close connection between the two markets. A forward swap is an agreement to buy one currency in exchange for a second currency and a simultaneous agreement to sell back the currency at a future date, but at a different rate of exchange.

The difference between the exchange rate for the initial purchase and subsequent sellback is accounted for by the interest rate differential between the Eurocurrencies. Figure shows the development of EURUSD. Until the 1 s, many countries-imposed protectionist measures on trade and the movement of currency.

Movements of domestic currency out of the country might also be restricted. Exchange controls restricted the growth of the FX market, and until the end of 1 s, only the US was relatively free from controls.

Exchange control regulations still exist in parts of Eastern Europe and in many developing countries around the world. Within the European Community, Great Britain was the first to remove all exchange controls, in In the late s and early s most of the rest of the European Community countries did the same. Free from controls, foreign exchange business boomed, since international trade was less restricted, and companies were able to invest freely and raise funds overseas. Pension funds and other similar institutions were able to diversify their portfolios by investing in other countries, giving another boost to foreign exchange trading.

The rapid growth of derivative transactions, such as currency swaps and options, and tailored financial transactions, has increased the use of the spot and forward FX Markets for hedging purposes. selling or buying back the currency. Goods and Services Monitoring of different Time differences may last Machinery and finished markets for cross from a couple of minutes till goods Arbitrage i. The dealer must have a Investments precise idea about the market direction.

they sell, buy, lend and borrow - across international boundaries and the local currency of the buyer or borrower is a foreign currency to the seller or lender. Foreign exchange is the trading of one currency in exchange for another. International trade creates a requirement for foreign exchange.

Project finance and international investments also give rise to cross border transactions, for which foreign currency has to be purchased or borrowed. For example, Japanese investors to buy US Treasury bonds will need to buy US dollars in exchange for yen to make their bond purchases.

The growth in foreign exchange trading over recent years has been stimulated by the liberalization of international trade the reduction in trade barriers and the trend towards the removal of exchange controls. Many of the leading trading nations now permit the free movement of capital, so that firms and individuals can buy, sell, borrow or lend foreign currencies without restriction.

However, the global abolition of restrictions on foreign trade and investments is far from complete. These transactions take place in the foreign exchange FX Market. The main participants in the FX Market are the major international banks; they deal in the market on behalf of their customers and speculatively for themselves. Other participants include brokers, investment institutions, corporates, and central banks. Most FX Market transactions are inter-bank.

FX business with non-bank customers and institutions accounts for less than one quarter of daily turnover in the market. There are also major centers in other countries, e. Canada, Switzerland, Hong Kong, Germany, France, and Australia. Allowing for the five- hour time lag between London and New York and nine hours between Tokyo and London, the effective opening hours are virtually round the clock.

The major banks deal in all three time zones and are prepared to execute customer orders throughout the day and night. In a free market these prices move up or down according to demand and supply, whereas in regulated markets exchange rates are controlled.

Foreign Exchange Market for the major traded currencies is partially regulated, to the extent that some governments try to stabilize the exchange rate for their domestic currency against other major currencies. Exchange rates between the major currencies, most notably the US dollar, the yen and the EUR, fluctuate freely according to demand and supply. The only firm prices are those shouted out all lay by brokers and those quoted by banks to their customers and to each other.

Prices shown on Reuters and other screens are for information only; however, these are updated continually and give a good indication of the current market rate.

In recent years, world-wide trading in yen and Deutschmarks has increased in volume, and these currencies have begun to challenge the supremacy of the dollar. Every currency is quoted against the dollar, and most FX Market transactions include the dollar as one of the two constituent currencies. Sell Currency A 2. Sell US dollars Buy US dollars Buy Currency B Thus, if a bank transacts the purchase of a large quantity of EURs in exchange for sterling, it would sell sterling and purchase EURs for US dollars in two separate transactions.

Long-term factors are economic and regulatory conditions that create the Demand for buying or selling a currency for trading or investment purposes. The average exchange rate between two currencies over time, and changes in this exchange rate, should reflect the differing conditions in each country. Short-term factors are influences on Demand and supply arising out of immediate conditions the FX Market which should not persist for the longer term.

Similarly, political developments, for example the prospect of a change of government if an election is called, can drive the market. If sentiment, rumor or political events result in speculative or precautionary buying or selling of that currency, its exchange rate might shift substantially in the short term, and perhaps for periods of several days, weeks or even months.

Fluctuations or volatility in exchange rates cause currency risk. A stable currency reduces or removes currency risk, and so creates an environment in which international trade is more likely to flourish.

In other words, the commercial banks are the market makers. The major banks trade in many currencies from offices in several countries.

Other banks specialize in certain currencies, for example Canadian banks might specialize in the Canadian dollar, hoping to attract a large proportion of the market transactions in that currency. A bank should only want to be a major dealer in a particular currency if its trading profits are sufficient to support the costs of the operation, and to justify the risks involved.

Inter-bank transactions account for a high proportion of FX Market transactions, but the potential profit margins are smaller. Dealers need to understand clearly how an exchange rate will respond to new information in order to profit from trading with professional counterparties in other banks. This was made possible by the limited technology available at the time.

Making a phone call to New York from London was not easy. Sometimes it had to be booked with an operator in advance. Computers and even calculators were in their infancy and dealers relied on brokers to get prices. There were no screens and few loudspeaker boxes. meaning that the price of sterling in the New York market should be checked via the telex link, as it was often possible for an arbitrage to exist between the London price and the New York price.

Since those times, opportunities for true arbitrage between two FX Market centers have virtually disappeared, due to a combination of technology advances and greater sophistication amongst dealers.

If an arbitrage opportunity emerges, however small, it is quickly exploited and hence removed. Computers, astute programs, and sharp-eyed dealers will move the exchange rates rapidly to keep the market in equilibrium.

A survey of the London FX Market by the Bank of England in April found that brokers acted as intermediaries for about one-third of foreign exchange businesses. The function of a broker is to match buyers and sellers of currency.

They are in constant communication with the dealers in the banks, arid receive orders from them. They continually call out the best prices they have been given, and any bank wishing to deal at these prices can do so. The broker charges a commission on the deal. Investment institutions such as insurance companies and pension funds that invest overseas also use the FX Markets to buy the currency they need for foreign investments and to sell foreign currency income from holding the investments interest, dividends or selling them.

In general, the treasury departments of corporates do not speculate actively in the currency markets. However, if their currency risk hedging strategy is influenced by their perceptions of how exchange rates might move, their hedging transactions will be at least partially speculative.

The volumes traded in the market are too large for any central bank to affect total Demand or supply sufficiently.

Intervention may be carried out by one central bank acting alone, or by a group of central banks acting in concert to affect the value of one of the major currencies e. the US dollar. If the intervention is not supported by other economic action e.

on interest rates it will have at best a brief effect. Nevertheless, central banks have the resources to deal in very large amounts in a very short space of time, so some immediate impact on exchange rates is inevitable. This is often amplified by commercial banks, aiming to profit from any exchange rate movement, however short-lived.

If it is well-timed, even the threat of intervention can serve to support a currency as the commercial banks will be nervous of taking the opposite view to the central bank. Central banks can also influence the FX Markets by draining liquidity from the money market, forcing up the level of short-term interest rates. It then becomes extremely expensive to the short of the currency, so dealers will buy the currency to cover their positions, forcing up the exchange rate temporarily.

Every dealing desk is equipped with at least one screen which provides a vast amount of real time information from all over the world. in the major currencies, these prices will be updated every few seconds.

on the same continent. Spot rates, forward points and LIBOR are all described in later chapters. Most major banks around the world now have this facility, which is of particular advantage to banks which do most of their business with counterparties in other financial centers.

The Reuters dealing screen enables banks to call each other using a simple code, and to have conversations with counterparty dealers by typing on to a screen. This is extremely quick and efficient and has the following advantages over telephone calls. USD 84 billion for equities worldwide. the Exchange Rate Mechanism of the European Monetary System. The value of each currency is fixed against a common standard, such as gold or the US dollar. If Demand for a currency in the FX Market exceeds supply, or if supply exceeds Demand, the central bank will intervene to sell or buy the surplus, in order to maintain the exchange rate at or near its parity value.

Over time, the value of strong currencies will appreciate, and the value of weak currencies will depreciate. It will intervene in the FX Market to buy or sell its currency when the exchange rate weakens to breach the tipper or lower target limit. In most instances, the central bank in a dirty float system acts as a buffer against an external economic shock before its effects become disruptive to the domestic economy. Business days do not include Saturdays, Sundays or bank holidays in either of the countries of the two currencies concerned.

The large volume of foreign exchange between these two currencies has led to the evolution of an efficient system, and there is no time difference between the main money centers, New York, and Toronto. The way in which the exchange rate is quoted for each particular pair of currencies has become standardized around the world. However, an exchange rate may be quoted differently in the domestic market compared to the international FX Market.

The following points of exchange rate quotations need to be understood: SWIFT codes, base currencies and variable or quoted currencies, direct and indirect quotes, pips and the big figure, bid and offer rates and Spread. The first 2 letters usually represent the name of the country and the third the name of the currency. However, there are some exceptions. These codes are used by the SWIFT message system for international banks and have become internationally accepted standards.

A list of SWIFT codes is given below, for the major traded currencies and currencies that feature in examples or exercises in this text. Figure: 2. The base currency is therefore the currency against which others are quoted. Most currencies are quoted against the USD. Within a domestic market, it is sometimes more convenient to quote exchange rates the other way around. For example, the method of quoting a rate for the Italian lira against the Spanish peseta might differ between Milan and Madrid.

What should the rate be? The rest of the rate is called the big figure. Exchange rates are usually quoted to five figures.

The first three digits of the quote are the big figure. Deals are often conducted without any mention of the big figure, and only the pips arc quoted. It is good practice, however, always to state the big figure to avoid the possibility of errors, for example when the market is moving rapidly. By market convention, the bid rate is quoted as the left-hand rate and the offer rate is on the right-hand side. The market user, whether it is a corporate customer, institutional investor, commercial bank, or a central bank always get the worst of the bargain.

The market makers will always quote the price bid rate or offer rate that is most favorable to them. When a dealer receives a call from another bank for a price, he is acting as market maker. If he then calls another bank to close the position i. to transact an opposite deal he is acting as a market user, taking the price quoted to him.

Example Exercises A multinational wants to buy USD5 To gain familiarity with spot exchange rates, determine the million in exchange for Swiss correct answers to the following problems. Assume that francs. A bank quotes: 1. Problem I A UK bank wants to purchase USD 10 million from a market maker in exchange for sterling. What price would the market maker quote? What amount of sterling would the UK bank have to pay?

Solution 1 The market maker is buying sterling the base currency and the spot rate is therefore the lower bid rate of 1. The customer will have to pay GBP 6,, What rate would the market maker quote and what amount of dollars would the US corporate receive?

Solution 2 The market maker is selling dollars the base currency and will therefore quote the higher offer rate of 1. The US corporate will receive USD 3,, Solution 3 The market maker is buying dollars the base currency and the spot rate is therefore the lower bid rate of The US bank will have to pay USD 4,, In the case of prices from brokers, it is the difference between the highest hid and the cheapest offer.

Most currencies are quoted with spreads of 3 to 5 pips. The spread represents an opportunity for the market maker to make a profit, provided that exchange rates do not move. The cash flows on the value date will be: Bank receives: USD 1,, Bank pays: EUR 1,, Bank pays: USD 1,, Bank receives: Balance: EUR 1,, Nil EUR The dealer has made a profit of EUR or 5 points on USD1 million at EURI 00 per point per million dollars and has a square or flat position in dollars.

There is of course no guarantee that the dealer will be able to make this profit, as market rates are constantly changing. However, the wider the spread quoted, the greater the likelihood of closing the position at a profit. The size of the spread will be related to the amount of risk attached to any given deal. A party is said to have a long position in a particular currency when the total assets exceed total liability. If a party whose foreign exchange position in a particular currency shows a deficit, that party is said to have a short position in the currency.

This is referred to as a square position. Changes in exchange rates will have no impact on profit or loss. normally moves rapidly and erratically, and large changes are common, then there is a greater risk that the dealer will be unable to cover his position at a profit. He will therefore widen the spread so that a larger movement must take place before he is in a loss-making position.

His risk is therefore less, and a narrower spread can be quoted. The normal spread for inter-bank deals in major currencies is 3 to 5 points. In illiquid markets, there is a risk that some time may be taken to execute a deal, and that the deal itself will adversely affect the market price. Spreads therefore tend to be considerably wider. Prices quoted to other banks must have narrow spreads or no business will be done. Additionally, most banks have a good credit rating, and the risk that they will fail to settle the deal.

The same applies to very large, sophisticated corporate customers such as major multinationals. Corporate customers are generally less likely to refuse a price. Smaller companies have a limited choice of banks to deal with. The bid-offer spread quoted to these companies tends to be wider. The number 4. I therefore pay DKK 4,, 1,,×4. In this case it is CHF , This sometimes reflects the importance EURCAD CADJPY of the relationship between the pair of the CHFJPY AUDJPY currencies.

The economic relationship between NZDJPY AUDCAD CHF and EUR, for example, is closer than the relationship CHF and USD. The principle of calculating cross rate remains the same however. If a bank is prepared to buy USD 1. A cross rate can be calculated from the respective rate for each of the currencies against the dollar. The first step is to decide which is to be the base currency. Either can be the base currency and cross rates are published both ways in the financial press, i.

with each currency as the base. In most cases, however, the market convention is that the currency with the higher value per unit is the base, so that the cross rate will be a number greater than 1. From the 1 1 above rates we can see that 1US dollar is worth less than 1 Singapore dollars and over 6 2 2 SEK, so the Singapore dollar must have greater unit value than the krone.

Since US dollars, the base currency, are being sold, the market maker would quote the offer price, 1. Since US dollars base currency are being purchased, the market maker would quote the bid l price, 6. Since USD is the base, the bid rate of 1. Since USD is the base, the offer rate of 6. Exercise Solution Attempt your own answer to this problem, The EUR has a higher value, and will be taken the following spot rates apply: as the base currency. It is sometimes the more internationally recognized currency that is the base; or for historic reasons the less valuable currency is sometimes the base.

For example, the Australian dollar AUD and the New Zealand dollar NZD are the base in a quote against US dollars, even though their value is less than one dollar. Bid price Market maker buys GBP, sells CAD Buy GBP, sell USD at 1. This spread is not necessary is a position can be covered directly in one market.

Spreads will be wider for less-activity traded cross currency Paris, because the market maker will split deals into two-dollar positions, with equal and opposite notional dollar values, and cover them in the respective markets. Most inter-bank FX Market transactions do not involve cross rates, i. do not involve the exchange of two non-dollar currencies. A bank wishing to buy EURs and sell Belgian francs would sell Belgian francs for US dollars and buy EUR with the US dollars.

Some cross rates, however, are increasingly traded by banks in addition to US dollar-based rates. the actual bid- offer spread may be narrower than that calculated from the respective dollar rates. As mentioned earlier, cross rates might be quoted differently depending on who is quoting it.

as a direct cross rate. The exchange rate will be quoted as the number of USD per EUR or per EUR against, as a direct rate.

USD 1. The rate in terms of francs per DM is therefore Therefore: and sells SGD at 1. Also, since each 1EUR is worth 1. rate must be the products of these two numbers. Similarly: Therefore: 1. This chapter describes outright forward transactions - i. FX Market swaps and short dated forwards are described in the next two chapters. Forward Exchange Contracts It is a contract between two parties for the purchase or sale of a specific quantity of a stated foreign currency at a rate of exchange fixed at the time of making the contract and for performance by delivery and payment at a future time agreed upon when making the contract … 4.

An FX Forward transaction is a deal which is executed today to buy or sell one currency for another at a rate that is agreed today, for delivery at an agreed future date. Compared to the prevailing spot rate, the forward exchange rate can be either Higher trade at Premium , or Lower trade at discount , or Equals trade at Par.

Forward Exchange Rates Cases Forward Premium Forward Par Forward Discount Occurs when Occurs when Occurs when Forward rate is higher Forward rate equals spot Forward rate is lower than than spot rate rate spot rate Interest rate of commodity Interest rate of commodity Interest rate of commodity currency is lower than currency equals interest currency is higher than interest rate of reference rate of reference currency interest rate of reference currency currency Figure 3.

The value date for a forward exchange transaction is measured from the spot value date. Spot value date is usually two working days after the dealing date, see Chapter 2. For example, the value date for a three-month forward contract agreed on Monday 12 February will be Tuesday 14 May.

This is three calendar months after spot value date, 14 February. Similarly, the value date for a one-month forward contract agreed on Tuesday 8 October will be Monday 11 November since Sunday 10 November is not a working day. Predictions of future movements in the spot rate would be extremely unreliable, and so quoting prices based on such predictions would be intolerably risky.

The difference between a forward exchange rate and the spot rate reflects the interest rate differential between the two currencies. If forward rates did not reflect interest rate differentials between currencies, it could be possible to profit through arbitrage from the price differences between the FX Market and the Eurocurrency market.

The six month interest period is days. The resulting value should be the same whichever option is chosen.

If one option is more profitable than the other, the organization will select it. The same opportunity for further profit would exist to every other participant in the FX Market and Eurocurrency markets. Buy EUR 1. Suppose that on 4 July, a bank is asked to sell USD I million in exchange for EURs, for settlement on 6 October, the three month value date. The bank now has an open position in USD i. the total balance of its USD assets and liabilities is no longer zero.

This exposure can be covered by buying I million dollars in the spot market at 1 36 on 4 July. Balance Nil? Interest will amount to: EUR 10, At the same time, the bank must borrow EUR 1,, to settle the spot deal.

Interest on the loan will be: EUR 17, The cash available at the forward date, with which to repay the EUR borrowing, comprises two elements: i EUR received in settlement of the forward deal ii USD deposit interest, converted to EUR at the forward rate.

Hence, we can say that if the cash available to repay the EUR loan must be exactly equal to the amount payable on the loan, we can establish the following formula.

These examples are intended to show that a bank can calculate precisely what the forward exchange rate of any given date should be, from the currently available spot rate and interest rates on the two currencies in the money market. b is the base currency interest rate for the period D is the number of days in the interest period B is the day base for the variable currency Bb is the day base for the base currency i.

the number of days in the base currency money market year. Hence the information required to calculate a forward rate is: The spot rate, the time period in days and the interest rate for each currency.

The rate calculated is the outright forward rate, i. the actual exchange rate applied to a forward deal. Forward prices can only be calculated where money market rates are known. This limits the maximum possible maturity of forward deals in many markets. For example, where inflation is very high, interest rates may be quoted only up to 3 months, and forward deals for longer periods could not then be hedged or priced.

The variable currency EUR therefore has a lower value forward than spot against the base currency USD , because the interest rate on the variable currency is lower than the interest rate on the base currency. What is the 12 month forward rate? The variable currency EUR therefore has a lower value forward than spot against the base currency USD , because the interest rate on the variable currency is higher than the interest rate on the base currency. Therefore the forward rate will be higher than the spot rate - i.

the base currency will be worth more forward than spot against the variable currency. the base currency will be worth less forward than spot against the variable currency. This is the method often used in the financial press e. the Financial Times. However, banks do not normally quote forward prices in this way. Instead, rates are quoted as the number of points by which the spot price must be adjusted to arrive at the outright forward price.

These are known as the forward points, or swap points. If we know the relevant interest rates, then we know whether the forward price should be higher or lower than the spot price.

However, the quote itself shows whether the points should be added or subtracted, because we can tell whether to add or subtract the points from the way in which the points are written. The customer always deals on the price which is less favorable to him i.

more favorable to the market maker. When the forward points are applied to the spot price to calculate an outright forward price, this is always done in such a way that the forward price has a wider spread than the spot price to account for the additional risk to the market maker. To find the forward rate, a premium is added to the spot rate whereas a discount is subtracted. They therefore change much less rapidly than the spot price. If outright prices were quoted, they would have to be updated continually as the spot price moves.

Forward points are therefore quoted by a specialist dealer, rather than by the spot dealer. In some banks, forward points are quoted by the money markets dealers, since the forward points depend on money market interest rates. Swaps will be discussed in the next chapter. Similarly, a currency is worth less forward if it is at a forward discount to the other. This general terminology is valid, and can be applied to whether the base or the variable currency.

Exercises Exercise I Solution 1 Corporate wishes to sell CHF 4,, The bank is selling USD. The forward points are three months forward in exchange for USD deducted. The forward rate is therefore: dollars.

Forward points The forward rate is therefore: wants to buy the EUR forward in exchange Spot 2. Outright forward rate 2. To establish what the domestic currency cost or revenue, they can cover the exposure by means of an outright forward deal. He can buy the CHF in the forward market and needs to pay nothing until settlement date. Even if the UK Company has sterling available, there is a cost equal to the interest which could have been earned by depositing that sterling until the forward value date.

The total GBP cost of buying the CHF is likely to be less using the forward market. This is much greater than the interest rate spread implied by forward foreign exchange rates. Most corporates except for very large, highly rated companies cannot deal in interbank forward prices any more than they can borrow at LIBOR, but the credit risk margin they must pay will be greater for lending than for forward foreign exchange.

As a result, if the corporate wishes to hedge the forward transaction, it will arrange an outright forward transaction. Institutions can match the value date of the currency deal to the settlement of underlying investment transaction using the forward FX Market. These can be calculated readily from the corresponding money market interest rates for those periods.

Value dates other than these are called broken dates. We wish to calculate accurately the forward points for a non-standard date we must look at the yield curves and determine the correct interest rate differential for the period. Software exists which can perform these calculations for us, but in the absence of this a reasonable approximation can be arrived at by simple interpolation. Simply interpolation is based on the assumption that the unknown value we are trying to calculate lies on a straight line, graphically, between two known values.

For example: - Example We can estimate the 4-month forward price from the above information. Suppose that the 4-month value date is days from spot. The closest dates we have are the 3 months and 6 months. During this 92 - day period, the left-hand side increases from 57 to , and the right-hand side from 53 to The swap for this period i.

the forward swap points is therefore: 0. As with spot transactions, most large forward transactions between banks involve the sale or purchase of dollars, and large cross rate deals are comparatively uncommon.

To sell EURs forward in exchange for sterling, a bank would normally make two transactions. The bank will offer a forward exchange contract but will give the customer the option to settle the contract on any working day between two agreed dates. The value date is therefore decided by the customer but must be within the earlier and latest option dates of the contract.

With a time, option, the bank will quote either the two month forward rate or the three month forward rate. The rate chosen by the bank market maker will be the rate most favorable to itself. The bank is selling EUR and buying the base, GBP. It therefore wants the lower of the two rates. Two month outright forward rate: 2. He portrays how to utilize the device appropriately, dodge regular snares, and clarify the integral primary investigation methods, which affirms how markets will probably run.

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Most importantly, she details out the short-term and long-term factors affecting currency pairs. For those who are still on the fence about trading, this book is worth checking out.

The author, Courtney Smith provides you with awesome trading strategies that you can use to make money even when the markets are tough. Smith also shares a strategy aimed at doubling profit generated using a simple channel breakout system. In this book, Edwin walks us through the journey of one Mr. Livingston who moves from being financially broke to amassing unbelievable wealth over time. A seasoned expert in momentum indicators, Jim Brown provides you with the latest insights from the financial world.

He equips you with 75 useful graphics that provide you with useful information regarding the merits and demerits of different technical indicators used today. So, there you have it. The complete list of some of the good forex trading books we could find out there.

Currency Trading for Dummies. Japanese Candlestick Charting Techniques. Forex Trading: The Basics Explained in Simple Terms. The Disciplined Trader. Start Day Trading Now. Day Trading and Swing Trading the Currency Market. How to Make a Living Trading Foreign Exchange. Reminiscences of a Stock Operator. Trading Review.

It contrasts with the capital market for longer-term funding, which is supplied by bonds and equity. OPTIONS TRADING CRASH COURSE [6 BOOKS IN 1]: The 1 Beginner to Advanced Guide. The universe of foreign trade, or forex, can be overwhelming even to experienced active financial traders. Sell on Amazon Start a Selling Account. P is the principal amount R is the interest, rate as an annual percentage amount? Book Depository Books With Free Delivery Worldwide.

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