To understand the implications of the new tax, it’s important to understand how iShares MSCI Brazil (NYSEArca: EWZ) works.

EWZ is a “cash create” product, unlike most ETFs where delivery is taken in the form of securities. Regulations in Brazil don’t allow in-kind share creations. Cash is taken in lieu of actual shares, and the money is taken and invested in Brazil.

When a market participant (MP) wants to create more shares of EWZ, there’s a fee associated with this creation that’s already built in. This new tax may eventually become a part of the fund expenses in the event that an increase in demand for EWZ leads to the creation of more shares.

According to its prospectus, Market Vectors Brazil Small-Cap (NYSEArca: BRF) also issues and redeems creation units primarily for cash.

Anything already issued in any fund is not impacted because it’s already in the local currency.

Meanwhile, money is flooding into Brazil. About $31 billion in foreign direct investment is expected this year. In turn, this news has upped their stock market and increased the value of the currency. The risk Brazil runs is the real getting too strong, which is a new problem for a country that has usually had to deal with inflation, reports Carl Mortished for Times Online.

This is what led to the tax: the country feared losing its foreign customers and exporters raised a ruckus, hence the 2% tax. While investors and the International Monetary Fund (IMF) initially balked, for the most part investors seem to feel the positives of growth prospects in Brazil outweigh the negatives of the tax.

For more stories about Brazil, visit our Brazil category.

• iShares MSCI Brazil Index (NYSEArca: EWZ): up 116.3% year-to-date

• Market Vectors Brazil Small-Cap (NYSEArca: BRF): up 86.7% year-to-date

• WisdomTree Dreyfus Brazilian Real (NYSEArca: BZF): up 34% year-to-date

The WisdomTree Dreyfus Emerging Currency (NYSEArca: CEW) accesses “non-deliverable” forward (NDF) exchange contracts, and the fund captures the broad and sudden shifts of investor sentiments in the emerging currencies market, writes Rakesh Saxena for Seeking Alpha.

CEW fund provides access to the short-term money market in the emerging markets without encumbering investors with possible settlement risks. It is noted that only those comfortable with foreign exchange risks should be investing in this type of fund. (More on currency investing in our special report).

Potential traders should also note that NDF contracts incorporate interest rate differentials and speculative orders, which means that during stressful times in the financial markets, the exchange rates available in the NDF market are more accurate than the official quotes from emerging market banks.

NDF contracts are essentially outright forward exchange contracts with profits and losses adjusted between two counterparties based on the difference between the contracted and spot rate on the contract maturity date. (More on forward contracts can be found here).

Why is a basket of currencies beneficial?

• Emerging markets can be volatile; currency basket ETFs can give you broad exposure to a range of currencies and mitigate your overall risk. (More on emerging markets here).
• They are lower-correlating assets. The currencies in emerging markets generally move independently  of other domestic investments and alternative asset classes, such as commodities.
• They’re another way to access the overall growth of a currency category; in this case, emerging markets.

For more information on world currencies, visit our currency category. Or take a look at our ETF currency guide for currency ETF selections.

• WisdomTree Dreyfus Emerging Currency (NYSEArca: CEW): up 5.9% since inception; currencies include Mexican peso, Brazilian real, Chilean peso, South African rand, Polish zloty, Israeli shekel, Turkish new lira, Chinese yuan, South Korean won, Taiwanese dollar, Indian rupee

Max Chen contributed to this article.

Because of government restrictions, capital controls and sometimes liquidity issues, WisdomTree applies currency contracts, or non-deliverable forwards, and U.S. dollar-denominated short-term government and commercial paper in its foreign currency funds, writes Don Dion for TheStreet.

A forward contract is an agreement to exchange currencies at a predetermined rate at a specific time. The benefit is that the contracts allow foreign investors to gauge the return of a money market fund in a foreign currency. (Read our currency special report).

WisdomTree uses forward contracts to reflect foreign currency holdings in its Chinese, Brazilian and Indian currency ETFs. Its Japanese yen and euro ETFs hold short-term yen  and euro debt. WisdomTree’s currency ETFs have been outperforming the underlying currency thanks to implied yields in forward contracts.

• WisdomTree Dreyfus Chinese Yuan Fund ETF (NYSEArca: CYB): up 1.8% year-to-date
• WisdomTree Dreyfus Brazilian Real Fund ETF (NYSEArca: BZF): up 35.7% year-to-date
• WisdomTree Dreyfus Indian Rupee (NYSEArca: ICN): up 9.5% year-to-date
• WisdomTree Dreyfus Japanese Yen Fund ETF (NYSEArca: JYF): up 0.5% year-to-date
• WisdomTree Dreyfus Euro Fund ETF (NYSEArca: EU): up 8.6% year-to-date

Interest rates are a major determinant in forex prices. For example,  country “X” has a higher interest rate than country “Y,” and a person from country “Y” purchases a forward contract to exchange currency “Y” back to currency “X” at 2-to-1 in one year. A person would lock in the exchange rate in the future and would profit from the higher interest rate with no risk – this is known as arbitrage. Traders would then buy up the foreign currency until the exchange rate no longer overcompensates for the higher foreign interest rates.

Potential currency traders should note that trading in currencies includes risks, and trading in emerging market currencies carries even more risk. Have a strategy when you invest.

For more information on foreign currencies, visit our currency category.

Max Chen contributed to this article.

Holdings

BZF typically invests in a combination of U.S. money market securities with forward currency contracts as well as currency swaps. Like all of WisdomTree’s currency funds, it is not a money market fund.

Objective

BZF seeks to achieve the total returns that reflect money market rates in Brazil and the changes in value of the Brazilian real relative to the U.S. dollar.

Of Note

• BZF is one of the top-performing currency ETFs year-to-date, up 24.3%
• Brazil is still considered an emerging market, so its currency can be subject to high volatility
• The expense ratio is 0.45%

The Latest News

• The real strengthened on Wednesday in anticipation that the Federal Reserve would keep interest rates where they are in order to spur on economic recovery
• The real has been boosted in recent weeks by strong corporate earnings, rising equity prices and higher metal prices
• Merrill Lynch says the real may climb another 7% in the next month, reports Fabio Alves for Bloomberg
• Brazil’s Bovespa index recently reached an 11-month high after ending July with its best monthly gain since 1995, write Alexander Ragir and Emily Schmall for Bloomberg

For more information on currency ETFs, check out our special report.

Some good things happening over there:

• Brazil’s Bovespa index recently reached an 11-month high after ending July with its best monthly gain since 1995, write Alexander Ragir and Emily Schmall for Bloomberg. Bovespa’s valuations are up 23.25 times reported earnings, more than the average 17.91 price-to-earnings ratio of emerging market stocks tracked by the MSCI Emerging Market Index.

• Earnings that exceeded estimates and small contraction for the U.S. economy prompted investors to speculate on a global recovery. Commodities, which make up two-thirds of Brazil’s exports, climbed to a six-week high.

• The Brazilian banking sector is gaining on a growing consumer market.

• Brazil’s June industrial production rose 0.2% from May, which is also its sixth straight month of gains, reports John Kolodziejski for The Wall Street Journal.

• Consumption in autos, which pushed output up 12% in the first half of the year, construction, and domestic appliances, services and retail sectors were areas that contributed to the industrial recovery.

• Capital goods output increased 2.1% from May, mining output gained 5.3%, basic metal processing was up 2.0% and petrochemicals rose 2.9%.

• Exports increased from $9.78 billion in January to $14.14 billion in July. The mining sector, especially iron ore, was the largest contributor to the trade balance.

• The Brazilian real is also on a hot streak. It’s the world’s best-performing currency against the dollar this year, and Merrill Lynch says it may climb another 7% in the next month, reports Fabio Alves for Bloomberg.

• iShares MSCI Brazil Index (EWZ): up 73.9% year-to-date

• WisdomTree Dreyfus Brazilian Real (BZF): up 24.2% year-to-date

For more information on Brazil, visit our Brazil category. Or if you’re more interested in other BRIC countries, take a look at our special guide to BRIC ETFs.

Max Chen contributed to this article.

The dollar has taken a hit over the past few months and many currency experts believe that it will continue to remain weak because American consumers aren’t feeling confident,  U.S. policymakers want to keep U.S. goods cheap to entice foreigners to buy more of our stuff and the ballooning of the U.S. budget deficit, states Gary Gordon at ETF Expert.

As a result of the aforementioned, 12 out of the 14 “pure play” currency ETFs are trading above their 200-day moving averages and most have year-to-date gains. (The two exceptions are the PowerShares DB U.S. Dollar Bullish (UUP) and the CurrencyShares Mexican Peso (FXM)).

To play currencies, mind the trend lines and have an exit strategy if you’re invested.

Some of the best performing currency ETFs include:

• CurrencyShares British Pound Sterling (FXB): up 12.5% year-to-date

• WisdomTree South African Rand (SZR): up 26.2% year-to-date

• WisdomTree Brazilian Real (BZF): up 20.1% year-to-date

For more information on currency ETFs, take a look at our special report on currencies and visit our currency etf category.

Read the disclaimer, as Tom Lydon is a board member of Rydex Funds.

Kevin Grewal contributed to this article.

• This year, Brazil is forecast to grow around 4% to 5%, as the Central bank is set to cut interest rates in order to spur more growth, according to Alexander Ragir for Bloomberg.

• The Brazilian real has risen to nine-month highs as strong corporate earnings have come in, and rising equity prices are mixing with high metals prices to bolster the Brazilian economy,  reports Fabio Alves for Bloomberg reports.

• Ana Nicolaci da Costa for Reuters notes that Brazil will not need an added fiscal stimulus, as the country has almost emerged from the recession. The primary budget surplus is under scrutiny, as this is a gauge of a country’s ability to service its debt. The OECD expects Brazil to have a primary surplus of 2.3% of GDP this year.

• iShares MSCI Brazil Index (EWZ): up 55.6% year-to-date

• WisdomTree Dreyfus Brazilian Real (BZF): up 17.9% year-to-date

For more stories about Brazil, visit our Brazil category.

The Forex Market

The foreign exchange market, also known as the forex market, is the largest market in the world. In 2007, for example, it garnered $3.2 trillion worth of transactions each day. It’s the quiet giant of finance and dwarfs all other capital markets worldwide.

Unlike most other trading, such as futures, stocks or options, forex trading doesn’t happen on an exchange. It’s not controlled by any governing body, has no central exchange and there are no clearing houses involved guaranteeing trades. It’s a global network, made up of banks, corporations and individuals. The forex is also the most liquid market – there are always ready and willing buyers and sellers for the currency someone is seeking to trade.

The vast majority of currency trading is done bank-to-bank, and when each party enters into an agreement, they both take on the counterparty risk of the other. They’re not only competitors, but they’ve got to cooperate, as well.

There’s no actual buying and selling in the currency market – only trading, hence the need for cooperation.

Exchange traded funds (ETFs) have made entering this market much easier than it used to be. Prior to the launch of currency-related ETFs in 2005, the forex was a challenging market for individual investors to gain access to. Many investors might find this simplified access appealing, especially when you’re talking about a market that’s open 24 hours a day. If you’ve been eager to play this market, there are a rapidly growing number of opportunities to play the currency markets in the form of both ETFs and exchange traded notes (ETNs), which we’ll detail later.

Currency Basics

When entering the currency market, much of the focus is on the eight major currencies, which give you the best over- or under-valued opportunities. The eight major countries that make up the currency trading market are the United States, the Eurozone (Germany, France, Italy and Spain), Japan, United Kingdom, Switzerland, Australia, Canada and New Zealand.

There are many, many more currencies beyond the eight majors, such as the Brazilian real, Polish zloty and Hungarian forint.

Some of the key points to consider when you’re investing in currencies are:

• When trading currencies, yield drives return. Every currency has a yield.
• The forex allows huge leverage; often as high as 100:1 – which means that you can control $10,000 worth of assets with as little as $100 of capital. Remember, leverage works both ways, though.
• Since currency values never stay the same, the carry trade became a popular theory. Carry traders hope to earn not only the interest rate differential between the two currencies, but also look for their positions to appreciate in value. We’ll discuss this in more detail in the next section.
  
• Interest rates matter – a lot. Becoming familiar with the economics of the country in which the currency you are trading holds will help you understand when inflation is looming and when opportunity is knocking.

In currency markets, there’s always a bull somewhere. Why? The foreign exchange market is all about opposites and all about relativity. As one currency gains value, another has to be losing.

Dan McCabe, CEO at Next Investments, points out that one of the biggest advantages to investing in currencies is that it’s a great way to get non-U.S. dollar exposure.

“As an investor, I have nearly all my stuff in U.S. dollars. When I want to buy something, it’s often foreign-made. If I don’t have a hedge for the fact that the U.S. dollar may depreciate, I’m just losing my buying power on the world stage.”

For example, have a look at this five-year chart of the euro vs. the U.S. dollar. For the last three years, the euro steadily gained before falling off mid-way through 2008:

This means that as the euro gained strength, perhaps tourism in Europe suffered as Americans couldn’t afford to go over there and spend as much. But on the flip side, it likely brought tourists over here who were itching to spend and find bargains. Currency is all about relationships, and a currency being either weak or strong doesn’t necessarily mean it’s bad or good.

McCabe sees currencies as more of a buy-and-hold hedge instead of getting caught up in trading. “You’d rather just come in, buy it and put it away and look at it like a foreign money market account,” he says.

The Carry Trade

One of the most popular ways for institutional investors to play currencies is with the carry trade. Putting it simply, the carry trade involves borrowing currencies from countries with low interest rates and investing it in high interest rate countries. The strategy aims to take advantage of the wide spread in interest rates between certain currencies.

As of June 24, some interest rates for various currencies were:

• Australian Dollar, 3%
• New Zealand Dollar, 2.5%
• Euro, 1%
• U.S. Dollar, 0.25%
• Japanese Yen, 0.1%

You can track these interest rates at Daily FX.

With these interest rates in mind, an investor utilizing the carry trade would want to buy Australian dollars with the much lower-yielding Japanese yen, which is one of the most popular carry trade combinations around.

The carry trade isn’t a risk-free strategy, though. One of the biggest risks is if the exchange rate devalues by more than the average annual yield. If you’re using leverage, your losses could be even greater.

ETFs have simplified the carry trade for retail investors. The PowerShares DB G-10 Currency Harvest (DBV) tracks the interest rates of the U.S. dollar, euro, Japanese yen, Canadian dollar, Swiss franc, British pound, Australian dollar, New Zealand dollar, Norwegian krone and the Swedish krona. DBV looks at the three-month interest rates of the G10 currencies and goes long on the three with the highest rates and short on the three with the lowest. The ETF seeks to capitalize on the trend that the currencies with high interest rates generally tend to rise in value relative to currencies that have low interest rates.

Currency Risks

McCabe points out that currencies are non-correlated assets. “The risk you have oftentimes is performance vs. the underlying currency you’re purchasing in.”

As an example, assume that $1 equals 1 yen. If the dollar increases in value, you might get 1 yen for 90 cents – great if you’re traveling to Japan when this happens. However, it’s not so great if you have an asset priced in yen that you bought when dollars and yens were of equal value.

The flip side also works: if the dollar falls against various currencies, you stand to make money on assets based in those currencies if you bought them before the dollar weakened.

When searching for currencies to invest in, McCabe looks at the country behind it. Political upheaval can wreak havoc on a currency.

“I would look for a stable country with strong jurisprudence and rule of law…a country you believe is going to be stable, in case of turmoil.”

Why Use ETFs Instead?

Investing in currencies on your own, without an ETF, can be an arduous task. The currency market is one that never closes. Twenty-four hours a day, trillions and trillions of dollars in trades are taking place. You could find yourself sitting up in the middle of the night, waiting for a key signal to pounce on a trade.

That probably doesn’t sound like the average retail investor’s idea of a good time.

There are now two options for exchange traded currency investing: ETFs and exchange traded notes (ETNs).

Two key differences between currency ETFs and ETNs are:

1. Currency ETNs (like all ETNs) are backed by the full faith and credit of the issuer. If the issuer goes under, you have to get in line with all the other creditors. It’s a small risk, but it’s one to keep in mind.
2. Currency ETNs linked to a single currency are treated like debt for federal tax purposes, according to a 2007 IRS ruling. It means that any interest is taxable to investors, even though the interest is reinvested and not paid out until the ETN is sold or upon maturity of the contract. It also means that investors can’t elect capital gains treatment.

Not all exchange traded currency products are structured in the same way, either.

McCabe points out that it’s wise to be aware of what makes currency products different from one another. For example, Rydex’s CurrencyShares funds are grantor trusts – they hold the actual currency.

The interest earned on them is accrued on a daily basis and reinvested monthly. This reinvested interest is then reflected in the fund’s net asset value (NAV).

On the other hand, PowerShares‘ currency ETFs, PowerShares DB US Dollar Bullish Fund (UUP) and PowerShares DB US Dollar Bearish Fund (UDN), hold futures contracts and are registered as open-ended ETFs. Any gains from futures contracts are subject to 60/40 tax treatment, in which 60% of the gains are long-term, 40% are short-term.

In the bullish fund, the futures contracts are designed to be long on the U.S. dollar against the euro, yen, pound, canadian dollar, Swedish krona and Swiss franc. The bearish fund is designed to be short on the U.S. dollar against those currencies.

WisdomTree’s currency income ETFs invest in either non-U.S. moey market securities, or in a combination of money market instruments designed to provide exposure to non-U.S. money market securities or rates. They are not money market funds. They seek to give investors current income reflective of foreign money market rates available to U.S. investors, as well as exposure to changes in the value of a specific currency relative to the U.S. dollar.

Market Vectors‘ currency ETNs are senior, unsecured debt securities that give exposure to the exchange rate between U.S. dollars and foreign currencies. The underlying indexes are also affected by movements in interest rates in the country of the underlying currency and that of the United States’.

Market Vectors and ProShares also have some double long and double short ETNs for investors looking to enhance their exposure. They aim to double the daily performance of a specific currency. Know the risks of short and leveraged funds before you invest, however. They aren’t for everyone.

Barclays’ iPath currency ETNs measure the relative values of two currencies. In the EUR/USD fund, for example, when the euro rises against the U.S. dollar, the fund increases, and vice versa. The provider also has a currency carry ETN, iPath Optimized Currency Carry (ICI), that seeks to capture the returns potentially available from a carry trade. The pool of currencies the index may apply its strategies are known as the “G10″ currencies, which includes the U.S. dollar, euro, Japanese yen, Canadian dollar and Swiss franc.

How to Choose

At this point, there are enough ETNs and ETFs targeting currencies that investors have a whole range of choices when it comes to figuring out how they want to play them. When choosing currency ETFs, consider the differences between the available funds, how they access currencies and their tax treatment. In short, know what you own.

Perhaps one of the easiest ways is via a broad basket of currencies, which help spread out the risk and lessen the blows a volatile stock market can deliver. Some examples:

• Barclays Global Emerging Market Strategy [GEMS] Asia 8 Index ETN (AYT)
• Barclay’s iPath Optimized Currency Carry Exchange Traded Note (ICI)
• PowerShares DB G10 Currency Harvest Fund (DBV)
• WisdomTree Dreyfus Emerging Currency Fund (CEW)

There are a number of single-currency funds available, as well, along with a number of others that are in registration:

• PowerShares DB US Dollar Bullish Fund (UUP)
• PowerShares DB US Dollar Bearish Fund (UDN)
• CurrencyShares Australian Dollar Trust (FXA)
• WisdomTree Dreyfus Brazilian Real Fund ETF (BZF)
• CurrencyShares British Pound Sterling Trust (FXB)
• iPath GBP/USD Exchange Rate ETN (GBB)
• CurrencyShares Canadian Dollar Trust (FXC)
• Market Vectors – Chinese Renminbi/USD ETN (CNY)
• WisdomTree Dreyfus Chinese Yuan Fund ETF (CYB)
• CurrencyShares Euro Trust (FXE)
• iPath EUR/USD Exchange Rate ETN (ERO)
• WisdomTree Dreyfus Euro Fund ETF (EU)
• Market Vectors – Indian Rupee/USD ETN (INR)
• WisdomTree Dreyfus Indian Rupee Fund (ICN)
• CurrencyShares Japanese Yen Trust (FXY)
• iPath JPY/USD Exchange Rate ETN (JYN)
• WisdomTree Dreyfus Japanese Yen Fund ETF (JYF)
  
• CurrencyShares Mexican Peso Trust (FXM)
• CurrencyShares Russian Ruble Trust (XRU)
• CurrencyShares Swedish Krona Trust (FXS)
• CurrencyShares Swiss Franc Trust (FXF)
  

There are also leveraged funds, which enable investors to maximize the movements of a particular currency. The following funds all double exposure by 200%:

• ProShares Ultra Yen ETF (YCL)
• ProShares UltraShort Yen ETF (YCS)
• ProShares Ultra Euro ETF (ULE)
• ProShares UltraShort Euro ETF (EUO)
• Market Vectors Double Long Euro ETN (URR)
• Market Vectors Double Short Euro ETN (DRR)

In registration include CurrencyShares for Hong Kong, Singapore and South Africa, as well as WisdomTree funds for the Czech koruna, Chilean peso, Israeli Shekel, the Russian ruble and many more.

Read the disclaimer, as Tom Lydon is a board member of Rydex Funds.

For more stories on currencies, visit our currency ETF category. For more special reports, view our special report page.

The Federal Reserve said it would expand its balance sheet to include another $750 billion of agency mortgage-backed securities, $100 billion in agency secrities and $300 billion in longer-term Treasury securities over the next six months.

After the announcement, foreign currencies rallied and ultimately brought the rally seen in the U.S. dollar to a grinding halt, leading to its biggest daily drop in more than two decades. Yesterday, the dollar fell 3.8% against the euro and 3.6% against the pound.

The long-term value of the dollar is now being questioned by some officials at Asia’s top think tanks, reports Reuters. Will the dollar remain a key global currency when all is said and done? Asia hopes that any decline in the dollar will be gradual to avoid more shocks to financial systems. For the time being, many market participants believe that the latest stimulus could lead to a prolonged decline in the dollar’s value.

If this is true, we could be looking at upswings in foreign currency ETFs in the near future. Watch the trend lines to see if this bears out, though. Note that these funds have already popped above their 50-day moving averages, and in some cases, the 200-day.

• WisdomTree Chinese Yuan (CYB): up 0.4% in the last week

• WisdomTree Dreyfus Brazilian Real (BZF): up 3.2% in the last week

• CurrencyShares Swedish Krona (FXS): up 9.1% in the last week

• CurrencyShares Swiss Franc (FXF): up 1.2% in the last week

It was during 2008 when the global financial crisis intensified and the dollar’s six-year decline against the euro and other top-performing currencies reversed their trends, reports Patrick Lane for Economist.

But there are currencies out there that are faring quite well against the dollar. The yen is one, but that is overlooking the fact that Japan’s economy is a bit shaky. The slowdown of exports probably won’t reverse the the upward trend of the Chinese yuan. The central banks in Frankfurt, Germany, and London have a little bit more room for increased rate cuts and are likely to take advantage of it.

In previous years, large volumes of cash from the United States and Japan and found their way into the E.U. and emerging-market currencies, but the money will eventually return. Current slowing economies has shown that investors are snuggling safely in U.S. Treasury notes.

Some currencies could be facing some risk, though. They include the Indian rupee, South Korean won, Brazilian real, and “most” east European currencies. Most vulnerable currencies belong to countries whose banks, companies, and households owe short-term debt denominated in foreign currency, the most conscious being the Icelandic krona.

• PowerShares DB USD Index Bullish (UUP): up 4.9% in 2008