CurencyDerivatvs Final

8/8/2019 CurencyDerivatvs Final

1/13

Currency Derivatives


A derivative is a financial instrument that is derived from some other

asset , index , event, value or condition (known as the underlying

asset).This underlying asset can vary from being a commodity (wheat,

potato, etc), metal (gold, silver), debt securities, interest rates, shares,

index (Nifty), or currency.

Exchange rate

It is way of expressing one countrys currency in terms of other countrys

currency. Factors affecting exchange rates are as follows:

Balance of Payment: If there is BOP deficit, then your own country

would require foreign currency & thus depreciating the value of your

own currency.

Interest rates: If the interest rates in your currency are high, that will

attract foreign currency & will help in appreciating your own currency.

Speculation: If the exchange rate falls, then the speculators may

speculate that the exchange rate will fall further & may sell the

currency, bringing down the exchange rate further.

3 kinds of currency derivatives discussed:

Currency forwards, where buying & selling of currencies takes place

at a future date & the rates of exchange are agreed on the very day of

the deal.

The forward rates of the forward contracts are determined on the

basis of forward margins & the spot rates (refer example in ppt)

(Arbitrageurs are people who take advantage of the market

imperfection. An opportunity arises when 1 banks Ask rate is lower

than another banks Bid rate) (refer example in ppt)

Currency futures are contracts to exchange 1 currency with anotherat specified rate & date in future.

1
http://en.wikipedia.org/wiki/Financial_instrumenthttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Index_(economics)http://en.wikipedia.org/wiki/Underlyinghttp://en.wikipedia.org/wiki/Financial_instrumenthttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Index_(economics)http://en.wikipedia.org/wiki/Underlying


2/13


Features: Standardized & exchange traded, Contract size (USD 100),

Initial margin (amt of money to be deposited for taking a position),

Maintenance margin (minimum amt of money to be kept in the

account)

Long position in futures: Buy the base currency (USD) & sell the terms

currency as you are expecting the base currency to rise in value

(example explained in ppt)

Short position in futures: Buy terms currency & sell base currency

(Hedging means to take an opposite position in futures market to the

position in physical market) (Example explained in ppt)

Currency options are nothing but options where by the holder of the

option has the right to exchange a fixed amount of one currency for

another at a pre-fixed rate on or upto a specified rate in future.

(example explained in ppt)

Call option: Right to buy but not an obligation to buy

Put option: Right to sell but not an obligation to sell

Global Currency Derivatives

Many of the most popular futures markets that are based upon currencies include the

following :

EUR - The Euro to US Dollar currency future

GBP - The British Pound to US Dollar currency future

CHF - The Swiss Franc to US Dollar currency future

AUD - The Australian Dollar to US Dollar currency future

CAD - The Canadian Dollar to US Dollar currency future

RP - The Euro to British Pound currency future

RF - The Euro to Swiss Franc currency future

2


3/13


Other currencies in futures are South African Rand, Hungarian Forint, Polish, Zloty, Czech

Koruna, Brazilian Real, and Swedish Krona

Currency distribution

USD rules the roast and still enjoy 32% share of the global currency derivative market which shows it

still remains the most actively traded currency in the market. Pound Sterling comes second, the edvent

of euro has brought a new dimension in the currency derivative market which is not far behind USD

and Sterling with 23% of market share, fourth comes 17 % of market share and others constitute 4%

of the market share.

Market Participants In Currency Derivative Market

The relative weight of the core

currencies (EUR, USD, JPY and GBP)

declined in April 2007.

USD has declined slightly in JPY and

the CAD remains unchanged.

EUR as a base currency rose further

between 2004 and 2007.

The GBP declined, confirming the

global trend.

3


4/13


Currency Futures in India

Product Specifications: Underlying : Initially, currency futures contracts on US Dollar Indian

Rupee (US$-INR) would be permitted. Trading Hours: The trading on currency futures would be available

from 9 a.m. to 5 p.m. Size of the contract: The minimum contract size of the currency

futures contract at the time of introduction would be US$ 1000. The

contract size would be periodically aligned to ensure that the size of

the contract remains close to the minimum size.

Quotation : The currency futures contract would be quoted in rupeeterms. However, the outstanding positions would be in dollar terms.

Tenor of the contract : The currency futures contract shall have a

maximum maturity of 12 months. Available contracts : All monthly maturities from 1 to 12 months would

be made available. Settlement mechanism : The currency futures contract shall be settled

in cash in Indian Rupee. Settlement price : The settlement price would be the Reserve Bank

Reference Rate on the date of expiry. The methodology of

computation and dissemination of the Reference Rate may be publicly

disclosed by RBI. Final settlement day : The currency futures contract would expire on

the last working day (excluding Saturdays) of the month. The last

working day would be taken to be the same as that for InterbankSettlements in Mumbai. The rules for Interbank Settlements, including

those for known holidays and subsequently declared holiday would

be those as laid down by FEDAI.

Currency futures trading started in India on August 29, 2008 on National

Stock Exchange. This was the first time currency derivatives got listed on

an exchange in India. Till this time, the currency futures trading took place

over the counter and were unorganized. With the entry of the National

4


5/13


Stock Exchange in the picture, currency trading became more organized

with the NSE acting as a counter party to all the transactions. Soon after

the BSE and MCX also marked their entry into the currency derivatives

market.

Volumes on currency futures exchanges (mainly NSE and MCX) have

consistently increased over the last few months since the start of trading.

Combined daily volumes on the most active currency futures bourses

MCX Stock Exchange (MCX-SX) and the National Stock Exchange (NSE)

have increased from $ 60 million per day (on NSE in early Sept 2008) to

around $ 700 million per day (on NSE and MCX together in end Jan 2009)

over 99 trading days. The traded volumes in currency futures has

increased substantially in the last month, with the average total volumes

traded on the two exchanges being around Rs 2,500 crore (around $0.5

billion) a day. This could soon rise to $1billion per day if more currency

pairs are allowed, trades than NSE.

Advantages of Currency Futures Market: Decent intra day volatility : There is an opportunity for the intraday

traders to make short term profits as the median intraday volatility for

the last 6 months on NSE has been about 43 paise. On the MCX, the

median trading range has been wider at about 52 paise. Traders can

capitalize on the same and make intraday profits. Lower Margins : The margins on the trades on NSE have been reduced.

At the start of the currency futures trading on NSE, the margins per

contract were about Rs.2900, which have been reduced by about 50%.

This works out to 3-3.5% of contract value compared to average10-

15% on index/stock futures. Low Brokerage charges : The brokerage charges vary between 3 to 10

bps depending on volumes and squaring up period. Easy to trade : Since the contract is exchange traded, it is easy to trade

and also it smoothens the transaction process.

5


6/13


Transparency : The futures market is transparent as compared to the

OTC market, as the exchange guarantees the settlement process.

6


7/13


Regulations

CDX (Currency Derivative Exchange), currency derivative segment of BSE

(Bombay Stock Exchange) commenced currency futures trading from 1st

October. BSE on its very first day of trading in currency futures clocked a

turnover of about 65,000 contracts, which is approximately Rs. 300

Crores.

With ever-growing global financial crisis, exchange rates are fluctuating

widely. INR exchange rate has touched 47 against USD. Currency futures

trading in India has generated huge interest among Indian retail investorsand traders. There is a strong demand for information gathering about the

intricacies of currency futures from small investors and enterprises.

Who carries out the process of clearing and settlement?

NSCCL (National Securities Clearing Corporation Limited ), a wholly

owned subsidiary of NSE acts as the body responsible for carrying out the

entire clearing and settlement process. NSCCL, established in August1995, is the first clearing corporation in India.

What are the primary functions of NSCCL?

To operate tight risk containment system To carry out the Novation (It is a process of replacement of one

obligation by another by mutual agreement of both the parties) To act as the counter party to all the trades To guarantee the final settlement

What is the model of clearing and settlement process?

Clearing members and clearing banks are the entities that help

NSCCL in carrying out the activities of clearing and settlement.

There are two types of clearing members.

7


8/13


Trading cum clearing members (TCM) TCM clear and settle, their

own trades as well as the trades of other trading members (TM) Professional clearing members (PCM) PCM clear the trades

executed by trading members TCM and PCM have to pay deposit to undertake clearing and

settlement of trades of every TM. TCM and PCM have to open a separate bank account with NSCCL

designated bank for settlement of trades. The entire process of clearing and mechanism comprises of three

components clearing, settlement and risk management

How the clearing mechanism takes place?

NSCCL works out open positions and obligations of clearing

members (TCM and PCM) at the end of every business day. Daily exposure limits and margin obligations are derived based on

net open positions. Net open contracts (Buy Sell) multiplied by

1000 gives the net open positions in USD terms.

How the settlement mechanism takes place?

Settlement is done in cash mode payable in INR. Daily MTM (Marking to Market) settlement takes place based on DSP

(Daily settlement price) which is calculated by taking the weighted

average of last half an hours trades. NSE daily disseminates DSP on its website. Daily MTM or profit and loss are calculated by taking the difference

of trade price and DSP. If a client has carried forward the position

from previous day then MTM is calculated as the difference between

previous days DSP and current days DSP. Clearing members with net loss in daily MTM have to pay the

amount in cash. Clearing members with net profit will receive the

amount in cash. Payment and receipts are to be settled on the basis

of T+1 day.

8


9/13


Clearing members are responsible for collection/payment of daily

MTM from/to the trading members, who in turn are responsible for

the clients liabilities. At the end of the day all the net positions are carried forward to

next day after resetting with respect to the current days DSP. Final settlement is also done in cash mode in terms of INR. Final settlement price is the RBI reference rate on the last trading

day of the expiry contract. Final profit and loss or MTM of all the net open positions of the

clearing members will be on the basis of final settlement price.

Settlement takes place on the basis of T+2 days.

Salient features of risk management system of NSCCL:

Financial soundness of the members is ensured by imposing

stringent conditions about capital adequacy. NSCCL enforces the

requirement about sufficient net-worth and cash and collateral

security deposit.

NSCCL follows real-time and scientific margining system. Net open positions of the members are daily settled in cash based

on MTM. Members open positions are monitored online and alerts are issued

on real time basis in respect of violation of margin and open

positions. Whenever any trading member exceeds intra-day limits or

violates the margins and open positions then further trading of that

member is stopped for the rest of the day and until the compliancesare fulfilled.

NSCCL maintains separate settlement guarantee fund, which is

created out of the capital of the members.

Margining System : Trading in currency future and for that matter any

derivatives involves highly leveraged trading. Any leveraged trading is

capable of generating enormous losses even with minor movement in the

price of underlying. Smooth functioning of the market demands perfect

9


10/13


margining system. Most critical component of a healthy margining system

requires online monitoring. Margining system of NSCCL monitors online

positions on intra-day basis by using PRISM (Parallel Risk Management

System). In PRISM, risk of each member is monitored online on real time

basis. As and when any member approaches certain limits, alerts are

generated and sent online to the members. In case a member exceeds the

set limits then further trading of the member is stopped automatically.

NSCCL calculates initial margin on portfolio based margining system by

using SPAN (Standard Portfolio Analysis of Risk)

NSCCL SPAN : Main objective of SPAN is to identify the overall risk in the

entire portfolio of each member. Main emphasis is on calculating the

maximum loss that a portfolio might be expected to suffer from the

current day to the next day on the base of 99% VaR (Value at Risk)

methodology. SPAN system constructs the probable scenarios in the

changes in the price of the underlying presuming various levels of

volatility.

Types of Margins

Initial Margin NSCCL computes initial margin up to client level on

the base of SPAN methodology. Client has to pay the initial margin

upfront. Extreme Loss Margin 1% of value of gross open positions of any

member is adjusted online and on real-time basis from the liquid

assets of the member towards extreme loss margin. Client Margins NSCCL daily communicates to the members about

the margin liability of each and every client. Members are

responsible for pay-in and pay-out of the margins to clients.

Members are also required to submit compliance report to NSCCL

Currency Trading INR-EURO

Need for Rs- CURRENCY TRADING, Indias integration with theglobal economy

10


11/13


In particular since the early 1990s, India has embarked on a process of

economic reform and progressive integration with the global economy

that aims to put it on a path of rapid and sustained growth. Per capita

incomes more than doubled during the period 1990-2005. In parallel, EU-

India trade has grown impressively and doubled from 28.6billion in 2003

to over 55billion in 2007. EU investment to India has more than tripled

since 2003 from 759million to 2.4billion in 2006 and trade in

commercial services has more than doubled from 5.2billion in 2002 to

12.2billion in 2006. However, India's trade regime and regulatory

environment still remain comparatively restrictive and in 2008 the World

Bank ranked India 120 (out of 178 economies) in terms of the 'ease of

doing business'. In addition to tariff barriers to imports, India also imposes

a number of non-tariff barriers in the form of quantitative restrictions,

import licensing, mandatory testing and certification for a large number of

products, as well as complicated and lengthy customs procedures.

Currency composition: Over the past three years, the share of turnover

accounted for by currency pairs among the US dollar, euro and yen has

declined. Most of this fall can be explained by the decline in the share of

the US dollar/yen pair. The offsetting increase was mainly for transactions

involving currencies with relatively low turnover i.e. Increase in the share

of emerging market foreign exchange in total turnover

Volatility in currency: Annualized volatility in the Euro versus the rupee

increased to 20% during FY08-09 (first half) compared with 9% a year ago

increasing the need for hedging on a transparent platform.

Increase in use of euro as invoice currency: A different pattern

emerges in the international trade usage of the euro. The euros role has

grown over time but mainly from its inception through 2004. Initially, the

growth in the role of the euro came about through its replacement of euro

area legacy currencies in invoicing international trade transactions. Later,

the role of the euro expanded within countries that

11


12/13


were at that point on the periphery of the euro area. Now, euro use is

broadly observed as a European phenomenon, with widespread use of

euros concentrated in, but not extending broadly beyond, transactions

between countries with geographical proximity to the euro area.

Spot rate INR Vs EURO

India EU FTA

The

European

Union is of

great

importance to

us as Indias

largest trading partner

accounting for about quarter of

our external trade. It is the

largest overseas investor in

India. Much of its investment is

in high technology areas.

A B Vajpayee at India-EU Business

Summit at Copenhegen on October

9, 2002

The corner

stone of the

EU-India

relationship

lies in trade

and

investment. The EU is India's

largest trading and investment

partner. Our bilateral trade

constitutes a quarter of India's

total trade. The EU is also India's

biggest partner in development

cooperation and the second

largest source of foreign direct

investment."

Pascal Lamy at Luncheon meeting at CII

on March 14, 2003 The conglomerate of 15 European nations with more to join the bloc next

year, the European Union has emerged as India's single largest tradingpartner accounting for more than one-fifth share in both exports and

12
http://www.indiaonestop.com/tradepartners/eu/euoverview.htm#membercountrieshttp://www.indiaonestop.com/tradepartners/eu/euoverview.htm#membercountries


13/13

CurencyDerivatvs Final

Documents

Transcript of CurencyDerivatvs Final