Currency Futures (CF)

8/8/2019 Currency Futures (CF)

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Currency FuturesFor the first time from 29/08/08, individuals wereallowed to punt in foreign currency, just as they bet on stock and commodity futures, without having anyunderlying forex exposure. In true spirit, this isCapital account convertibilityOver 5,000 contracts were traded in the openingminute.

First trade took place at Rs.44.15 to a $.Till then, only Banks could do the similar trade but with a limit and with actual underlying like exportsand imports.



D efinition of CF A CF is a derivative contract to

exchange one currency foranother at a specified futuredate.

The price would be theexchange rate prevailing on thelast trading date.



Chicago Mercantile Trade (CME)

CME started its life as butter and eggs exchange. After some mergers and demergers (such as ChicagoBoard of Trade and New York Mercantile Exchange),it evolved into a largest US financial derivativesexchange.CFs were first introduced in 1972 at the CMEbetween $ and seven other currencies, after theinternational gold standard was abolished andcurrency values were allowed to float .

As per CME s 2007 report, world over, exchangetraded derivatives are slowly eating into thetraditional foreign exchange trading platforms,especially, the spot and the OTC markets.



Linkage between Commodity & Currency Futures

Actually the Commodity price risks and theCurrency value risks are not quite

independent of each other but are closelyinter-related.Currency fluctuations cause price movementsin the international commodity markets (e.g.

latest crude price going upto $ 147); surgesand slides in commodity prices, in turn, upset trade balances and bring about theconsequential changes in currency values.




It was proved time and again that international players in commodities can

improve their competitive efficiency byhedging foreign exchange exposures nosooner than they hedge their commodityprice risks.

It is but natural that a commodity hedgertaking a position in a commodity exchangewould prefer to look out for anotherinstrument, CF, on the same exchangeplatform, with the operations and regulationsof which he is very familiar/comfortable.




Commodity Traders are also exposed tovagaries of freight costs on their shipment,especially when export-import commitmentsare based on CIF or C&F prices that arequoted in foreign currencies.The CF mechanism will, definitely, be aninstrument to combat the freight cost volatility caused due to exchange ratefluctuations.



D ubai Gold & Commodity ExchangeRupee futures was launched in D ubai Gold and CommodityExchange ( D GCX) from June 2007.This replaced the overseas Non- D eliverable Forward Market (ND F). The N D F market has been in existence since 1993-94.

Volumes started raising in this market from 2003-04.D GCX is having decent turnover of INR futures & settles therupee contract every eight weeks.The Exchange also allows future trading in Euro/$, $/Yen andSterling/$.The size of future contract is Rs.20 lakhs with monthly contractsfor the first three months and quarterly contracts from thefourth to 12 th month.

Settlement is done on the third Wednesday of the expiry month.Settlement will be in $ as per the RBI s reference rate.Companies having offshore entities or subsidiaries can hedgeeither locally or through D GCX and could also avail of arbitrageopportunity whenever possible.



Currency Futures (CF)

guidelines for BanksRBI unveiled the norms for the Banks for trading in CFon 01/08/2008. Some of the norms are:

- Banks need to have a networth of Rs.500 crores to tradein CF.

- CAR level of 10%- Net NPA level of 3% of total loans.- Should not have incurred losses over the past 3 years.

Banks have to obtain the approval of their Boardsbefore for trading in CF.Those Banks which do not fulfill the requirements canparticipate only as a client and that too after securingthe RBI approval.



Currency FuturesRBI has allowed only the resident Indians or locals toparticipate in CF and effectively kept out the foreigninvestors such as portfolio investors, hedge fundsbesides NRIs to start with.Initially trading contracts denominated in US D /INRonly will be allowed.The size of the contract has been set at $ 1000 and

the tenure at 12 months.The margin payable is 1.75% of the contract valueThe contracts would be quoted and settled only inINR.Participants in the CF cannot keep an open positionlarger than $ 5 million.



Currency Futures As per Sebi guidelines, any exchangedesirous of launching CF has to have at least

50 broker membersSebi has presently permitted BSE, NSE andMCX exchanges for trading in the CF.Moving ahead, Sebi may permit some more

exchanges to trade in CF.The CF started its trading in all the above 3exchanges from 29/08/2008.



Currency FuturesThe Competition amongst several stock andcommodity exchanges trading in currency

derivatives simultaneously will not only helpimprove their operating efficiency, but alsofacilitate arbitrage, usher in liquidity, reduceexchange rate volatility and reduce, as aconsequence, the total transaction cost,benefiting in the process the market players,while servicing their varied needs, includingthose of price discover, risk management,market intelligence and informationdissemination fairly proficiently.



Currency FuturesCF can be bought and sold through trading membersof the currency exchange.So far (upto September 2008), 300 trading membersand 11 banks have signed up with NSE.Individuals have to open account with tradingmembers.Individuals have to sign agreements with tradingmember including risk disclosure document.

After this trading member will allot a unique client I D code.Before starting the trade, the individual has todeposit margin in the form of cash or Govt. securitieswith the trading member.If Govt. security is accepted as margin, the value issubject to haircut adjustment



Beneficiaries of Currency FuturesThe beneficiaries in CF are many includingthe following:

Importers whose future obligation is in foreigncurrency. A tourist willing to go on excursionStudents or Professionals pursuing higher studiesabroad.Exporters, who are keeping their assets in foreigncurrency.Money changers and D ealers who buy or sellforeign currency.



Beneficiaries of Currency Futures A speculator, much like the equity futurestrader, can bet on the direction of the

currency by going long and short. A hedger, on the other hand, can use longand short The beneficiaries in CF are manyincluding the following:

Importers whose future obligation is in foreigncurrency. A tourist willing to go on excursionStudents or Professionals pursuing higher studiesabroad.Exporters, who are keeping their assets in foreign



H ow to trade in CF?The market lot in CF is kept at $ 1000.

If the spot rate is Rs.42.96 per $, atrader need to commit a minimum lot of Rs.42,960/- for a contract, which ismuch less than one Mini Nifty FuturesContract.



Currency FuturesPresent Spot rate (01/10/2008) of $/INR is say Rs.48.00/48.10.

An importer wants to make a dollar payment for a shipment onemonth later.

Fearing that the rupee could fall against the $ to Rs.50, he buysdollar for ,say, Rs.49 on the exchange.One month later (01/11/2008), if the rupee falls to say Rs.50,he still buys $ by paying Rs.49 since the price was locked in at Rs.49.So, he makes a profit of Rs.1 (with exchange) by squaring off his position and selling $ for Rs.50 (RBI reference rate).H owever, he still has to pay Rs.50 to buy one $ for his actualimport payment with his bankers.The net impact is neither gain nor loss. But by taking the coverwith the exchange, his import is covered at Rs.49 per $.

Similarly, the exporter will do just the opposite.



Currency FutureOn 29 th July 2008, one individual is expecting aninward remittance of $ 1,000 on say August 29,2008.H e wants to lock in the future rate on 29/07/08 itself.The future quote for 29/08/08 is say Rs.44.25 per.Let us say the spot rate on 29/07/08 is Rs.43.00The value of the future contract is Rs.44.25 x 1000 =Rs.44,250.On 27/08/08 (2 days prior to expiry date), RBI fixesits reference rate at Rs.44.00 per $.

On 27/08/08 sell to the Bank wherefrom Inwardremittance has come at Rs.44 per $.The individual stands to gain Rs. 250 (44,250 44,000).



Gold Futures & Currency

FuturesThe bullion/gold traders desperately need aUSD /INR hedge which CF will provide.

A Gold trader who is long on Gold Futuresshould ideally gain when gold prices go up inthe international markets.H owever, the gain may be wiped out byadverse movement in $/INR parity (rupeedepreciation when the actual imports takesplace)These commodity traders can take currencyfutures as a hedge for $/INR positions.



Advantage of CF over Forward Contracts An outright forward contracts which exports andimporters enter require a credit line from theBankers.

At times, for small exporters, the Bankers may bereluctant to extend the credit line.

Again for small exporters, the rate would be lessattractive than what would be offered to a big

corporate with millions of dollars to cover.Futures trading is much safer and standardized thanforwardsThe biggest advantage is that the hedgers need not produce any basic exposures for taking a position in

CF.



Currency Futures some issuesSince the participants cannot keep open position beyond $ 5million, the big corporates will continue to depend on theconventional forward contract route.

Only the small corporates and the punters will be attracted byCF.The trading for CF is fixed from 9 am to 5 pm and almost followthe forward contract timings given by the Banks. H ence, the CFfor the present will follow the Forward Contract market ratherthan stand on its own.

The participants cannot hedge their position if there is hugemovements in global currencies after close of the trading time.Entry of NRIs and FIIs are forbidden. In the N D F markets inSingapore and D ubai, these two constituents are the leadclients.There are not enough CTC L (computer to computer linked)terminals with CF software installed on CTC L.

Currency Futures (CF)

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