Trading in Currency Futures

Why to Trade in Currency Futures

•A separate Asset Class

•Correlation with different Asset Classes

•Commodities•International/COMEX Gold Price

•USD/INR depreciation leads to rise in MCX gold prices

•International Crude Price

•Equities

Why to Trade in Currency Futures:

Market Potential of USD 34 Billion a day(Average Daily Volume in the OTC Market)

Conservatively:USD 30 Billion= 30 X 100 X 40 = INR 1, 20, 000 Crs

Lets Assume 1 USD = INR 40.00

50% of the above will be Rs 50 – 60, 000 Crs a day

Foreign Exchange Markets in India

Regulated by Reserve Bank of India

Participants include; banks, corporate entities, FIIs, NRIs and individuals

All participants trade within limits or parameters prescribed by the

Reserve Bank of India

Tenor

Amount

Direction

Past Performance

The average daily volume stands at USD 34 billion

All foreign currency spot and forward transactions need to be routed

through Scheduled Commercial Banks, which have been granted

Authorized Dealer licenses by the RBI

Currency Futures - FrameworkMarket timings 09:00 to

17:00

Order driven market

Last trading day: two

business days prior to last

business day of the month

(spot convention)

Expiring contract will trade

till 12:00 noon on the last

trading day

Category Description

Underlying Rate of exchange between 1 USD and INR (USDINR)

Contract Size USD 1000

Contract Months

12 near calendar months

Final Settlement Date

Last business day of the month

Min Price fluctuation

0.25 paise or INR 0.0025(46.9000 – 46.9025)

Settlement Cash settled in INR on relevant RBI reference rate

Currency Futures - FrameworkAll resident Indian entities and individuals permitted to trade

No underlying required to be provided, this enables hedging of derived exposures

Position limits will determine amount that can be traded

Trading member – USD 25 million or 15% of Open Interest whichever is higher

Client position limits – USD 5 million or 6% of Open Interest whichever is higher

Margins to be posted with the trading / clearing member pre - trade

Daily mark to market on the following day

OTC vs Currency futuresOTC Market Exchange Traded

Futures

Accessibility Credit dependent High

Price Transparency

Low High

Liquidity Subject to credit limits

High

Agreements Customized Standard

Credit Exposure

Yes Mitigated through the clearing corporation

Margins (collateral)

Usually not required Required

Daily MTM No Yes

OTC vs Currency futures

OTC Market Exchange Traded Futures

Execution Bank Trading Member

Underlying exposure

Required Not required

Settlement Physical Delivery Net Settled in INR

Position limits

Dependent on Underlying

Higher of USD 5 mio or 6% of Open Interest

As a client on NSE CDS…

Underlying not required to trade on the exchange

Immediate trade reversal can be done

Margins released when trade is unwound or expires

MTM settlement happens the next day and you need not wait for

original contract maturity date for cash flow

Trading screen accessible to client - price transparency

CDS - ParticipationMore than 500 Members are Participating

12 Banks are trading members and more are in the pipeline

Daily gross traded volume: around Rs. 2000 crs.

– Proprietary : 40%– Corporate : 10%– Banks : 10%– Retail : 40%

Near month most active

Thin Bid-ask spreads

Understanding the Rate Fluctuation• INR/USD goes from Rs.40 to Rs.45• Thus more INR will be required to buy the same amount of

USD• This is appreciation of USD• But depreciation of INR• Holders of buy position in USD will benefit

• If INR/USD goes from Rs.40 to Rs.35• This is depreciation of USD• But appreciation of INR• Holders of Sell position in USD will benefit

What factors affect Exchange Rate& hence trading decisions ?

Macro economic views

Monetary Policy

RBI intervention

Flow information

Performance of other Asian

currencies

Performance of equity markets

USD sentiment

Performance of key commodities

affecting trade

Policy announcements affecting

flows – trade or capital

REER – Real Effective Exchange

Rate

Data announcements

Indian Foreign Exchange Markets:

INR trades in a managed floating exchange rate regime

INR is fully convertible on India’s current account, but not on the capital

account

Foreign institutional investors can fully repatriate their investments

Resident Indian individuals have been permitted to invest offshore

All foreign currency spot and forward transactions need to be routed

through schedule commercial banks (Authorized Dealers)

Access is restricted to banks and entities having a commercial exposure

Volumes and tenor is restricted to underlying exposure

Only banks have open position limits

A new and better alternative for trading:

USD-INR cash-settled futures market at NSE• Access to all Indians• Currently restrictions on NRI / FII• No requirement for underlying position• Small contract size• Low margins• Settlements guaranteed & no counter party risks• Online real-time screen based trading• Convergence of national / international investors• Transparent order book

What drives trading of currencies & who are the participants

Directional ViewsPositioning for INR appreciation or depreciation

Hedging existing exposureImporters & Exporters hedging future payables or receivablesBorrowers hedging FCY loans – interest or principle paymentsNRIs looking to hedge their investment in IndiaResident Indians looking to hedge investments offshoreFIIs hedging their investments in India

Trade and Capital FlowsRemittances for trade or services and capital transactions

ArbitrageEntities who can access onshore and non deliverable forward markets

Taking a View on the Spot

Market

Volatility of USD/INR exchange rate

USD/INR 28th Jan 09 Contract : 49.20

Current Spot Rate (29th Dec ‘08) : 49.10 View : INR to depreciate

Position in Futures : Buy USD/INR future Contract at 49.20

Position at maturity (28th Jan 09) : 49.60

Profit / Loss : Profit Rs. 400 on 01 Contract

A currency future contract is similar to a futures contract on any Scrip or Index

Taking a View on Spot INR

Investment in Margin : Approx. 5% of the Contract size

Factors Affecting Trading decisions

Hedge Currency Risk

Using Futures to Hedge Currency Risk An exporter wants to protect himself from the likely appreciation in Rupee. He has dispatched the consignments on 5th September and he is expecting the payment of $25,000 by December end. Current spot rate of USD-INR is 44.80.

•On 5th September sell 25 numbers of USD-INR future contracts (each of $1000) of December month at the prevailing rate of 44.95

•On 28th December cover sell position by purchasing 25 contracts of December month at the then prevailing rate of say 44.45.

•Simultaneously sell $25,000 (receipt from overseas party) in the spot market at the rate of 44.45

•Profit from future contracts = 25,000 x (44.95 – 44.45) = Rs. 12,500

•In spot Market: Loss due to currency appreciation from 44.80 in September to 44.45 in December = 25,000 x (44.8 – 44.45) = Rs.8, 750

Payoff of Hedge vis-à-vis the transaction

•His Notional Net Profit as a result of Hedging transactions would be: Rs. 12,500 - Rs.8, 750 = Rs.3, 750

o   NOTE: Had he not taken position in the currency futures, he would have made a loss of Rs.8, 750. On the contrary, he has not only covered his loss but also earned little profit from the futures transaction.

Remove Forex Risk while trading in the Commodity Market

• COMEX gold prices have direct relationship with MCX gold prices

• MCX prices decreases along with decrease in COMEX

prices

• But USD/INR depreciation leads to rise in MCX gold

prices

• This fluctuation affects the profit margins of

corporate/clients

• By hedging USD/INR through futures, offsets the deviation caused in COMEX and MCX prices

Remove Forex Risk while trading Commodities

Scenario I - USD/INR = 44.30 Scenario II - USD/INR = 44.60 (Constant) (Depreciates from 44.30)

Sell COMEX Gold @ $830 Sell COMEX Gold @ $830

Buy COMEX Gold @ $820 Buy COMEX Gold @ $820

Profit = $10 Profit = $10

Sell MCX Gold @ 11,860 Sell MCX Gold @ 11,860

Buy MCX Gold @ 11,760 Buy MCX Gold @ 11,810

Profit = Rs.100/- Profit = Rs.50/-

Pay off from the Hedge

Arbitrage (Futures Market & OTC Market)

• Sell in futures @ 44.4625 levels (1 month) • Buy in forward @ 44.3250 + 3 paisa premium = 44.3550 (1 month)

• Net Gain = 44.4625-44.3550 = 0.1075

• i .e. Approx 11 Paisa arbitrage

• Arbitrage will be realized at the expiry of the contract.

Arbitrage Opportunity

Currency Futures Trading at Sharekhan

CDS WEB site

Currency Futures Trading at Sharekhan:

• Market Timing : 9.00 A.M. to 5.00 P.M.• Contract Size : 1000 USD per lot• Maturity Period : 12 monthly contracts with expire

on the last working day (excluding Saturdays) of the month

• Quote : INR per USD • Margin : Initial Margin + SPAN

(Maintenance Margin), Total would be approx. 5% - 6%

• Tick : 0.0025 INR• Profit/Loss (per Contract) : 01 tick = Rs 2.50

01 Paise = Rs. 10.00

Brokerage % 0.01% 0.02% 0.03% 0.04% 0.05%Absolute Brokerage 0.00475 0.0095 0.01425 0.019 0.02375

Service Tax On Brok. 12.00% 0.00057 0.00114 0.00171 0.00228 0.00285

w.e.f. 16.05.08Edu. CESS on Service Tax 2.00% 0.0000114 0.0000228 0.0000342 0.0000456 0.000057

Higher Edu.CESS on Service Tax 1.00% 0.0000057 0.0000114 0.0000171 0.0000228 0.0000285

Transaction Charge on T.O. SEBI Turnover fees on Value 0.0002% 0.000095 0.000095 0.000095 0.000095 0.000095

Stamp Duty on T.O. 0.002% 0.00095 0.00095 0.00095 0.00095 0.00095

Total 0.0063821 0.0117192 0.0170563 0.0223934 0.0277305

Tick (0.25 paise or INR 0.0025) 3 5 7 9 11

If Price is 47.50

Important Websites :

•Nseindia.com•Sharekhan.com•Reuters.in (in.reuters.com)•Rbi.org.in•Fedai.org.in

Last Trade Date

RBI Reference Rate

Last Traded Price

Diff.

25-SEP-2008 46.2500 46.2500 0.0000

27-OCT-2008 50.0900 50.1050 0.0150

26-NOV-2008 49.8500 49.8550 0.0050