Introduction of Currency Derivatives

8/4/2019 Introduction of Currency Derivatives

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INTRODUCTION OF CURRENCY DERIVATIVES

Each country has its own currency through which both national and international

transactions are performed. All the international business transactions involve an

exchange of one currency for another.

For example,

If any Indian firm borrows funds from international financial market in US dollars for

short or long term then at maturity the same would be refunded in particular agreed

currency along with accrued interest on borrowed money. It means that the borrowed

foreign currency brought in the country will be converted into Indian currency, andwhen borrowed fund are paid to the lender then the home currency will be converted

into foreign lenders currency. Thus, the currency units of a country involve an

exchange of one currency for another. The price of one currency in terms of other

currency is known as exchange rate.

The foreign exchange markets of a country provide the mechanism of exchanging

different currencies with one and another, and thus, facilitating transfer of purchasing

power from one country to another.

With the multiple growths of international trade and finance all over the world, trading

in foreign currencies has grown tremendously over the past several decades. Since

the exchange rates are continuously changing, so the firms are exposed to the risk of

exchange rate movements. As a result the assets or liability or cash flows of a firm

which are denominated in foreign currencies undergo a change in value over a period

of time due to variation in exchange rates.

This variability in the value of assets or liabilities or cash flows is referred to exchange

rate risk. Since the fixed exchange rate system has been fallen in the early 1970s,

specifically in developed countries, the currency risk has become substantial for

many business firms. As a result, these firms are increasingly turning to various risk

hedging products like foreign currency futures, foreign currency forwards, foreign

currency options, and foreign currency swaps.


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HISTORY OF CURRENCY DERIVATIVES

Currency futures were first created at the Chicago Mercantile Exchange (CME) in

1972.The contracts were created under the guidance and leadership of Leo Melamed,

CME Chairman Emeritus. The FX contract capitalized on the U.S. abandonment of the

Bretton Woods agreement, which had fixed world exchange rates to a gold standard

after World War II. The abandonment of the Bretton Woods agreement resulted in

currency values being allowed to float, increasing the risk of doing business. By creating

another type of market in which futures could be traded, CME currency futures

extended the reach of risk management beyond commodities, which were the mainderivative contracts traded at CME until then. The concept of currency futures at CME

was revolutionary, and gained credibility through endorsement of Nobel-prize-winning

economist Milton Friedman.

Today, CME offers 41 individual FX futures and 31 options contracts on 19 currencies,

all of which trade electronically on the exchanges CME Globex platform. It is the largest

regulated marketplace for FX trading. Traders of CME FX futures are a diverse group

that includes multinational corporations, hedge funds, commercial banks, investment

banks, financial managers, commodity trading advisors (CTAs), proprietary trading

firms; currency overlay managers and individual investors. They trade in order to

transact business, hedge against unfavorable changes in currency rates, or to speculate

on rate fluctuations.

Source: - (NCFM-Currency future Module)


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CURRENCY DERIVATIVE PRODUCTS

Derivative contracts have several variants. The most common variants are

forwards, futures, options and swaps. We take a brief look at various derivatives

contracts that have come to be used.

FORWARD :

The basic objective of a forward market in any underlying asset is to fix a price

for a contract to be carried through on the future agreed date and is intended to

free both the purchaser and the seller from any risk of loss which might incur dueto fluctuations in the price of underlying asset.

A forward contract is customized contract between two entities, where settlement

takes place on a specific date in the future at todays pre -agreed price. The

exchange rate is fixed at the time the contract is entered into. This is known as

forward exchange rate or simply forward rate.

FUTURE :

A currency futures contract provides a simultaneous right and obligation to buy

and sell a particular currency at a specified future date, a specified price and a

standard quantity. In another word, a future contract is an agreement between

two parties to buy or sell an asset at a certain time in the future at a certain price.

Future contracts are special types of forward contracts in the sense that they are

standardized exchange-traded contracts.


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SWAP :

Swap is private agreements between two parties to exchange cash flows in the

future according to a prearranged formula. They can be regarded as portfolio of

forward contracts.

The currency swap entails swapping both principal and interest between the

parties, with the cash flows in one direction being in a different currency than

those in the opposite direction. There are a various types of currency swaps like

as fixed-to-fixed currency swap, floating to floating swap, fixed to floating

currency swap.

In a swap normally three basic steps are involve___

(1) Initial exchange of principal amount

(2) Ongoing exchange of interest

(3) Re - exchange of principal amount on maturity.

OPTIONS :

Currency option is a financial instrument that give the option holder a right and

not the obligation, to buy or sell a given amount of foreign exchange at a fixed

price per unit for a specified time period ( until the expiration date ). In other

words, a foreign currency option is a contract for future delivery of a specified

currency in exchange for another in which buyer of the option has to right to buy

(call) or sell (put) a particular currency at an agreed price for or within specified

period. The seller of the option gets the premium from the buyer of the option for

the obligation undertaken in the contract. Options generally have lives of up to

one year, the majority of options traded on options exchanges having a

maximum maturity of nine months. Longer dated options are called warrants

and are generally traded OTC.


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Participants in the Foreign Exchange Markets

Non Bank entities i.e. the customers who wish to exchange currencies to meet

contractual obligations i.e. arising from exports, imports, remittances etc.

Commercial Banks which exchange currencies to meet client requirements.

Central Banks which in most countries are charged with the responsibility of maintainingthe external value of the currency of the country.Apart from the intervention, Central

Banks deal in Foreign Exchange markets for the purpose of Exchange Rate Management

and Reserve Management.

Exchange brokers play a very important role in the foreign exchange market.

Speculators buying and selling currencies in the hope of profiting from price movement.

Besides these entities, Commercial Companies, Hedge Funds as well as InvestmentManagement Firms play a very vital role in the Foreign Exchange Market.

FACTORS AFFECTING CURRENCY RATES

Supply and Demand Forces

Dollar against major currencies like Euro, Pound, Yen

Global and Asian Stock markets

Indian Stock markets

Economic factors Government budget deficits Interest rates Inflation Fiscal and Monetary Policy


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BENIFICIARIES OF CURRENCY FUTURE/FORWARD

MARKET

Hedgers:Example

Presume Entity A is expecting a remittance for USD 1000 on 27 August 08.

Wants to lock in the foreign exchange rate today so that the value of inflow in

Indian rupee terms is safeguarded. The entity can do so by selling one contract

of USDINR futures since one contract is for USD 1000.

Presume that the current spot rate is Rs.43 and USDINR 27 Aug 08 contract is

trading at Rs.44.2500. Entity A shall do the following:

Sell one August contract today. The value of the contract is Rs.44,250.

Let us assume the RBI reference rate on August 27, 2008 is Rs.44.0000. The

entity shall sell on August 27, 2008, USD 1000 in the spot market and get Rs.

44,000. The futures contract will settle at Rs.44.0000 (final settlement price =

RBI reference rate).

The return from the futures transaction would be Rs. 250, i.e. (Rs. 44,250 Rs.

44,000). As may be observed, the effective rate for the remittance received by

the entity A is Rs.44. 2500 (Rs.44,000 + Rs.250)/1000, while spot rate on that

date was Rs.44.0000. The entity was able to hedge its exposure.

Speculation: Bullish, buy futures

Take the case of a speculator who has a view on the direction of the market. He

would like to trade based on this view. He expects that the USD-INR rate

presently at Rs.42, is to go up in the next two-three months. How can he trade

based on this belief? In case he can buy dollars and hold it, by investing the

necessary capital, hecan profit if say the Rupee depreciates to Rs.42.50.


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Assuming he buys USD 10000, it would require an investment of Rs.4,20,000. If

the exchange rate moves as he expected in the next three months, then he shall

make a profit of around Rs.10000.This works out to an annual return of around

4.76%. It may please be noted that the cost of funds invested is not considered

in computing this return.A speculator can take exactly the same position on the

exchange rate by using futures contracts. Let us see how this works. If the INR-

USD is Rs.42 and the three month futures trade at Rs.42.40. The minimum

contract size is USD 1000. Therefore the speculator may buy 10 contracts. The

exposure shall be the same asabove USD 10000. Presumably, the margin may be

around Rs.21, 000. Three months later if the Rupee depreciates to Rs. 42.50

against USD, (on the day of expiration of the contract), the futures price shall

converge to the spot price (Rs.42.50) and he makes a profit of Rs.1000 on an

investment of Rs.21, 000. This works out to an annual return of 19 percent. Because

of the leverage they provide, futures form an attractive option for speculators.

Speculation: Bearish, sell futures

Futures can be used by a speculator who believes that an underlying is over-

valued and is likely to see a fall in price. How can he trade based on his

opinion? In the absence of a deferral product, there wasn 't much he could do to

profit from his opinion. Today all he needs to do is sell the futures.Let us

understand how this works. Typically futures move correspondingly with

theunderlying, as long as there is sufficient liquidity in the market. If the

underlying price rises, so will the futures price. If the underlying price falls, so

will the futures price. Now take the case of the trader who expects to see a fall

in the price of USD-INR. He sells one two-month contract of futures on USD say

at Rs. 42.20 (each contact for USD 1000). He pays a small margin on thesame. Two months later, when the futures contract expires, USD-INR rate let us

say is Rs.42.On the day of expiration, the spot and the futures price converges.

He has made a clean profit of 20 paise per dollar. For the one contract that he

sold, this works out to be Rs.2000


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Arbitragers:Example

Arbitrage is the strategy of taking advantage of difference in price of the same

or similar product between two or more markets. That is, arbitrage is striking a

combination of matching deals that capitalize upon the imbalance, the profit

being the difference between the market prices. If the same or similar product is

traded in say two different markets, any entity which has access to both the

markets will be able to identify price differentials, if any. If in one of the marketsthe product is trading at higher price, then the entity shall buy the product in the

cheaper market and sell in the costlier market and thus benefit from the price

differential without any additional risk.

One of the methods of arbitrage with regard to USD-INR could be a trading

strategy between forwards and futures market. As we discussed earlier, the

futures price and forward prices are arrived at using the principle of cost of

carry. Such of those entities who can trade both forwards and futures shall be

able to identify any mis-pricing between forwards and futures. If one of them is

priced higher, the same shall be sold while simultaneously buying the other

which is priced lower. If the tenor of both the contracts is same, since both

forwards and futures shall be settled at the same RBI reference rate, the

transaction shall result in a risk less profit.


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INTRODUCTION TO CURRENCY FUTURES

A futures contract is a standardized contract, traded on an exchange, to buy or sell a

certain underlying asset or an instrument at a certain date in the future, at a specifiedprice. When the underlying asset is a commodity, e.g. Oil or Wheat, the contract is

termed a commodity futures contract. When the underlying is an exchange rate, the

contract is termed a currency futurescontract. In other words, it is a contract to

exchange one currency for another currency at a specified date and a specified rate

in the future.

Therefore, the buyer and the seller lock themselves into an exchange rate for a

specific value or delivery date. Both parties of the futures contract must fulfill their

obligations on the settlement date.

Currency futures can be cash settled or settled by delivering the respective obligation

of the seller and buyer. All settlements however, unlike in the case of OTC markets,

go through the exchange.

Currency futures are a linear product, and calculating profits or losses on Currency

Futures will be similar to calculating profits or losses on Index futures. In determining

profits and losses in futures trading, it is essential to know both the contract size (the

number of currency units being traded) and also what is the tick value. A tick is the

minimum trading increment or price differential at which traders are able to enter bids

and offers. Tick values differ for different currency pairs and different underlying. For

e.g. in the case of the USD-INR currency futures contract the tick size shall be 0.25

paise or 0.0025 Rupees. To demonstrate how a move of one tick affects the price,

imagine a trader buys a contract (USD 1000 being the value of each contract) atRs.42.2500. One tick move on this contract will translate to Rs.42.2475 or

Rs.42.2525 depending on the direction of market movement.


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Purchase price: Rs .42.2500

Price increases by one tick: +Rs. 00.0025

New price: Rs .42.2525

Purchase price: Rs .42.2500

Price decreases by one tick: Rs. 00.0025

New price: Rs.42. 2475

The value of one tick on each contract is Rupees 2.50. So if a trader buys 5 contracts

and the price moves up by 4 tick, she makes Rupees 50.

Step 1: 42.2600 42.2500

Step 2: 4 ticks * 5 contracts = 20 points

Step 3: 20 points * Rupees 2.5 per tick = Rupees 50

History of currency futures

Currency futures were first created in 1970 at the International Commercial Exchange in

New York. But the contracts did not "take off" due to the fact that the Bretton Woodssystem was still in effect. They did so a full two years before the Chicago MercantileExchange (CME) in 1972, less than one year after the system of fixed exchange rateswas abandoned along with the gold standard. Some commodity traders at the CME didnot have access to the inter-bank exchange markets in the early 1970s, when theybelieved that significant changes were about to take place in the currency market. TheCME actually now gives credit to the International Commercial Exchange (not to beconfused with the ICE for creating the currency contract, and state that they came upwith the idea independently of the International Commercial Exchange). The CMEestablished the International Monetary Market (IMM) and launched trading in sevencurrency futures on May 16, 1972. Today, the IMM is a division of CME. In the fourth

quarter of 2009, CME Group FX volume averaged 754,000 contracts per day, reflectingaverage daily notional value of approximately $100 billion. Currently most of these aretraded electronically.

Other futures exchanges that trade currency futures are Euronext.liffe, Tokyo FinancialExchange and IntercontinentalExchange
http://en.wikipedia.org/wiki/Bretton_Woods_systemhttp://en.wikipedia.org/wiki/Bretton_Woods_systemhttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/1972http://en.wikipedia.org/wiki/Fixed_exchange_ratehttp://en.wikipedia.org/wiki/Gold_standardhttp://en.wikipedia.org/wiki/International_Monetary_Markethttp://en.wikipedia.org/wiki/2009http://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/Tokyo_Financial_Exchangehttp://en.wikipedia.org/wiki/Tokyo_Financial_Exchangehttp://en.wikipedia.org/wiki/IntercontinentalExchangehttp://en.wikipedia.org/wiki/IntercontinentalExchangehttp://en.wikipedia.org/wiki/Tokyo_Financial_Exchangehttp://en.wikipedia.org/wiki/Tokyo_Financial_Exchangehttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/2009http://en.wikipedia.org/wiki/International_Monetary_Markethttp://en.wikipedia.org/wiki/Gold_standardhttp://en.wikipedia.org/wiki/Fixed_exchange_ratehttp://en.wikipedia.org/wiki/1972http://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Chicago_Mercantile_Exchangehttp://en.wikipedia.org/wiki/Bretton_Woods_systemhttp://en.wikipedia.org/wiki/Bretton_Woods_system


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CURRENCY FUTURES IN INDIA

Currency futures trading was started in Mumbai on August 29, 2008. With over 300 trading members

including 11 banks registered in this segment,the first day saw a very lively counter, with nearly 70,000

contracts being traded. The first trade on the NSE was by East India Securities Ltd .Amongst the banks,

HDFC Bank carried out the first trade. The largest trade was by Standard Chartered Bank constituting15,000 contracts. Banks contributed 40 percent of the total gross volume. Currency Futures is the latest

product introduced in Indian securities markets. It will lead to further maturity and deepening of the

financial markets in India. Worldwide, trading in currency futures is a US$ 3 trillion (Rs 150 lakh crore)

market, and, given the rapid growth of Indian economy, it is poised to assume a significant role in the

growth of Indian securities markets.Exchange-traded currency derivatives segment operates under the

regulatory control of the Securities & Exchange Board of India (SEBI) and the Reserve Bank of India

(RBI). This segment will enable importers, exporters, investors, corporations, and banks to hedge their

currency risks at low transaction costs and with greater transparency and safety. Currency futures will

benefit small and medium enterprises (SMEs), which have hitherto not had easy access to the currency

market.

Why Trade Using Currency Futures?

The liberalization of Indian economy in 1990s and the increasing exports and imports fuelled by higher

growth rate in the last five years have led to doubling of volatility in the dollar-rupee (USD/INR) market.

These factors, coupled with the integration of global asset classes, increased remittances from non-

resident Indians (NRIs), forex cash inflow and outflow by foreign institutional investors (FIIs), have led to

increased risk for corporates and their clients having forex exposure


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FEATURES OF CURRENCY FUTURES (AS PER RBI REPORT)

USD, EURO, POUND, YEN contracts are allowed to be traded.

The size of each contract shall be USD 1000.

The contracts shall be quoted and settled in Indian Rupees.

The maturity of the contracts shall not exceed 12 months.

The settlement price shall be the Reserve Banks Reference Rate on the lasttrading day.

TRADE EXCHANGES FOR CURRENCY FUTURES

National Stock Exchange (NSE)

Bombay Stock Exchange (BSE)

Multi-Commodity Exchange (MCX)

United Stock Exchange

FUTURE TERMINOLOGY

SPOT PRICE :

The price at which an asset trades in the spot market.The transaction in which

securities and foreign exchange get traded for immediate delivery. Since the

exchange of securities and cash is virtually immediate, the term, cash market,

has also been used to refer to spot dealing. In the case of USDINR, spot value is

T + 2.

FUTURE PRICE :

The price at which the future contract traded in the future market.


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CONTRACT CYCLE :

The period over which a contract trades. The currency future contracts in Indian

market have one month, two month, three month up to twelve month expiry

cycles. In NSE/BSE will have 12 contracts outstanding at any given point in time.

VALUE DATE / FINAL SETTELMENT DATE :

The last business day of the month will be termed the value date /final settlement

date of each contract. The last business day would be taken to the same as that

for inter bank settlements in Mumbai. The rules for inter bank settlements,

including those for known holidays and would be those as laid down by Foreign

Exchange Dealers Association of India (FEDAI).

EXPIRY DATE :

It is the date specified in the futures contract. This is the last day on which the

contract will be traded, at the end of which it will cease to exist. The last trading

day will be two business days prior to the value date / final settlement date.

CONTRACT SIZE :

The amount of asset that has to be delivered under one contract.Also called as

lot size. In case of USDINR it is USD 1000.

BASIS :

In the context of financial futures, basis can be defined as the futures price minus

the spot price. There will be a different basis for each delivery month for each

contract. In a normal market, basis will be positive. This reflects that futures

prices normally exceed spot prices.


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COST OF CARRY :

The relationship between futures prices and spot prices can be summarized in

terms of what is known as the cost of carry. This measures the storage cost plus

the interest that is paid to finance or carry the asset till delivery less the income

earned on the asset. For equity derivatives carry cost is the rate of interest.

INITIAL MARGIN :

When the position is opened, the member has to deposit the margin with the

clearing house as per the rate fixed by the exchange which may vary asset to

asset. Or in another words, the amount that must be deposited in the margin

account at the time a future contract is first entered into is known as initial

margin.

MARKING TO MARKET :

At the end of trading session, all the outstanding contracts are reprised at the

settlement price of that session. It means that all the futures contracts are daily

settled, and profit and loss is determined on each transaction. This procedure,

called marking to market, requires that funds charge every day. The funds are

added or subtracted from a mandatory margin(initial margin) that traders are

required to maintain the balance in the account. Due to this adjustment, futures

contract is also called as daily reconnected forwards.

MAINTENANCE MARGIN :

Members account are debited or credited on a daily basis. In turn customers

account are also required to be maintained at a certain level, usually about 75

percent of the initial margin, is called the maintenance margin. This is somewhat

lower than the initial margin. This is set to ensure that the balance in the margin

account never becomes negative. If the balance in the margin account falls

below the maintenance margin, the investor receives a margin call and is

expected to top up the margin account to the initial margin level before trading

commences on the next day.


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PRODUCT DEFINITIONS OF CURRENCY FUTURE ON

NSE/BSE

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 rupee terms. 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.


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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 Interbank Settlements in Mumbai. The rules for Interbank Settlements, including

those for known holidays and subsequently declared holiday would be those as laid

down by FEDAI.

The contract specification in a tabular form is as under:

Underlying Rate of exchange between one USD and

INR

Trading Hours

(Monday to Friday)

09:00 a.m. to 05:00 p.m.

Contract Size USD 1000

Tick Size 0.25 paisa or INR 0.0025

Trading Period Maximum expiration period of 12 months

Contract Months 12 near calendar months

Final Settlement date/

Value date

Last working day of the month (subject to

holiday calendars)

Last Trading Day Two working days prior to Final Settlement

Date

Settlement Cash settled

Final Settlement Price The reference rate fixed by RBI two

working days prior to the final settlement

date will be used for final settlement


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TRADING PROCESS AND SETTLEMENT PROCESS

Like other future trading, the future currencies are also traded at organized

exchanges. The following diagram shows how operation take place on currency

future market:

It has been observed that in most futures markets, actual physical delivery of the

underlying assets is very rare and hardly it ranges from 1 percent to 5 percent.The

currency futures contracts are settled in cash in Indian Rupee. Most often buyers and

sellers offset their original position prior to delivery date by taking opposite positions.

This is because most of futures contracts in different products are predominantly

speculative instruments. For example, X purchases American Dollar futures and Y sells

it. It leads to two contracts, first, X party and clearing house and second Y party and

clearing house. Assume next day X sells same contract to Z, then X is out of the picture

and the clearing house is seller to Z and buyer from Y, and hence, this process goes on.

TRADER

( BUYER )

TRADER

( SELLER )

MEMBER

( BROKER )

MEMBER

( BROKER )

CLEARING

HOUSE

Purchase order Sales order

Transaction on the floor (Exchange)

Informs


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FINAL SETTLEMENT DAY IN CASE OF CURRENCYFUTURES

1. Final settlement date for the each contract is the last working day of each month

2. The reference rate fixed by RBI two days prior to the final settlement date is usedfor final settlement.

3. The last trading day of the contract is therefore 2 days prior to the final settlementdate.

4. On the last trading day, since the settlement price gets fixed around 12:00 noon.

Currency Forward

In finance, a forward contract or simply a forward is a non-standardized contractbetween two parties to buy or sell an asset at a specified future time at a price agreedtoday.[1]This is in contrast to a spot contract, which is an agreement to buy or sell anasset today. It costs nothing to enter a forward contract. The party agreeing to buy theunderlying asset in the future assumes a long position, and the party agreeing to sell theasset in the future assumes a short position. The price agreed upon is called thedelivery price, which is equal to the forward price at the time the contract is enteredinto.The price of the underlying instrument, in whatever form, is paid before control ofthe instrument changes. This is one of the many forms of buy/sell orders where the timeof trade is not the time where the securities themselves are exchanged.Theforward

price of such a contract is commonly contrasted with the spot price, which is the price atwhich the asset changes hands on the spot date. The difference between the spot andthe forward price is the forward premium or forward discount, generally considered inthe form of a profit, or loss, by the purchasing party.Forwards, like other derivativesecurities, can be used to hedge risk (typically currency or exchange rate risk), as ameans of speculation, or to allow a party to take advantage of a quality of the underlyinginstrument which is time-sensitive.A Forward contract is closely related to afuturescontract; they differ in certain respects. Forward contracts are very similar to futurescontracts, except they are not exchange-traded, or defined on standardizedassets.Forwards also typically have no interim partial settlements or "true-ups" inmargin requirements like futures - such that the parties do not exchange additional

property securing the party at gain and the entire unrealized gain or loss builds up whilethe contract is open. However, being traded OTC, forward contracts specification canbe customized and may include mark-to-market and daily margining.Hence, a forwardcontract arrangement might call for the loss party to pledge collateral or additionalcollateral to better secure the party at gain.
http://en.wikipedia.org/wiki/Forward_contract#cite_note-hull-0http://en.wikipedia.org/wiki/Forward_contract#cite_note-hull-0http://en.wikipedia.org/wiki/Forward_contract#cite_note-hull-0http://en.wikipedia.org/wiki/Spot_contracthttp://en.wikipedia.org/wiki/Long_positionhttp://en.wikipedia.org/wiki/Short_positionhttp://en.wikipedia.org/w/index.php?title=Delivery_price&action=edit&redlink=1http://en.wikipedia.org/wiki/Forward_pricehttp://en.wikipedia.org/wiki/Securitieshttp://en.wikipedia.org/wiki/Forward_pricehttp://en.wikipedia.org/wiki/Forward_pricehttp://en.wikipedia.org/wiki/Spot_pricehttp://en.wikipedia.org/wiki/Spot_datehttp://en.wikipedia.org/wiki/Forward_premiumhttp://en.wikipedia.org/wiki/Profit_%28accounting%29http://en.wikipedia.org/wiki/Hedge_%28finance%29http://en.wikipedia.org/wiki/Speculationhttp://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Futures_contract#Futures_versus_forwardshttp://en.wikipedia.org/wiki/Futures_contract#Futures_versus_forwardshttp://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Speculationhttp://en.wikipedia.org/wiki/Hedge_%28finance%29http://en.wikipedia.org/wiki/Profit_%28accounting%29http://en.wikipedia.org/wiki/Forward_premiumhttp://en.wikipedia.org/wiki/Spot_datehttp://en.wikipedia.org/wiki/Spot_pricehttp://en.wikipedia.org/wiki/Forward_pricehttp://en.wikipedia.org/wiki/Forward_pricehttp://en.wikipedia.org/wiki/Securitieshttp://en.wikipedia.org/wiki/Forward_pricehttp://en.wikipedia.org/w/index.php?title=Delivery_price&action=edit&redlink=1http://en.wikipedia.org/wiki/Short_positionhttp://en.wikipedia.org/wiki/Long_positionhttp://en.wikipedia.org/wiki/Spot_contracthttp://en.wikipedia.org/wiki/Forward_contract#cite_note-hull-0


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Major Differences Between OTC(Forward) And Exchange-Traded(Future) Derivatives Market?

Attribute Over-the-Counter Forward MarketExchange-Traded Currency

Futures Market

Size Structured as per requirement of the parties Standardized

Delivery date Tailored on individual needs Standardized

Method oftransaction

Established by the bank or broker throughelectronic media

Open auction among buyers and seller on thefloor of recognized exchange.

Participants Banks, brokers, forex dealers, multinationalcompanies, institutional investors, arbitrageurs,traders, etc.

Banks, brokers, multinational companies,institutional investors, small traders, speculators,arbitrageurs, etc.

Maturity Tailored to needs: from one week to 10 years Standardized

Market place Over the telephone worldwide and computernetworks

At recognized exchange floor with worldwidecommunications

Accessibility Limited to large customers banks, institutions, etc. Open to any one who is in need of hedgingfacilities or has risk capital to speculate

Delivery More than 90 percent settled by actual delivery Actual delivery has very less even below onepercent

Secured Risk is high being less secured Highly secured through margin deposit.

AccessibilityInter-bank market accessed through Online electronic trading through leased

Telephone line, VSAT, Internet

PriceHigh bid-ask spread due to high Transparent online trading platform

transaction cost owning to bank ensures uniform real-time price accessTransparency

Charges for all market participants

Contract Size Customized. Banks prefer forward Standard futures contract lot size as lowcontracts for at least US$ 1 million as US$ 1,000

Credit ExposureNo counterparty default risk due to

Counterparty default risk exists novation and settlement guarantee by clearinghouse


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Settlement only on maturity date in

Settlementcase of profits from cancelled Settlement only in INR based on

forward contracts. Loss to be paid mark-to-market T+1 day basis

immediately

Clients: Higher of 6% of openProof of interest or US$ 5 million

underlying Members: Higher of 15% of open

import /Mandatory as per RBI guidelines

interest or US$ 25 million

export Banks: Higher of 15% of open

exposure interest or US$ 100 million

Compensating bank balances or

Margincredit lines needed (such as FD, Margin is as low as 3% to 5% of total

Bank Guarantee, etc.). Usually exposure. Tracked on real-time basisDeposits

ranges from 5% to 10% depending on using Value-at-Risk (VaR) measures

the credit profile of client

Banks, Corporates having mandatoryWider participation by all strata of

market participants, including banks,

Clearing Handled by individual authorised Handled by exchange clearing house

Operation forex intermediaries banks with 100% guarantee against default

TransactionBanks bid-ask spread Negotiated brokerage fees

cost


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BENEFITS OF CURRENCY FUTURE OVER CURRENCY

FORWARD IN INDIAN MARKET

They are standardized contract.

Market lot is fixed at smaller size who enable even small corporate andinvertors to hedge and participate in the market.

Equal treatment, in terms of price, is provided to all investors whether largeor small.

Exchange traded market offers greater transparency, efficiency andaccessibility.

No counter party default risk.

FUTURE TURNOVER AS A % OF FORWARD TURNOVER

Month Forwardturnovercurrency (inbillion $)

Futureturnover(NSE,MCX)(in billion $)

Futureturnover at% of ForwardTurnover

NOV 08

DEC 08

JAN 09

FEB 09

MAR 09

APRIL 09

MAY 09

JUNE 09

JULU 09

AUG 09

87.77

89.60

65.66

61.29

92.04

73.24

75.10

76.21

65.35

62.62

6.3

9.38

9.89

12.92

19.40

15.40

25.74

29.92

38.08

37.32

7.19

10.50

15.09

21.10

21.13

21.07

34.31

39.26

58.27

59.60


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CONCLUSION

By far the most significant event in the Indian financial sector during the past decade

has been the extraordinary development and expansion of financial deriva tivesThese

instruments enhance the ability to differentiate risk and allocate it to those investors

most able and willing to take it. This process has undoubtedly improved national

productivity, growth and standard of livings.

The currency future gives a safe and standardized contract to its investors and

individuals who are aware about the forex market or predict the movement of exchange

rates so they will get the right platform for trading in currency future. Because of

exchange traded future contract and its standardized nature counter party risk is

minimized.

Initially only NSE provided this platform, but now BSE and MCX have also started

currency future trading. This shows how currency futures and Forwards cover ground as

compared to other available derivative instruments. Not only HNIs, exporters and

importers use this but also individuals who are interested and have knowledge of theforex market can invest in currency futures and forwards

The Currency Futures and Forwards Market in India is very big and as and when the

awareness of these markets increases a lot many investors will be attracted to invest in

this sector .


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Introduction of Currency Derivatives

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