A Study on Currency Derivatives

A STUDY

ON

“CURRENCY DERIVATIVES”

A Project Report Submitted in Partial Fulfillment for the Award

Of

POST GRADUATE DIPLOMA IN MANAGEMENT

(Batch 2011-2013)

SUBMITTED BY

Mr. Deepak sharma

PGDM 2011-13

Regd. No.-7024

(Faculty guide) (Director Academics)

Dr. P. Chakravarthi Prof. Mir Irfan ul Haq

VISHWA VISHWANI INSTITUTE OF SYSTEM AND MANAGEMENT HYDERABAD Page 1

Declaration

I, Deepak Sharma hereby declare that this short-term project titled “A STUDY ON

CURRENCY DERIVATIVES” is an original work done by me under the supervision of

Mr. Naveen Dhonte, Branch Manager of Future Capital Holdings Hyderabad. This

project report or any part thereof has not been submitted for any other degree to any

other institute or college.

This project is the result of sincere efforts by me, wherein the Endeavour to complete up

with best possible result.

Signature of the student

(Deepak Sharma)

Date:


Certificate from the organization


Faculty Guide Certificate

I Prof. __________________ certify Mr/Mrs. __________________that the

work done and the training undertaken by him/her is genuine to the best of my knowledge and acceptable.

Signature

Date :


Acknowledgement

I deeply acknowledge the guidance of my faculty guide Dr. P. chakravarthi (Prof. of

Vishwa Vishwani Institute of System & Management Hyderabad) who has firmly

inculcated the everlasting and invaluable teachings in me and made me get the deeper

insight of knowledge and inspiration to realize this unprecedented project work.

Ineffable are my feelings desperately indebted to him, a vivacious and enviable

personality whose contribution is praiseworthy. I believe that anyone can take a leaf

from his book.

I cannot express my gratitude in words to Naveen Dhonti (Manager of FUTURE

CAPITAL HOLDING) my company guide for the rigorous proof reading and sharing his

precious time. He is the person who has given me timely feedback, suggestion and

motivated me to embark on this strenuous project.

I am very grateful to my institution who has invariably been the beacon of my

advancement through their timely appreciation.

Signature of the student

(Name of the student)

Date :

Place:


INDEX

Chapter.No. Content Page No.

Chapter 1 Introduction 7-10

Chapter 2 Company Profile

Industry Profile

Literature Review

About Topic

11-21

22-25

26-27

28-50

Chapter 3 Research Methodology 51

Chapter 4 Data Analysis & Interpretation

52-67

Chapter 5 Findings

Recommendations

Conclusions

68

69

70

Bibliography Books / Articles

referred

Websites referred

71


CHAPTER – 1

INTRODUCTION TO 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,

and when borrowed fund are paid to the lender then the home currency will be

converted into foreign lender’s 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.

OBJECTIVES OF THE STUDY:

The basic idea behind undertaking Currency Derivatives project is to gain knowledge

about currency future market.

To understand the ways of considering currency future price.

To analyze different currency future derivatives.

To analyze the hedging in currency future.

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 main

derivative 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 exchange’s CME Glob ex 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.

UTILITY OF CURRENCY DERIVATIVES

Currency-based derivatives are used by exporters invoicing receivables in foreign

currency, willing to protect their earnings from the foreign currency depreciation by

locking the currency conversion rate at a high level. Their use by importers hedging

foreign currency payables is effective when the payment currency is expected to

appreciate and the importers would like to guarantee a lower conversion rate. Investors

in foreign currency denominated securities would like to secure strong foreign earnings

by obtaining the right to sell foreign currency at a high conversion rate, thus defending

their revenue from the foreign currency depreciation. Multinational companies use

currency derivatives being engaged in direct investment overseas. They want to

guarantee the rate of purchasing foreign currency for various payments related to the

installation of a foreign branch or subsidiary, or to a joint venture with a foreign partner.

A high degree of volatility of exchange rates creates a fertile ground for foreign

exchange speculators. Their objective is to guarantee a high selling rate of a foreign

currency by obtaining a derivative contract while hoping to buy the currency at a low

rate in the future. Alternatively, they may wish to obtain a foreign currency forward

buying contract, expecting to sell the appreciating currency at a high future rate. In

either case, they are exposed to the risk of currency fluctuations in the future betting on

the pattern of the spot exchange rate adjustment consistent with their initial

expectations.

The most commonly used instrument among the currency derivatives are currency

forward contracts. These are large notional value selling or buying contracts obtained

by exporters, importers, investors and speculators from banks with denomination

normally exceeding 2 million USD. The contracts guarantee the future conversion rate


between two currencies and can be obtained for any customized amount and any date

in the future. They normally do not require a security deposit since their purchasers are

mostly large business firms and investment institutions, although the banks may require

Compensating deposit balances or lines of credit. Their transaction costs are set by

spread between bank's buy and sell prices.

Exporters invoicing receivables in foreign currency are the most frequent users of these

contracts. They are willing to protect themselves from the currency depreciation by

locking in the future currency conversion rate at a high level. A similar foreign currency

forward selling contract is obtained by investors in foreign currency denominated bonds

(or other securities) who want to take advantage of higher foreign that domestic interest

rates on government or corporate bonds and the foreign currency forward premium.

They hedge against the foreign currency depreciation below the forward selling rate

which would ruin their return from foreign financial investment. Investment in foreign

securities induced by higher foreign interest rates and accompanied by the forward

selling of the foreign currency income is called a covered interest arbitrage


CHAPTER -2

COMPANY PROFILE

COMPANY INTRODUCTION:

Future Capital Holdings Limited (FCH) is a provider of financial services across retail

businesses and wholesale credit business. The company is preferred partners in

helping its clients succeed in their businesses by providing innovative product solutions,

high level of convenience & service supported by robust technology.

The company believes that MSMEs are largely underserved in India and hence this is a

large business opportunity. Financing of MSMEs is the largest component of the

businesses done by the company, which is over 40% of the company's business. The

company is also capitalizing on the growing consumption in India through financing

Consumer durables and two wheelers. The company also provides Gold Loans, Vehicle

loans, and Home Loans.

Future Capital also provides debt finance and working capital finance to corporate

against identified projects against security of receivables and inventories of the

company. The cash flows from the projects are escrowed to Future Capital. The

company also provides financing in the form of term loans to promoters of select

corporate with proven track record against security of listed stock with adequate liquidity

and value.

The company further believes that retail business provides ample opportunities for

growth, provides for ample diversification over a larger pool of customers, and finally

gives us the opportunity to meet multiple needs of the customer across lending,

investments, insurance and broking. Hence over the last 2 years, the company has

significantly increased retail portfolio as a percentage of the total portfolio, from 18% of

the loan portfolio to 45% as of now, and plans to grow this further. The company has a

team of over 1000 employees, who are experienced in the financial industry. The


company's senior management has excellent track records and each of them have

between 15-20 years of experience in financial services.

FCH has invested in People, Processes and Technologies and has placed a strong

Credit and Risk Management Team. The credit team is a separate vertical within the

organization, which undertakes detailed credit analysis, and processes files after

checking credit performance with credit bureaus.

Company’s Vision:

To capitalize on growing “consumption” in India, the key driver of the Indian

economy and support the growth of the MSME enterprises

To grow into a significant financial conglomerate and build businesses of retail

loans, corporate loans, Wealth Management & Equity broking

To be a preferred partner in helping our clients succeed in the rapidly evolving

financial markets by providing innovative product solutions, high level of

convenience & service supported by robust technology.& Growth

Path


LEADERSHIP IN FUTURE CAPITAL HOLDINGS

Executive management


INDEPENDENT DIRECTORS

Shailesh Haribhakti Anil Singhvi GN Bajpai NC Singhal Pradeep Mukharjee

V.Vaidyanathan(vice-chairman and Managing Director)

Apul Nayar (CEO- Retail Finance services)

Shailesh Srirali(CEO-Wholesale credit)

Aahok Shinkar (CEO & Head corporate center)

Pankaj Sanklecha(Chief Risk Officer)

PRODUCT, SERVICES AND DISTRIBUTION OF COMPANY

Through Comprehensive Products and Services Suite, FCH has been able to address the Four Key Needs of a Consumer.

Borrowing Needs: Protection Needs:

Investment Needs: Planning Needs:

Gold Coins

Property Broking

Mutual Funds

Structured products

Real Estate Funds

Equity Broking

Commodity Broking


Mortgages (for SMEs)

Gold Loans

Consumer Durable Loans

Two Wheeler Loans

Home Loans

Auto Loans

Life Insurance

General Insurance

Auto Insurance

Health insurance

Personal accident insurance

Travel insurance

Estate Planning- Creation of Private Trust

Wills Creation

Real estate Advisory

Wealth Management Financial Planning


FCH-Lines of Business

Loan Against Property

Loan Against Gold

Consumer Durable Loan

Home Loan

Two Wheeler Loan

Auto Loan

Wealth Manager & Broking

Wholesale Credit

Wholesale Loan Syndication

RETAIL BUSINESS

WHOLESALE BUSINESS BBUSINESS

Future Capital Branch Network

(By Feb 29, 2012)

Through the Extensive Branch Network, FCH has been able to reach to the Customers

across most of the states and major cities (Tier -1, Tier -2) in India. There are total 185 branches of future capital across the country.

Branch City Branch City

Delhi & NCR

Bhopal

Chandigarh:

Dehradun

Jaipur

Jalandhar:

Jodhpur

Lucknow

Ludhiana

Udaipur

Ahmadabad

Ajmer

Amritsar:

Kotta

Mumbai& Thane

Pune

Bangalore

Hyderabad

Baroda Kolkata

Bhubaneswar

Coimbatore

Indore

Nasik

Nagpur

Raipur

Rajkot

Surat:

Salem

Vellore

Chennai

Vizag


Growth of branches over the quarters

The Company intends to expand the branch network up to ~350 branches by

FY12-13

The branch network will continue to be dominated by the Gold Loan branches

The expansion focus will be concentrated around tier-1 and tier-2 cities

Manpower:

Growth of Manpower


Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-120

200

400

600

800

1000

1200

299

435 455497 510

579636

748

843895

9701043

Business Function Wise Employee Breakup

827

690

120

Retail Business Whole sale Business Corporate functionRisk Functin

Employee growth has been driven by the Business Aspirations of growing the loan book

in a steady manner and the Expansion in the Retail Business – Reach & Operations


Shareholding

(Shareholding Pattern as of 31 Dec 2011)

61.00%

22.20%

11.30%

2.20% 1.90% 0.60%0.70%

Promoters Individuals Bodies Corporates FII Mutule funds Financial Institutions

Others


Particulars Value

The Individuals include Non Residential Indians (Repatriable) and Non

Residential Indians (Non-Repatriable)

Financial Institutions include Banks, Insurance Companies and other Financial

Institutions

Others include Clearing Members and Trusts

The stock is listed on NSE (stock code: FCH) and BSE (stock code: 532938)

LIST OF COMPETITORS


No of Shares 64,798,484

No of Shareholders 1,47,603

Facevalue of Shares 10

EPS-H1-FY11-12 12.20

EPS-FY10-11 4.87

There is the list of competitors is given below which is made on the basis of market capital, sales turn over, net profit and total assets and current share price of the

company.

(As on 22nd June 2012)

Name Last price Market cap. (Rs. In Cr.)

Sales Turnover

Net Profit Total Assets

Indiabulls 224.95 7,08.19 2,929.26 723.79 17,797.15Edelweiss Cap

33.75 2,557.98 206.95 68.64 4,919.13

India Infoline 63.65 1,840.01 603.23 63.30 1,554.51Motilal Oswal

101.10 1,467.19 46.43 56.30 512.58

Delta Corp 63.55 1,423.00 1.17 -0.71 660.09

Pilani Invest 1,469.00 1,161.80 47.49 42.76 651.91

Future Capital

153.50 994.66 238.54 55.26 3,303.65

INDUSTRY PROFILE

INTRODUCTION OF FOREIGN EXCHANGE MARKET


The foreign exchange market (fx or forex) as we know it today originated in 1973.

However, money has been around in one form or another since the time of Pharaohs.

The Babylonians are credited with the first use of paper bills and receipts, but Middle

Eastern moneychangers were the first currency traders who exchanged coins from one

culture to another. During the middle ages, the need for another form of currency

besides coins emerged as the method of choice. These paper bills represented

transferable third-party payments of funds, making foreign currency exchange trading

much easier for merchants and traders and causing these regional economies to

flourish.

From the infantile stages of forex during the Middle Ages to WWI, the forex markets

were relatively stable and without much speculative activity. After WWI, the forex

markets became very volatile and speculative activity increased tenfold. Speculation in

the forex market was not looked on as favorable by most institutions and the public in

general. The Great Depression and the removal of the gold standard in 1931 created a

serious lull in forex market activity. From 1931 until 1973, the forex market went through

a series of changes. These changes greatly affected the global economies at the time

and speculation in the forex markets during these times was little, if any.

Timeline of Foreign Exchange

1944 – Bretton Woods Accord is established to help stabilize the global economy after

World War II.

1971 Smithsonian Agreement established to allow for greater fluctuation band for

currencies.

1972 European Joint Float established as the European community tried to move away

from its dependency on the U.S. dollar.

1973 Smithsonian Agreement and European Joint Float failed and signified the official

switch to a free-floating system.


1978 The European Monetary System was introduced so other countries could try to

gain independence from the U.S. dollar.

1978 Free-floating system officially mandated by the IMF.

1993 European Monetary System fails making way for a world-wide free-floating system

Major currency pairs

The most traded currency pairs in the world are called the Majors. The list includes

following currencies: Euro (EUR), US Dollar (USD), Japanese Yen (JPY), Pound

Sterling (GBP), Australian Dollar (AUD), Canadian Dollar (CAD), and the Swiss Franc

(CHF). These currencies follow free floating method of valuation. Amongst these

currencies the most active currency pairs are: EURUSD, USDJPY, GBPUSD,

AUDUSD, CADUSD and USDCHF. According to Bank for International Settlement (BIS)

survey of April 2010, the share of different currency pairs in daily trading volume is as

given below:

CURRENCY SHARE(%)

EURUSD 28

USDJYP 14

GBPUSD 9

AUD/USD

USD/CHF

6

4

USD/CAD 5

USD/OTHERS 18

OTHERS/OTHERS 16


TOTAL 100

Top Foreign Exchange Trading Center in the World

Forex market trading is truly a global phenomenon as well as the largest financial

market in the world with over $4 trillion changing hands on a daily basis. Looking at the

most recent Bank of International Settlements foreign-exchange report, published every

three years, we get a clear view of where most of the daily forex trading volume takes

place. Many of the usual suspects like the UK and USA are found at the top of the list

for the largest fx trading centers while others such as Singapore may be more surprising

to many. Below is a list of the 8 largest forex trading centers in the world.

(Data from Bank of International Settlements (BIS) foreign-exchange report as of

April 2010, All totals in US dollars)

S.N. Country Currency (symbol) Average daily

Trading volume

($ in billions)

Percentage of daily

Global Forex

volume (%)

1 United Kingdom GBP – Pound 1854 37

2 United States USD- US Dollar 904 18

3 Japan JPY- Japanese Yen 312 6

4 Singapore SGD- Dollar 266 5

5 Switzerland CHF- Swiss franc 263 5

6 Hong Kong HKD- Dollar 238 5

7 Australia AUD- Dollar 192 4

8 France EUR- Euro 150 3

9 India INR- India Rupee 0.9

INTRODUCTION TO INDIAN FOREIGN EXCHANGE MARKET


The foreign exchange market in India started in earnest less than three decades ago

when in 1978 the government allowed banks to trade foreign exchange with one

another. Today over 70% of the trading in foreign exchange continues to take place in

the inter-bank market. The market consists of over 90 Authorized Dealers (mostly

banks) who transact currency among themselves and come out “square” or without

exposure at the end of the trading day. Trading is regulated by the Foreign Exchange

Dealers Association of India (FEDAI), a self regulatory association of dealers. Since

2001, clearing and settlement functions in the foreign exchange market are largely

carried out by the Clearing Corporation of India Limited (CCIL) that handles transactions

of approximately 3.5 billion US dollars a day, about 80% of the total transactions.

The liberalization process has significantly boosted the foreign exchange market in the

country by allowing both banks and corporations greater flexibility in holding and trading

foreign currencies. The Sodhani Committee set up in 1994 recommended greater

freedom to participating banks, allowing them to fix their own trading limits, interest

rates on FCNR deposits and the use of derivative products.

The growth of the foreign exchange market in the last few years has been nothing less

than momentous. In the last 5 years, from 2000-01 to 2005-06, trading volume in the

foreign exchange market (including swaps, forwards and forward cancellations) has

more than tripled, growing at a compounded annual rate exceeding 25%. The growth of

foreign exchange trading in India between 1999 and 2006. The inter-bank forex trading

volume has continued to account for the dominant share (over 77%) of total trading over

this period, though there is an unmistakable downward trend in that proportion. (Part of

this dominance, though, result s from double-counting since purchase and sales are

added separately, and a single inter-bank transaction leads to a purchase as well as a

sales entry.) This is in keeping with global patterns.

LITERATURE REVIEW


So far researchers have carried out a little work on the prospectus and problems of

currency future in India, but the suggestions based on the material published so far are

mentioned hereunder:

V D M V Lakshmi (2008) have quoted the decision taken by RBI to allow exchange

traded currency future in India as a gift to traders and investors as well since it is a

standardize and transparent instrument to hedge their exposure to the currency risk. He

also described how the currency future can be used by market participant to cover the

risk due to fluctuation in exchange rates in currency market besides the legal framework

and sanction approval procedure from authorized agencies.

Nirvikar Singh (2008) stated that off-shore non-deliverable forward markets have

existed in India and Reserve Bank of India also oversees domestic currency forward

trading but exchange traded currency future were simply banned. However, in June

2007, trading of rupee future started on Dubai Gold and Commodities Exchange

prompting the RBI to set up a Committee to look into this possibility for India. The paper

described that during 2007 rupee future trading on DGEX and despite the fact that it

was not controlled by the RBI, so there were no restriction on trading and participation

beyond those that would be normal for an exchange and it clearly seemed that the new

market was being used for short-term hedging, probably by parties engaged in

international trade. He concluded with stated the RBI role should be of macroeconomic

management not microeconomic details if India is serious about financial sector

development.

S. B. Kamashetty (2008) threw a light on trading mechanism of currency future with the

average daily traded volume in the global forex market and in India as well. He also

mentioned the guidelines for the currency future trading with its flip slide and

shortcomings. The author also suggested granting the permission in dealing with three-

four major currencies besides USD, in which India has strong underlying traded.

Krishnan Sitaraman and Satish Prabhu (2010) described the currency future with

mitigating exchange Rate risk with illustrative support. They have also showed the


progress, operational aspect and new developments of currency future in India. The

paper also suggested introducing the currency option in the market.

Padmalatha Suresh (2010) has admitted that currency future helped the

undernourished Indian financial markets in a big way and described how exchange

traded futures are the answer to preventing systematic risks in the future. He also

thanked to the RBI decision to extend the currency futures market to include three more

currency pairs as earlier stated financial advisors were saying and appears that

currency options, as natural extension at the currency future market, are also on the

anvil. He also reviewed the performance of currency futures in December, 2009 since

the inception of trading, and presents some interesting insights i.e. both OTC markets

( INR and other currencies ) and currency futures ( only INR/USD ) traded on NSE and

MCX showed a remarkable increase in the turnover of derivatives as a percentage of

OTC forward turnover. The paper also quoted some reasons for inefficient and illiquid

market in India such as inadequacy of financial firms, Regulators and structured

barriers, Frictions caused by taxes and suggested that currency futures are not an end

in themselves but more positive actions from the regulators and government are

expected to nourish the market without being overprotective.

CURRENCY FUTURE IN INDIA


In India the Forex future currency trade can be carried out through recognized stock

markets – Bombay Stock Exchange, National Stock Exchange and Multi Commodity

Exchange. National Stock Exchange has started Forex future currency trading from

August 29, 2008. NSE is the first exchange in India to have obtained an in principle

approval from Security and Exchange Board of India to set up currency derivatives

segment. BSE is the third exchange in India to have obtained an in principle approval

from Security and Exchange Board of India after NSE and MCX. In brief the history of

Trading in Currency Future contracts in India can be traced back to the year 2008 when

various stock exchanges started trading in currency futures on the following dates:

National Stock Exchange started its operation on August 29, 2008

Bombay Stock Exchange started its operation on October 1, 2008

Multi Commodity Exchange started its operation on October 7, 2008

United Stock Exchange launched its operations on September 20, 2010.

(MCX got the approval from SEBI before BSE but it could start trading in Currency

future after BSE) This shows that trading in currency futures in India is not very old

rather it is at the stage of infancy.

About Indian forex market:

In terms of daily turnover in 2010, India is the 16th largest market in the world. India’s market share in World FX Market increased from 0.1 % in 1998 to 0.9% in 2010. As per Latest RBI Data, Daily FX Indian Market volumes are $50 Billion in 2009.

Indian Currency Futures Market

The Reserve Bank of India permitted Exchange Traded Currency Futures in 2008. The National Stock Exchange of India (NSE) was the first to launch Currency Futures on 29 August 2008. The Bombay Stock Exchange (BSE) and MCX Stock Exchange (MCX-SX) started offering Currency Futures trading in September and October 2008 respectively.

“United Stock Exchange of India” is the upcoming exchange promoted by Bank of India, Federal Bank, MMTC & Jaypee Capital along with 9 other banks. The FX market in


India is regulated by The Foreign Exchange Management Act, 1999 or FEMA, Presently Daily Turnover on both exchanges averages Rs. 35000 crores. Banks are active participants on the exchanges. NRIs & FIIs are not permitted to trade as of now. Currency markets offer investors a step into the world of Forex. The global increase in trade and foreign investments has led to inter-connection of many national economies. This and the resulting fluctuations in exchange rates, has created a huge international market for Forex rendering investors another exciting avenue for trading. The Forex market offers unmatched potential for profitable trading in any market condition or any stage of the business cycle.

Policy-makers in India are keeping a close eye on Currency Futures. The obvious reasons are to keep a tab on the speculative activities by traders and arbitragers who do not have any underlying physical exposure in this market and trade purely for speculation.

With speculation increasing, there are concerns that excessive speculation may adversely affect both Futures and the underlying Spot markets. Considering these developments, attempts need to be made to study the pattern of trade and the impact of Futures on Forwards and Spot.

INTRODUCTION TO FINANCIAL DERIVATIVES


The term ‘Derivative’ stands for a contract whose price is derived from or is dependent

upon an underlying asset. The underlying asset could be a financial asset such as

currency, stock and market index, an interest bearing security or a physical commodity.

Today, around the world, derivative contracts are traded on electricity, weather,

temperature and even volatility.

According to the Securities Contract Regulation Act, (1956) the term “derivative”

includes:

(i) A security derived from a debt instrument, share, loan, whether secured or

unsecured, Risk instrument or contract for differences or any other form of security;

(ii) A contract which derives its value from the prices, or index of prices, of underlying

Securities.

“By far the most significant event in finance during the past decade has been the

extraordinary development and expansion of financial derivatives…These instruments

enhances the ability to differentiate risk and allocate it to those investors most able and

willing to take it- a process that has undoubtedly improved national productivity growth

and standards of livings.”

Alan Greenspan,

Former Chairman.

US Federal Reserve Bank

The past decades has witnessed the multiple growths in the volume of international

trade and business due to the wave of globalization and liberalization all over the world.


As a result, the demand for the international money and financial instruments increased

significantly at the global level. In this respect, changes in the interest rates, exchange

rate and stock market prices at the different financial market have increased the

financial risks to the corporate world. It is therefore, to manage such risks; the new

financial instruments have been developed in the financial markets, which are also

popularly known as financial derivatives.

DEFINITION OF FINANCIAL DERIVATIVES

A word formed by derivation. It means, this word has been arisen by derivation.

Something derived; it means that some things have to be derived or arisen out of the

underlying variables. A financial derivative is an indeed derived from the financial

market.

“Derivatives are financial contracts whose value/price is independent on the behavior of

the price of one or more basic underlying assets. These contracts are legally binding

agreements, made on the trading screen of stock exchanges, to buy or sell an asset in

future. These assets can be a share, index, interest rate, bond, rupee dollar exchange

rate, sugar, crude oil, soybeans, cotton, coffee and what you have.”

A very simple example of derivatives is curd, which is derivative of milk. The price of

curd depends upon the price of milk which in turn depends upon the demand and

supply of milk.

The Underlying Securities for Derivatives are:

Commodities: Castor seed, Grain, Pepper, Potatoes, etc.

Precious Metal : Gold, Silver

Short Term Debt Securities : Treasury Bills

Interest Rates

Common shares/stock

Stock Index Value : NSE Nifty

Currency : Exchange Rate


TYPES OF FINANCIAL DERIVATIVES

Financial derivatives are those assets whose values are determined by the value of

some other assets, called as the underlying. Presently there are Complex varieties

of derivatives already in existence and the markets are innovating newer and newer

ones continuously. For example, various types of financial derivatives based on

their different properties like, plain, simple or straightforward, composite, joint or

hybrid, synthetic, leveraged, mildly leveraged, OTC traded, standardized or

organized exchange traded, etc. are available in the market. Due to complexity in

nature, it is very difficult to classify the financial derivatives, so in the present

context, the basic financial derivatives which are popularly in the market have been

described. In the simple form, the derivatives can be classified into different

categories which are shown below:

DERIVATIVES

Financials Commodities

Basics Complex

1. Forwards 1. Swaps

2. Futures 2.Exotics (Non STD)

3. Options

4. Warrants and Convertibles

One form of classification of derivative instruments is between commodity derivatives

and financial derivatives. The basic difference between these is the nature of the


underlying instrument or assets. In commodity derivatives, the underlying instrument is

commodity which may be wheat, cotton, pepper, sugar, jute, turmeric, corn, crude oil,

natural gas, gold, silver and so on. In financial derivative, the underlying instrument

may be treasury bills, stocks, bonds, foreign exchange, stock index, cost of living index

etc. It is to be noted that financial derivative is fairly standard and there are no quality

issues whereas in commodity derivative, the quality may be the underlying matters.

Another way of classifying the financial derivatives is into basic and complex. In this,

forward contracts, futures contracts and option contracts have been included in the

basic derivatives whereas swaps and other complex derivatives are taken into complex

category because they are built up from either forwards/futures or options contracts, or

both. In fact, such derivatives are effectively derivatives of derivatives.

Derivatives are traded at organized exchanges and in the Over The Counter

( OTC ) market :

Derivatives Trading Forum

Organized Exchanges Over The Counter

Commodity Futures Forward Contracts

Financial Futures Swaps

Options (stock and index)

Stock Index Future

Derivatives traded at exchanges are standardized contracts having standard delivery

dates and trading units. OTC derivatives are customized contracts that enable the

parties to select the trading units and delivery dates to suit their requirements.


A major difference between the two is that of counterparty risk—the risk of default by

either party. With the exchange traded derivatives, the risk is controlled by exchanges

through clearing house which act as a contractual intermediary and impose margin

requirement. In contrast, OTC derivatives signify greater vulnerability.

DERIVATIVES INTRODUCTION IN INDIA

The first step towards introduction of derivatives trading in India was the promulgation of

the Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on

options in securities. SEBI set up a 24 – member committee under the chairmanship of

Dr. L.C. Gupta on November 18, 1996 to develop appropriate regulatory framework for

derivatives trading in India, submitted its report on March 17, 1998. The committee

recommended that the derivatives should be declared as ‘securities’ so that regulatory

framework applicable to trading of ‘securities’ could also govern trading of derivatives.

To begin with, SEBI approved trading in index futures contracts based on S&P CNX

Nifty and BSE-30 (Sensex) index. The trading in index options commenced in June

2001 and the trading in options on individual securities commenced in July 2001.

Futures contracts on individual stocks were launched in November 2001.

INTRODUCTION TO CURRENCY FUTURE


Currency futures are contracts just like any other derivatives, stock, index etc. Unlike

the stock, the underlying asset is currency. The value of the currencies determines the

value of currency derivatives. It is a futures contract to exchange one currency for

another at a specified date in the future at a price (exchange rate) that is fixed on the

date of purchase. It is also known as foreign exchange future or FX future. It is a forex

derivative. As per the guidelines of RBI, currency future means “a standardized foreign

exchange derivative contract traded on are cognized stock exchange to buy or sell one

currency against another on a specified future date, at a price specified on the date of

contract, but does not include a forward. contract”. Currency Futures market means the

market in which currency futures are traded.

Because currency futures contracts are marked-to-market daily, investors can exit their

obligation to buy or sell the currency prior to the contract's delivery date. This is done by

closing out the position. With currency futures, the price is determined when the

contract is signed, just as it is in the forex market, only and the currency pair is

exchanged on the delivery date, which is usually sometime in the distant future.

However, most participants in the futures markets are speculators who usually close out

their positions before the date of settlement, so most contracts do not tend to last until

the date of delivery. Currency futures are traded according to the rules and regulations

that are drawn by the futures exchanges. The trading can be done either on the floors of

these futures exchanges or these exchanges can facilitate electronic trading for its

members. The Chicago Mercantile Exchange is the world's largest and most successful

exchange for trading in currency futures, with offices in Chicago, New York,

Washington, London and Tokyo. Like all futures contracts, currency futures are

standardized contracts too. The futures exchange sets the contract specifications.

However, only the exchange rate can be negotiated by the buyers and sellers. The

remaining specifications, such as defining the underlying currency, trading unit and

delivery month, are set by the futures exchange.

The following are the obvious benefits of currency trading in India:


- Easy Accessibility – Small Investors would get an easy access to currency futures

trading on the popular exchanges

- Easy Affordability – Margins are very low and the contract size is very small

- Low Transaction Cost – As opposed to the high pay-out of commissions in overseas

forex trading, currency futures carries low costs for investors

- Transparency - It is possible for you to verify trade details on NSE if you have a doubt

that the broker has tried to cheat you

- Counter-party default risk - All the trades done on the recognized exchanges are

guaranteed by the clearing corporations and hence it eliminates the risks associated

with counter party default. NSCCL (National Securities Clearing Corporation Limited)

carries out all the notation, clearing and settlement process of currency futures trading

- Standardized Contracts - Exchange Traded currency futures are standardized in

respect of lot size ($1000) and maturity (12 monthly contracts). Retail investors with

their limited resources would find it tremendously beneficial to take positions in

standardized USD INR futures contracts.

Moreover, the currency futures market is used by some companies for hedging. These

companies either purchase currency futures for their future payables, or sell the futures

on currencies for their future receipts. Speculators may also buy or sell futures on a

foreign currency as a protection against the strengthening or weakening of the US

dollar. So, speculators may be able to earn profit from the rise or fall of these exchange

rates.

Features


• Standardized foreign exchange derivative contract.

• Traded on a recognized stock exchange.

• Price and date of delivery are predetermined.

• Margin Requirements.

• Eliminate counter party risk.

• Transparency in pricing

• Settlement through clearing house.

• Underlying is the exchange rates.

• Traded in a limited number of currencies.

• Contracts are quoted and settled in Indian Rupees.

• The maturity of the contracts shall not exceed 12 months.

• Settled on a specific future date known as settlement date.

• Only resident Indians are allowed to trade in currency futures.

• Future price = spot price + cost of carry.

• The Final settlement price (FSP) would be the RBI reference rate on the last trading day.

• No person other than a person resident in India' as defined in section 2(v) of the Foreign Exchange Management Act, 1999 (Act 42 of 1999) shall participate in the currency futures market.

• All non-deposit taking NBFCs with asset size of Rs. 100 crore and above may participate in the designated

Futures terminology


Some of the common terms used in the context of currency futures market are given

below:

Spot price: The price at which the underlying 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.

Futures price: The current price of the specified futures contract.

Contract cycle: The period over which a contract trades. The currency futures

contracts on the SEBI recognized exchanges have one-month, two-month, and

three-month up to twelve-month expiry cycles. Hence, these exchanges will have

12 contracts outstanding at any given point in time.

Value Date/Final Settlement Date: The last business day of the month will be

termed as the Value date / Final Settlement date of each contract. The last

business day would be taken to be the same as that for Inter-bank Settlements in

Mumbai. The rules for Inter-bank Settlements, including those for ‘known

holidays’ and ‘subsequently declared holiday’ would be those as laid down by

Foreign Exchange Dealers’ Association of India (FEDAI).

Expiry date: Also called Last Trading Day, it is the day on which trading ceases

in the contract; and is two working days prior to the final settlement date.

Contract size: The amount of asset that has to be delivered under one contract.

Also called as lot size. In the case of USDINR it is USD 1000; EURINR it is EUR

1000; GBPINR it is GBP 1000 and in case of JPYINR it is JPY 100,000.

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.

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: The amount that must be deposited in the margin account at the

time a futures contract is first entered into is known as initial margin.

Marking-to-market: In the futures market, at the end of each trading day, the

margin account is adjusted to reflect the investor's gain or loss depending upon

the futures closing price. This is called marking-to-market.

Maintenance Margin: Member’s 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.

NEED FOR EXCHANGE TRADED CURRENCY FUTURES


With a view to enable entities to manage volatility in the currency market, RBI on April

20, 2007 issued comprehensive guidelines on the usage of foreign currency forwards,

swaps and options in the OTC market. At the same time, RBI also set up an Internal

Working Group to explore the advantages of introducing currency futures. The Report of

the Internal Working Group of RBI submitted in April 2008, recommended the

introduction of exchange traded currency futures. Exchange traded futures as compared

to OTC forwards serve the same economic purpose, yet differ in fundamental ways. An

individual entering into a forward contract agrees to transact at a forward price on a

future date. On the maturity date, the obligation of the individual equals the forward

price at which the contract was executed. Except on the maturity date, no money

changes hands. On the other hand, in the case of an exchange traded futures contract,

mark to market obligations is settled on a daily basis. Since the profits or losses in the

futures market are collected / paid on a daily basis, the scope for building up of mark to

market losses in the books of various participants gets limited.

The counterparty risk in a futures contract is further eliminated by the presence of a

clearing corporation, which by assuming counterparty guarantee eliminates credit risk.

Further, in an Exchange traded scenario where the market lot is fixed at a much lesser

size than the OTC market, equitable opportunity is provided to all classes of investors

whether large or small to participate in the futures market. The transactions on an

Exchange are executed on a price time priority ensuring that the best price is available

to all categories of market participants irrespective of their size. Other advantages of an

Exchange traded market would be greater transparency, efficiency and accessibility.

RATIONALE FOR INTRODUCING CURRENCY FUTURE


Futures markets were designed to solve the problems that exist in forward markets. A

futures contract is an agreement between two parties to buy or sell an asset at a certain

time in the future at a certain price. But unlike forward contracts, the futures contracts

are standardized and exchange traded. To facilitate liquidity in the futures contracts, the

exchange specifies certain standard features of the contract. A futures contract is

standardized contract with standard underlying instrument, a standard quantity and

quality of the underlying instrument that can be delivered, (or which can be used for

reference purposes in settlement) and a standard timing of such settlement. A futures

contract may be offset prior to maturity by entering into an equal and opposite

transaction.

The standardized items in a futures contract are:

• Quantity of the underlying

• Quality of the underlying

• The date and the month of delivery

• The units of price quotation and minimum price change

• Location of settlement

The rationale for introducing currency futures in the Indian context has been outlined in

the Report of the Internal Working Group on Currency Futures (Reserve Bank of India,

April 2008) as follows;

The rationale for establishing the currency futures market is manifold. Both residents

and non-residents purchase domestic currency assets. If the exchange rate remains

unchanged from the time of purchase of the asset to its sale, no gains and losses are

made out of currency exposures. But if domestic currency depreciates (appreciates)

against the foreign currency, the exposure would result in gain (loss) for residents


Purchasing foreign assets and loss (gain) for non residents purchasing domestic assets.

In this backdrop, unpredicted movements in exchange rates expose investors to

currency risks. Currency futures enable them to hedge these risks. Nominal exchange

rates are often random walks with or without drift, while real exchange rates over long

run are mean reverting. As such, it is possible that over a long – run, the incentive to

hedge currency risk may not be large. However, financial planning horizon is much

smaller than the long-run, which is typically inter-generational in the context of

exchange rates. As such, there is a strong need to hedge currency risk and this need

has grown manifold with fast growth in cross-border trade and investments flows. The

argument for hedging currency risks appear to be natural in case of assets, and applies

equally to trade in goods and services, which results in income flows with leads and

lags and get converted into different currencies at the market rates. Empirically,

changes in exchange rate are found to have very low correlations with foreign equity

and bond returns. This in theory should lower portfolio risk. Therefore, sometimes

argument is advanced against the need for hedging currency risks. But there is strong

empirical evidence to suggest that hedging reduces the volatility of returns and indeed

considering the episodic nature of currency returns, there are strong arguments to use

instruments to hedge currency risks.

Uses of Currency Futures

Hedging:

Presume Entity A is expecting a remittance of USD 1000 on 27 August 09. It 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 USD-INR futures at NSE since one contract is for USD 1000. Presume that the current spot rate is Rs. 43 and ‘USDINR 27 Aug 09’ 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, 2009 is Rs.44.0000. The entity shall sell on August 27, 2009, 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, he can profit if say the

Rupee depreciates to Rs.42.50. 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 as above 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 the

underlying, 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 the same. 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.

Arbitrage:

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 markets the 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.

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 it hardly ranges from 1 percent to 5 percent. Most

often buyers and sellers offset their original position prior to delivery date by taking an

opposite positions. This is because most of futures contracts in different products are


TRADER

(BUYER)

TRADER

(SELLER)

MEMBER (BROKER) MEMBER (BROKER)

CLEARING HOUSING

SALES ORDERPURCHASE ORDER

TRANSACTION ON THE FLOOR (EXCHANGE)

INFORMS

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 is goes on.

REGULATORY FRAMEWORK FOR CURRENCY FUTURES

With a view to enable entities to manage volatility in the currency market, RBI on April

20, 2007 issued comprehensive guidelines on the usage of foreign currency forwards,

swaps and options in the OTC market. At the same time, RBI also set up an Internal

Working Group to explore the advantages of introducing currency futures. The Report of

the Internal Working Group of RBI submitted in April 2008, recommended the

introduction of exchange traded currency futures. With the expected benefits of

exchange traded currency futures, it was decided in a joint meeting of RBI and SEBI on

February 28, 2008, that an RBI-SEBI Standing Technical Committee on Exchange

Traded Currency and Interest Rate Derivatives would be constituted. To begin with, the

Committee would evolve norms and oversee the implementation of Exchange traded

currency futures. The Terms of Reference to the Committee was as under:

1. To coordinate the regulatory roles of RBI and SEBI in regard to trading of

Currency and Interest Rate Futures on the Exchanges.

2. To suggest the eligibility norms for existing and new Exchanges for Currency and

Interest Rate Futures trading.

3. To suggest eligibility criteria for the members of such exchanges.

4. To review product design, margin requirements and other risk mitigation

measures on an ongoing basis.

5. To suggest surveillance mechanism and dissemination of market information.

6. To consider microstructure issues, in the overall interest of financial stability


COMPARISION OF FORWARD AND FUTURES CURRENCY CONTRACT

BASICS FORWARD FUTURE

Size Structured as per requirement of the parties

Standardized

Delivery dateTailored on individual needs Standardized

Method of transaction

Established by the bank or broker through electronic media

Open auction among buyers and seller on the floor of recognized exchange.

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

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

Margins None as such, but compensating bank balanced may be required

Margin deposit required

Maturity Tailored to needs: from one week to 10 years

Standardized

Settlement Actual delivery or offset with cash settlement. No separate clearing house

Daily settlement to the market and variation margin requirements

Market place Over the telephone worldwide and computer networks

At recognized exchange floor with worldwide communications

Accessibility Limited to large customers banks, institutions, etc.

Open to anyone who is in need of hedging facilities or has risk capital to speculate

Delivery More than 90 percent settled by actual delivery

Actual delivery has very less even below one percent

Secured Secured Risk is high being less secured .

Highly secured through margin deposit

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

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.

Currency futures contract specification

Currently currency future contracts are permitted on four currency pairs i.e., USDINR, EURINR, GBPINR and JPYINR. The detail of contract design for these currency pairs is given in the table below:

Contract specification: USDINR, EURINR, GBPINR and JPYINR Currency

Derivatives

Underlying Foreign currency as base currency and INR as quoting currency

Market timing 9:00 AM to 5:00 PM

Contract Size USD 1000 (for USDINR), EUR 1000 (for EURINR), GBP 1000

(for GBPINR) and JPY 100,000 (for JPYINR)

Tick Size Re. 0.0025

Quotation

Available contracts

The contract would be quoted in Rupee terms. However,

outstanding position would be in USD, EUR, GBP and JPY terms

for USDINR, EURINR,GBPINR and JPYINR contracts

respectively

Maximum of 12 calendar months from current calendar month.

New contract will be introduced following the Expiry of current

month contract.

Settlement date

Last working day of the month (subject to holiday calendars) at

12 noon

Last trading day

(or Expiry day)

12 noon on the day that is two working days prior to the

settlement date


Settlement Basis Daily mark to market settlement will be on a T +1 basis and final

settlement will be cash settled on T+2 basis.

Daily

settlement Price

Daily mark to market settlement price will be announced by the

exchange, based on volume-weighted average price in the last

half an hour of trading, or a theoretical price if there is no trading

in the last half hour.

Settlement Cash settled in INR

Final

Settlement Price

The reference rate fixed by RBI on last trading day or expiry day.

Final Settlement Day

Last working day (excluding Saturdays) of the expiry month. The

last working day will 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.

CHAPTER -3


RESEARCH METHODOLOGY

To fulfill the objectives of the study both primary and secondary data has been

collected. In this study primary data was collected through interaction with staff of

FUTURE CAPITAL SECURITIES LTD.

Secondary data is the data collected previously by someone else for some other

purpose which can be analyzed and interpreted according to requirements. For

example, sources of secondary data are government publications, newspapers,

worldwide web etc.

In this study the Secondary data is mainly taken from

The company’s training material.

Reconciliation statements.

Other documents generated within the organization

Formulae use in data analysis:

1. F/S = (1+ Rh) / (1+Rf)

2. F = S x e^ (Rh-Rf)T

3. Value of the contract = (Value of currency future per USD*contract size*No of contract).

CHAPTER – 4


DATA ANALYSIS AND INTERPRETATION

PRICING OF FUTURES CONTRACT

Interest rate parity principle:

According to the interest rate parity theory, the currency margin is dependent mainly on the prevailing interest rate (for investment for the given time period) in the two currencies.

The forward rate can be calculated by the following formula:

F/S = (1+Rh)/ (1+Rf)

Where, F and S are future and spot currency rate. Rh and Rf are simple interest rate in the home and foreign currency respectively.

Alternatively, if we consider continuously Compounded interest rate then forward rate can be calculated by using the following formula:

F = S x e (rh- rf) x t

Where

rh and rf are the continuously compounded interest rate for the home currency and foreign currency respectively,

T is the time to maturity

e = 2.71828 (exponential).

If the following relationship between the futures rate and the spot rate does not hold, then there will be an arbitrage opportunity in the market. This will force the futures rate to change so that the relationship holds true.

Let us assume that risk free interest rate for one year deposit in India is 7% and in USA

it is 3%. You as smart trader/ investor will raise money from USA and deploy it in India

and try to capture the arbitrage of 4%. You could continue to do so and make this

transaction as a non ending money making machine. Life is not that simple! And such

arbitrages do not exist for very long.


We will carry out the above transaction through an example to explain the concept of

interest rate parity and derivation of future prices which ensure that arbitrage does not

exist.

Assumptions:

1. Spot exchange rate of USDINR is 50 (S)

2. One year future rate for USDINR is F

3. Risk free interest rate for one year in USA is 3% (RUSD)

4. Risk free interest rate for one year in India is 7% (R) INR

5. Money can be transferred easily from one country into another without any restriction

of amount, without any taxes etc)

You decide to borrow one USD from USA for one year, bring it to India, convert it in INR

and deposit for one year in India. After one year, you return the money back to USA.

On start of this transaction, you borrow 1 USD in US at the rate of 3% and agree to

return 1.03 USD after one year (including interest of 3 cents). This 1 USD is converted

into INR at the prevailing spot rate of 50. You deposit the resulting INR 50 for one year

at interest rate of 7%. At the end of one year, you receive INR 3.5 (7% of 50) as interest

on your deposit and also get back your principal of INR 50 i.e., you receive a total of

INR 53.5. You need to use these proceeds to repay the loan taken in USA.

Two important things to think before we proceed:

The loan taken in USA was in USD and currently you have INR. Therefore you

need to convert INR into USD

What exchange rate do you use to convert INR into USD?

At the beginning of the transaction, you would lock the conversion rate of INR into USD

using one year future price of USDINR. To ensure that the transaction does not result


into any risk free profit, the money which you receive in India after one year should be

equal to the loan amount that you have to pay in USA.

We will convert the above argument into a formula:

S(1+RINR)= F(1+RUSD) Or,

F/ S = (1+RINR) / (1+RUSD)

Another way to illustrate the concept is to think that the INR 53.5 received after one year

in India should be equal to USD 1.03 when converted using one year future exchange

rate.

Therefore, F/ 50 = (1+.07) / (1+.03) F= 51.9417

Approximately, F is equal to the interest rate difference between two currencies i.e.

F = S + (RINR- RUSD)*S

This concept of difference between future exchange rate and spot exchange rate being

approximately equal to the difference in domestic and foreign interest rate is called the

“Interest rate parity”. Alternative way to explain, interest rate parity says that the spot

price and futures price of a currency pair incorporates any interest rate differentials

between the two currencies assuming there are no transaction costs or taxes.

A more accurate formula for calculating, the arbitrage - free forward price is as follows.

F = S × (1 + RQC × Period) / (1 + RBC × Period)

Where F = forward price

S = spot price

RBC = interest rate on base currency

RQC = interest rate on quoting currency


Period = forward period in years

For a quick estimate of forward premium, following formula mentioned above for

USDINR currency pair could be used. The formula is generalized for other currency pair

and is given below:

F = S + (S × (RQC – RBC) × Period)

In above example, if USD interest rate were to go up and INR interest rate were to

remain at 7%, the one year future price of USDINR would decline as the interest rate

difference between the two currencies has narrowed and vice versa.

Traders use expectation on change in interest rate to initiate long/ short positions in

currency futures. Everything else remaining the same, if USD interest rate is expected

to go up (say from 2.5% to 3.0%) and INR interest rate are expected to remain constant

say at 7%; a trader would initiate a short position in USDINR futures market.

Illustration: Suppose 6 month interest rate in India is 5% (or 10% per annum) and

in USA are 1% (2% per annum). The current USDINR spot rate is 50. What is the

likely 6 month USDINR futures price?

As explained above, as per interest rate parity, future rate is equal to the interest rate

differential between two currency pairs. Therefore approximately 6 month future rate

would be:

Spot + 6 month interest difference = 50 + 4% of 50 = 50 + 2 = 52

The exact rate could be calculated using the formula mentioned above and the answer

comes to 51.98 = 50 x (1+0.1/12 x 6) / (1+0.02/12 x 6)


Interpretation:

Future price of USDINR depends upon the interest rate of each country. If USD price is

appreciated then borrower has to pay more USD in return but if USD is depreciated

then borrower has to pay less USD dollar.

Interpretation of Concept of premium and discount:

Therefore one year future price of USDINR pair is 51.94 when spot price is 50. It means

that INR is at discount to USD and USD is at premium to INR. Intuitively to understand

why INR is called at discount to USD, think that to buy same 1 USD you had to pay INR

50 and you have to pay 51.94 after one year i.e., you have to pay more INR to buy

same 1 USD. And therefore future value of INR is at discount to USD. Therefore in any

currency pair, future value of a currency with high interest rate is at a discount (in

relation to spot price) to the currency with low interest rate.

CURRENCY FUTURES PAYOFFS

A payoff is the likely profit/loss that would accrue to a market participant with change in

the price of the underlying asset. This is generally depicted in the form of payoff

diagrams which show the price of the underlying asset on the X-axis and the

profits/losses on the Y-axis. Futures contracts have linear payoffs. In simple words, it

means that the losses as well as profits for the buyer and the seller of a futures contract

are unlimited. Options do not have linear payoffs. Their pay offs are non-linear. These

linear payoffs are fascinating as they can be combined with options and the underlying

to generate various complex payoffs. However, currently only payoffs of futures are

discussed as exchange traded foreign currency options are not permitted in India.

Payoff for buyer of futures: Long futures

The payoff for a person who buys a futures contract is similar to the payoff for a

person who holds an asset. He has a potentially unlimited upside as well as a


Potentially unlimited downside. Take the case of a speculator who buys a two-month

currency futures contract when the USD stands at say Rs.57.0000. The underlying

asset in this case is the currency, USD. When the value of dollar moves up, i.e. when

Rupee depreciates, the long futures position starts making profits, and when the dollar

depreciates, i.e. when rupee appreciates, it start making losses.

Payoff for buyer of future:

The figure shows the profits/losses for a long futures position. The investor

bought futures when the USD was at Rs.57.0000. If the price goes up, his futures

position starts making profit. If the price falls, his futures position starts showing losses.

Payoff for seller of futures: Short futures

The payoff for a person who sells a futures contract is similar to the payoff for a person who shorts an asset. He has a potentially unlimited upside as well as a potentially unlimited downside. Take the case of a speculator who sells a two month currency futures contract when the USD stands at say Rs. 57.0000. The underlying asset in this case is the currency, USD. When the value of dollar moves down, i.e. when rupee appreciates, the short futures position starts making profits, and when the dollar appreciates, i.e. when rupee depreciates, it starts making losses. The Figure below shows the payoff diagram for the seller of a futures contract.

Payoff for seller of future:

The figure shows the profits/losses for a short futures position. The investor sold futures when the USD was at Rs.57.0000. If the price goes down, his futures position starts making profit. If the price rises, his futures position starts showing losses


Interpretation:

From the above figure it is clear that when US dollar goes up then long future buyers make profit and when US dollar price goes down then short future sellers make profit.

Here, spot price of 1 USD = Rs. 57.0000

PRICING FUTURES – COST OF CARRY MODEL

Pricing of futures contract is very simple. Using the cost-of-carry logic, we calculate the

fair value of a futures contract. Every time the observed price deviates from the fair

value, arbitragers would enter into trades to capture the arbitrage profit. This in turn

would push the futures price back to its fair value.

The cost of carry model used for pricing futures is given below:

F=Se^(Rh-Rf) T


1 USD Rs.57.00

Where:

Rh = Cost of financing (using continuously compounded interest rate)

Rf = one year interest rate in foreign

T=Time till expiration in years

e = 2.71828

To explain this, let us assume that one year interest rates in US and India are say 7%

and 10% respectively and the spot rate of USD in India is Rs. 44. From the equation

above the one year forward exchange rate should be

F = 44*e (0.10-0.07)*1=45.34

Suppose that the one year rate is less than this, say Rs. 44.50.

An arbitrageur can:

1. Borrow 1000 USD at 7% per annum for one year and convert to Rs. 44000 and invest

the same at 10% (both rates being continuously compounded)

2. An amount of USD 1072.5082 has to be repaid. Buy a forward contract for USD

1072.5082 for Rs. 47726.61 (i.e. Rs. 44.50*1072.5082) USD 1000 converted to Rs.

44000 and invested at 10% pa grow to Rs.52. Of this Rs. 47726.61 shall be used to buy

USD 1072.5082 and repay the loan (US Dollars borrowed earlier). The strategy

therefore leaves a risk less profit of Rs. 900.91

Suppose the rate was greater than Rs. 45.34 as given in the equation above, the

reverse strategy would work and yield risk less profit.

It may be noted from the above equation, if foreign interest rate is greater than the

domesticate i.e. rf > rh, then F shall be less than S. The value of F shall decrease

further as time T increase. If the foreign interest is lower than the domestic rate,

i.e. rf < rh, then value of F shall be greater than S. The value of F shall increase further

as time T increases.


Example-

Suppose, the spot rate is Rs. 48.0000 per USD and the prevailing continuously

compounded interest rates in India and US are 7% and 5% respectively. From the

equation above, the two years futures contract price should be Rs. 48*exp ^(.07- .05)*2.

F = 48.0000 x e^ (0.07 - .05) x 2 = 49.9589 or 49.9600

If the futures price is less than this, say Rs. 49.50, then an arbitrageur can make a profit

by:

Borrowing 1000 USD at 5% p.a. for 2 years, and converting it to INR thereby

getting Rs. 1000*48 = Rs. 48000. This will create a liability of USD 1000 * e

(0.05*2) = 1105.71.

He can invest the Rs. 48000 in a bank to earn interest @ 7% p.a.. Also, enter

into a 2 years futures contract to buy 1105.71 USD at the rate of Rs. 49.50. So

this requires an amount of Rs. 1105.71 * 49.50 = Rs. 54706 at the end of 2nd

year.

At the end of two years, the investment in the bank will mature and the investor

will receive Rs. 48000 * e (0.07*2) = Rs. 55213.

The investor can pay Rs. 54706 to obtain USD 1105.71, which will help him in

repaying the liability on the USD loan. This will leave the investor with a riskless

profit of Rs. 55213 – Rs. 54706 = Rs. 507 at the end of 2 nd year.

If the futures price is more than this , say Rs. 50.25, then an arbitrageur can make a

profit by:

Borrowing Rs. 48000 at 7% interest rate for a period of 2 years. This will create a

liability of Rs. 48000 * e (0.07 * 2) = 55213. The investor can get the Rs. 48000

converted to USD at the prevailing spot rate and obtain USD 1000 (48000/48). The

investor can invest the USD for 2 years at the rate of 5%. Simultaneously the

investor can enter into the futures contract to sell 1105.17 USD and obtain INR at

the end of 2 years, the contract exchange rate being Rs.50.2500 per USD.


At the end of 2 years the investor will get USD 1000 * e (0.05*2) = 1105.17.the

investor can then convert the USD into INR and obtain 1105.17 * 50.25 = Rs.

55535.

The investor can then repay the liability of Rs. 55213 and make a riskless profit

of Rs. 55535 – 55213 = Rs. 322

HEDGING USING IN CURENCY FUTURES

Exchange rates are quite volatile and unpredictable, it is possible that anticipated profit

in foreign investment may be eliminated, rather even may incur loss. Thus, in order to

hedge this foreign currency risk, the traders’ often use the currency futures. For

example, a long hedge (I.e.., buying currency futures contracts) will protect against a

rise in a foreign currency value whereas a short hedge (i.e., selling currency futures

contracts) will protect against a decline in a foreign currency’s value.

It is noted that corporate profits are exposed to exchange rate risk in many situation. For

example, if a trader is exporting or importing any particular product from other countries

then he is exposed to foreign exchange risk.

Similarly, if the firm is borrowing or lending or investing for short or long period from

foreign countries, in all these situations, the firm’s profit will be affected by change in

foreign exchange rates. In all these situations, the firm can take long or short position in

futures currency market as per requirement.

The general rule for determining whether a long or short futures position will hedge a

potential foreign exchange loss is:

Loss from appreciating in Indian rupee= Short hedge

Loss from depreciating in Indian rupee= Long hedge


Short hedge:

A short hedge involves taking a short position in the futures market. In a currency

market, short hedge is taken by someone who already owns the base currency or is

expecting a future receipt of the base currency. An example where this strategy can be

used : An exporter, who is expecting a receipt of USD in the future will try to fix the

conversion rate by holding a short position in the USD-INR contract.

Short hedge strategy through an example.

Exporter XYZ is expecting a payment of USD 1,000,000 after 3 months. Suppose, the

spot exchange rate is INR 57.0000: 1 USD. If the spot exchange rate after 3-months

remains unchanged, then XYZ will get INR 57,000,000 by converting the USD received

from the export contract. If the exchange rate rises to INR 58.0000: 1 USD, then XYZ

will get INR 58,000,000 after 3 months. However, if the exchange rate falls to INR

56.0000: 1 USD, then XYZ will get INR 56,000,000 thereby losing INR 1,000,000. Thus,

XYZ is exposed to an exchange rate risk, which it can hedge by taking an exposure in

the futures market .By taking a short position in the futures market, XYZ can lock-in the

exchange rate after 3- months at INR 57.0000 per USD (suppose the 3 month futures

price is Rs. 57). Since a USD-INR futures contract size is of 1000 USD, XYZ has to take

a short position in 1000 contracts. Whatever may be the exchange rate after 3-months,

XYZ will be sure of getting INR 57,000,000. A loss in the spot market will be

compensated by the profit in the futures contract and vice versa. This can be explained

as under:

If USD strengthens and the exchange

rate becomes INR 58.0000 : 1 USD

If USD weakens and the exchange


Spot Market:

XYZ will get INR 58,000,000 by selling 1

Million USD in the spot market.

Futures Market:

XYZ will lose INR (57 – 58)* 1000 = INR

1000 per contract. The total loss in 1000

Spot Market:

XYZ will get INR 56,000,000 by selling 1

Million USD in the spot market.

Futures Market:

XYZ will gain INR (57 – 56)* 1000 = INR

1000 per contract. The total gain in 1000


Contracts will be INR 1,000,000.

Net Receipts in INR:

58million – 1 million = 57 million

Contracts will be INR 1,000,000.

Net Receipts in INR:

56 million + 1 million = 57 million

An exporting firm can thus hedge itself from currency risk, by taking a short position in

the futures market. Irrespective, of the movement in the exchange rate, the exporter is

certain of the cash flow.

Long hedge:

A long hedge involves holding a long position in the futures market. A Long position

holder agrees to buy the base currency at the expiry date by paying the agreed

exchange rate. This strategy is used by those who will need to acquire base currency in

the future to pay any liability in the future. An example where this strategy can be used:

An importer who has to make payment for his imports in USD will take a long position in

USDINR contracts and fix the rate at which he can buy USD in future by paying INR An

Importer, IMP, has ordered certain computer hardware from abroad and has to make a

payment of USD 1,000,000 after 3 months. The spot exchange rate as well as the 3-

month’s future rate is INR 57.0000: 1 USD. If the spot exchange rate after 3-months

remains unchanged then IMP will have to pay INR 57,000,000 to buy USD to pay for the

import contract. If the exchange rate rises to INR 58.0000 : 1 USD, then IMP will have to

pay more - INR 58,000,000 after 3 months to acquire USD. However, if the exchange

rate falls to INR 56.0000: 1 USD, then IMP will have to pay INR 56,000,000 (INR

1,000,000 less). IMP wants to remain immune to the volatile currency markets and

wants to lock-in the future payment in terms of INR. IMP is exposed to currency risk,


which it can hedge by taking a long position in the futures market. By taking long

position in 1000 future contracts, IMP can lock-in the exchange rate after 3-months at

INR 57.0000 per USD. Whatever may be the exchange rate after 3-months, IMP will be

sure of getting the 1 million USD by paying a net amount of INR 57,000,000. A loss in

the spot market will be compensated by the profit in the futures contract and vice versa.

This can be explained as under:

If USD strengthens and the exchange


If USD weakens and the exchange


Spot Market:

IMP has to pay more i.e. INR

58,000,000 for buying 1 million USD in

The spot market.

Futures Market:

IMP will gain INR (58 – 57)* 1000 =

INR 1000 per contract. The total profit

in 1000 contracts will be INR

1,000,000.

Net Payment in INR:

– 58 million + 1 million = 57 million

Spot Market:

IMP will have to pay less i.e. INR

56,000,000 for acquiring 1 million USD

In the spot market.

Futures Market:

The importer will lose INR (57–56)*

1000 = INR 1000 per contract. The

total loss in 1000 contracts will be INR

1,000,000.

Net Payment in INR:

- 56 million - 1 million = 57 million

An importer can thus hedge itself from currency risk, by taking a long position in the

futures market. The importer becomes immune from exchange rate movement.

The choice of underlying currency

The first important decision in this respect is deciding the currency in which futures

contracts are to be initiated. For example, an Indian manufacturer wants to purchase

some raw materials from Germany then he would like future in German mark since his

exposure in straight forward in mark against home currency (Indian rupee). Assume that


there is no such future (between rupee and mark) available in the market then the trader

would choose among other currencies for the hedging in futures. Which contract should

he choose? Probably he has only one option rupee with dollar. This is called cross

hedge.

Choice of the maturity of the contract

The second important decision in hedging through currency futures is selecting the

currency which matures nearest to the need of that currency.

For example, suppose Indian importer import raw material of 100000 USD on 1st June

2012. And he will have to pay 100000 USD on 1st OCT 2012. And he predicts that the

value of USD will increase against Indian rupees nearest to due date of that payment.

Importer predicts that the value of USD will increase more than 58.0000. So what he will

do to protect against depreciating in Indian rupee? Suppose spots value of 1 USD is

57.0675.

Future Value of the USD on MCX-SX as below:

Currency future price watch (as on 22 June 2012)

ProductBuy Qty

Buy Price

Sell Price

Sell

Qty

Spread

LTPVolume(in Lots)

OI(in Lots)

Value(in

Crores)

No of Trade

s

USDINR 270612

80 57.0675 57.0700 176 0.0025 57.0700 2967803 646589 16839.39 101824

USDINR 270712

43 57.3525 57.3700 132 0.0175 57.3600 391933 546173 2234.68 18533

USDINR 290812

1 57.6025 57.6275 45 0.0250 57.6100 31650 140011 181.33 1929

USDINR 260912

100 57.7150 57.8850 4 0.1700 57.8625 10279 65179 59.05 370

USDINR 291012

26 57.9000 58.1100 5 0.2100 58.1500 2503 37888 14.43 124

USDINR 271112

102 58.0500 58.3500 5 0.3000 58.3000 1037 10364 6.00 70

USDINR 15 58.2400 58.7300 1 0.4900 58.6000 1162 7986 6.77 28


http://www.mcx-sx.com/SitePages/PriceWatch.aspx?mkt=all













271212

USDINR 290113

15 58.5150 59.1000 10 0.5850 58.8000 126 2468 0.74 7

USDINR 260213

15 58.7550 59.2500 25 0.4950 59.1000 125 6417 0.74 5

USDINR 270313

50 59.0950 59.9550 50 0.8600 59.6300 802 13947 4.78 15

USDINR 260413

1 59.0325 59.8000 10 0.7675 59.5900 871 31299 5.21 24

USDINR 290513

50 59.6100 59.9450 100 0.3350 60.0600 570 1284 3.41 17

Total: 3408861 1509605 19356.53 122946

No. of contracts- 3408861

ARCHIEVES

AS on 27 June 2012

UnderlyingUSDINR

RBI Reference Rate57.0675

Solution

He buys 100 contract of USDINR 27062012 at the rate of 57.0675.

Spot value of the contract = value of currency spot price*contract size*No of contract

= 57.0675*1000*100 = 5706750

Value of the contract = (Value of currency future per USD*contract size*No of contract).

Value of the currency future of USDINR29102012 is 57.9000

= (57.90*1000*100) = 5790000.

For that he has to pay 5% margin on 5790000.













Means he will have to pay Rs.299425 at present.

And suppose on settlement day the spot price of USD is 58.0000.

On settlement date payoff of importer will be (58.0000-57.0675) = 0.9325per USD.

And (0.9325 *100000) = Rs. 93250

Interpretation:

In Spot market importer has to pay 58, 00,000 for buying 100000 USD. And in future market importer will gain Rs.932.5 per contract and the total profit in 100 contracts is Rs. 93250. So, importer has to pay net payment (5800000 - 93250) is 5706750.

CHAPTER – 5


FINDINGS

Interest parity model is useful tool to find out the future price. By applying this I

found that the price of any currency future depends upon the interest rate or

exchange rate of particular country. Currency future of USD/INR shows that if

price of USD goes up it means Indian Rupee depreciates then borrower has to

pay the more dollars in return and vice versa.

Hedging in currency future helps to lock the standard price that helps to reduce

the risk in foreign exchange market that occurs in future trading.

New concept of Exchange traded currency future trading is regulated by higher

authority and regulatory. The whole function of Exchange traded currency future

is regulated by SEBI/RBI, and they established rules and regulation so there is

very safe trading is emerged and counter party risk is minimized in currency

Future trading. And also time reduced in Clearing and Settlement process up to

T+1 day’s basis.

Larger exporter and importer has continued to deal in the OTC counter, even

exchange traded currency future is available in markets.

There is a limit of USD 100 million on open interest applicable to trading member

who are banks. And the USD 25 million limit for other trading members so larger

exporter and importer might continue to deal in the OTC market where there is

no limit on hedges.

In India RBI and SEBI has restricted other currency derivatives except Currency

future, at this time if any person wants to use other instrument of currency

derivatives in this case he has to use OTC.

RECOMMENDATION


Currency Future need to change some restrictions it imposed such as cut off limit

of 5 million USD, Ban on NRI’s and FII’s and Mutual Funds from Participating.

The market should be efficient with widespread awareness amongst various

market players.

It is most important that the contract size should be kept at such a level that it

facilitates price discovery as well as trading, particularly for retail segment of

market.

If FIIs have to be allowed in currency future trading, there should than be a cap

on their open interest position in currency future. The positive aspects of the

entry of these securities will be that they will bring in huge volumes and liquidity

into the market.

In India the regulatory of Financial and Securities market (SEBI) has Ban on

other Currency Derivatives except Currency Futures, so this restriction seem

unreasonable to exporters and importers. And according to Indian financial

growth now it’s become necessary to introducing other currency derivatives in

Exchange traded currency derivative segment.

CONCLUSION


By far the most significant event in finance during the past decade has been the

extraordinary development and expansion of financial derivatives. These instruments

enhances the ability to differentiate risk and allocate it to those investors most able and

willing to take it- a process that has undoubtedly improved national productivity growth

and standards of livings.

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

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

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

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

minimized.

Initially only NSE had the permission but now BSE and MCX has also started currency

future. It is shows that how currency future covers ground in the compare of other

available derivatives instruments. Not only big businessmen and exporter and

importers use this but individual who are interested and having knowledge about forex

market they can also invest in currency future.

Exchange between USD-INR markets in India is very big and these exchange traded

contract will give more awareness in market and attract the investors.

BIBLIOGRAPHY


NCFM: Currency future Module.

BCFM: Currency Future Module

Report of the RBI-SEBI standing technical committee on exchange traded currency

future

Websites

www.nseindia.com

www.bseindia.com

www.moneycontrol.com

www.useindia.com

http://www.mcx-sx.com/sitepages/DayWiseTurnover.aspx

http://www.investopedia.com/articles/forex/10/introduction-currency-

http://www.economywatch.com/options-and-futures/currency-forex-futures.html

http://www.merinews.com/article/aiming-to-boost-rupee-and-economy-rbi-announces-steps/15871267.shtml

http://www.rbi.org.in/scripts/PublicationsView.aspx?id=13323

http://www.forexpros.com/charts/real-time-futures-charts

http://www.mcx-sx.com/SitePages/mkt_data.aspx

http://www.smctradeonline.com/nse-currency-futures.aspx

http://www.dalalstreetwinners.com/currency-derivatives-outlook-for-next-week30-april-to-4-may-2012/

http://bullage.co.in/currency_specifications.php


http://bullage.co.in/currency_specifications.php



http://www.smctradeonline.com/nse-currency-futures.aspx

http://www.mcx-sx.com/SitePages/mkt_data.aspx

http://www.forexpros.com/charts/real-time-futures-charts

http://www.rbi.org.in/scripts/PublicationsView.aspx?id=13323



http://www.economywatch.com/options-and-futures/currency-forex-futures.html

http://www.investopedia.com/articles/forex/10/introduction-currency-

http://www.mcx-sx.com/sitepages/DayWiseTurnover.aspx

http://www.useindia.com/

http://www.moneycontrol.com/

http://www.bseindia.com/

http://www.nseindia.com/

A Study on Currency Derivatives

Documents

vishwa vishwani institute

potentially unlimited downside

potentially unlimited upside

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interest rate parity

working days prior

chicago mercantile exchange