1 Chapter 1 INTRODUCTION 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. 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 riskof 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 oftime due to variation in exchange rates. This variability in 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 formany business firms that was the reason behind de velopment of currency derivatives.
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The financial environment today has more risks than earlier. Successful business
firms are those that are able to manage these risks effectively. Due to changes in themacroeconomic structures and increasing internationalization of businesses, there has
been a dramatic increase in the volatility of economic variables such as interest rates,
exchange rates, commodity prices etc. Firms that monitor their risks carefully and
manage their risks with judicious policies enjoy a more stable business than those who
are unable to identify and manage their risks. There are many risks which are influenced
by factors external to the business and therefore suitable mechanisms to manage and
reduce such risks need to be adopted. One of the modern day solutions to manage
financial risks is µhedging¶.
The project is all about what are the hedging instruments (Currency Derivatives)
available in India and how the business corporations are using currency derivatives as a
In India, the economic liberalization in the early nineties provided the economic
rationale for the introduction of FX derivatives. Business houses started activelyapproaching foreign markets not only with their products but also as a source of capital
and direct investment opportunities. With limited convertibility on the trade account
being introduced in 1993, the environment became even more favorable for the
introduction of these hedge products. Hence, the development in the Indian forex
derivatives market should be seen along with the steps taken to gradually reform the
Indian financial markets.
The first step towards introduction of derivatives trading in India was the
Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on
options 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. The committee recommended that the derivatives should be
declared as µsecurities¶ so that regulatory framework applicable to trading of µsecurities¶
could also govern trading of derivatives.
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.
RBI and SEBI jointly constituted a standing technical committee to analyze the
currency market around the world and lay down the guidelines to introduce Exchange
Traded Currency Futures in the Indian market. The committee submitted its report on
May 29, 2008. Further RBI and SEBI issued circulars in this regard on August 06, 2008.
Currently, Indian Currency market trades with all the major currencies like USD,
"To be a world-class financial services provider by arranging all
conceivable financial services under one-roof at affordable costs through
cost effective delivery systems, and achieve organic growth in business by
adding newer lines of business.´
1.3.2 COMPANY PROFILE
Marwadi Shares & Finance Limited is a Gujarat based financial service group
dealing in equities / commodities broking and portfolio management services. In the last
15 years MSFL has grown into a network of more than70 branches with an 850+
committed professional people and 475+ channel partners across India. MSFL has kept
the faith of over 1.90 lakh investors and it's growing. After establishing supremacy inGujarat, now expanding nationwide and to fuel growth plans they recently raised capital
from UK-based investment companies. MSFL got 5th rank in best broking houses also.
Marwadi Group strength lies in its team of confident, young, talented, qualified
and experienced professionals to carry out different functions under the able leadership of
its management.
³Marwadi Shares and Finance Limited´ is a huge and very reputed organization in
the world of securities and finance. The organization enjoys a large market share with
highly loyal customers, who in-turn provides a huge business to them.
A futures contract is an agreement between two parties to buy or sell an asset at acertain time in the future at a certain price. Futures contracts are special types of forward
contracts in the sense that they are standardized and are generally traded on an exchange.
A currency futures contract provides a simultaneous right and obligation to buy and sell a
particular currency at a specified future date, a specified price and a standard quantity.
Forwards:
A forward contract is a customized contract between two parties, where
settlement takes place on a specific date in the future at today's pre-agreed price. The
exchange rate is fixed at the time the contract is entered into. The basic objective of a
forward market in any underlying asset is to fix a price for a contract to be carried
through on the future agreed date and is intended to free both the purchaser and the seller
from any risk of loss which might incur due to fluctuations in the price of underlying
asset.
Swaps:
Swaps are agreements between two parties to exchange cash flows in the future
according to a prearranged formula. They can be regarded as portfolios of forward
contracts. The currency swap entails swapping both principal and interest between the
parties, with the cash flows in one direction being in a different currency than those in the
opposite direction. There are a various types of currency swaps like as fixed-to-fixed
currency swap, floating to floating swap, fixed to floating currency swap.
In a swap normally three basic steps are involve___
Futures is a standardized forward contract to buy (long) or sell (short) the
underlying asset at a specified price at a specified future date through a specifiedexchange. Futures contracts are traded on exchanges that work as a buyer or seller for the
counterparty. Exchange sets the standardized terms in term of quality, quantity, price
quotation, date and delivery place (in case of commodity).
Features:
The features of a futures contract may be specified as follows:
These are traded on an organized exchange like NSE, BSE, MCX etc.
These involve standardized contract terms viz. the underlying asset, the time of
maturity and the manner of maturity etc.
These are associated with a clearing house to ensure smooth functioning of the
market.
There are margin requirements and daily settlement to act as further safeguard.
These provide for supervision and monitoring of contract by a regulatory
authority.
Almost ninety percent future contracts are settled via cash settlement instead of
actual delivery of underlying asset.
Futures contracts being traded on organized exchanges impart liquidity to the
transaction. The clearinghouse, being the counter party to both sides of a transaction, provides a mechanism that guarantees the honoring of the contract and ensuring very low
CDs are used by exporters invoicing the receivables in foreign currency, willing
to protect the earnings foreign currency depreciation by locating the currency conversion
rate at a high level.
Importers:
Importers use CDs for hedging the payables in foreign currency when the foreigncurrency is expected to appreciate and they would always like to guarantee a low
conversion rate.
Investors:
Investors in foreign currency denominated securities would like to secure strong
foreign earnings by obtaining the right to sell the foreign currency at a high conversion
rate, thus defending their revenue from foreign currency derivatives.
MNCs:
MNCs use CDs being engaged in direct investment oversease. They want to
guarantee the rate of purchasing foreign currency for various payments related to
installation of a foreign branch or subsidiary, or to joint venture payment with foreign
partners.
A high degree of volatility creates a fertile ground for foreign exchange
speculators. Their objective is to guarantee a high selling rate of foreign currency by
obtaining a derivative contract while hoping to buy the currency at a low rate in the
The most commonly used instrument among the CDs is currency forward
contracts. These are large national value selling or buying contracts obtained by
Exporters, Importers, Investors and speculators from bank with the denomination
normally exceeding 2 million USD. The contracts guarantee the future conversion rate
between currencies and can be obtained for any customized amount and any date in the
future. They normally do not require any security deposits since their purchasers are
institutional investors etc. Their transaction costs are set by spread between banks buy
and sell price. Exporters are the most frequent users of this contract.
PARTICIPANTS OF CURRENCY MARKET
Hedgers:
They use derivatives markets to reduce or eliminate the risk associated with price
of an asset. Majority of the participants in derivatives market belongs to this category.
Speculators:
They transact futures and options contracts to get extra leverage in betting on
future movements in the price of an asset. They can increase both the potential gains and
potential losses by usage of derivatives in a speculative venture.
Arbitrageurs:
Their behavior is guided by the desire to take advantage of a discrepancy between
prices of more or less the same assets or competing assets in different markets. If, for
example, they see the futures price of an asset getting out of line with the cash price, theywill take offsetting positions in the two markets to lock in a profit.
In foreign exchange markets, the base currency is the first currency in a currency
pair. The second currency is called as the terms currency. Exchange rates are quoted in per unit of the base currency. That is the expression Dollar-Rupee, tells you that the
Dollar is being quoted in terms of the Rupee. The Dollar is the base currency and the
Rupee is the terms currency.
Exchange rates are constantly changing, which means that the value of one
currency in terms of the other is constantly in flux. Changes in rates are expressed as
strengthening or weakening of one currency vis-à-vis the second currency.
Changes are also expressed as appreciation or depreciation of one currency in
terms of the second currency.
Whenever the base currency buys more of the terms currency, the base currency
has strengthened / appreciated and the terms currency has weakened / depreciated.
Future 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 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 entering into an equal and opposite transaction.
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 transect at a forward price on a future date. On the maturity date, the obligation
of the individual equals to the forward price at which the contract was executed. Except
on the maturity date no money changes hands.
On the other hand in case of exchange traded currency futures contract mark to
market obligation is settled on a daily basis. Since the profit or loss in a future market are
collected/paid on a daily basis, the scope of building mark to market loss in the books of
various participants gets limited The counter party risk in future 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 the classes of
investors whether large or small to participate in the future market. The transaction on an
exchange are executed on a price time priority ensuring that the best price is available toall categories of market participant irrespective of their size. Other advantages of an
exchange traded market would be greater transparency, efficiency and accessibility.
The price at which an asset trades in the spot market. In the case of USD/INR, spot valueis T + 2.
Futures price:
The price at which the futures contract trades in the futures market.
Contract cycle:
The period over which a contract trades. The currency futures contracts on the SEBIrecognized 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 the Value date/ Final Settlement date
of each contract. The last business day would be taken to the same as that for Inter-bank
Settlements in Mumbai. The rules for Inter-bank Settlements, including those for µknown
holidays¶ and µsubsequently declared holiday¶ would be those as laid down by Foreign
Exchange Dealers¶ Association of India (FEDAI).
Expiry date:
It is the date specified in the futures contract. All contracts expire on the last working day
(excluding Saturdays) of the contract months. The last day for the trading of the contract
shall be two working days prior to the final settlement date or value date.
NSE trades Currency Derivatives contracts having near 12 calendar month expiry
cycles. All contracts expire two working days prior to the last working day of every
calendar month (subject to holiday calendars). This is also the last trading day for the
expiring contract. The contract would cease to trade at 12:00 noon on the last trading day.
A new contract with 12th month expiry would be introduced immediately ensuring
availability of 12 monthly contracts for trading at any point.
The Instrument type: FUTCUR refers to 'Futures contract on currency' andContract symbol: USDINR denotes a currency pair of 'US Dollars ± Indian Rupee'. Each
futures contract has a separate limit order book. All passive orders are stacked in the
system in terms of price-time priority and trades take place at the passive order price
(order which has come earlier and residing in the system). The best buy order for a given
futures contract will be the order to buy at the highest price whereas the best sell order
will be the order to sell at the lowest price.
Calendar spreads Minimum Rs. 250/- per contract for all months of spread
Settlement Daily settlement : T + 1
Final settlement : T + 2
Mode of settlement Cash settled in Indian Rupees
Daily settlement price
(DSP)
Calculated on the basis of the last half an hour weighted average
By far the most significant event in the finance during the past decade has been
the extraordinary development and expansion of financial derivatives. These instruments
enhance 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 futures gives the safe and standardized contract to its investors andindividuals 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
minimization.
Initially only NSE had the permission but now BSE & MCX-SX has also started
currency future contracts. It shows that how currency future covers ground in the
compare of the other available derivative instruments. Last month MCX-SX ranked top
amongst all three with more than 50% trades of currency futures contracts in India in
sense of volumes and number of contracts also.
Not only big business houses, exporters and importers use this but individuals
who are interested and having knowledge about forex market they can also invest in
currency future. At Marwadi Shares also many individual investors are investing in
currency futures.
Exchange between USD-INR markets in India is very big and along with it other
currency contracts of Euro, Pound and Japanese Yen are in the market and attracting the
investors which is the reason behind higher growth rate of currency futures in India.