S.

K SOMAIYA COLLEGE OF ARTS, SCIENCE &

COMMERCE
VIDYAVIHAR (EAST), MUMBAI - 400077

PROJECT ON:
CURRENCY FUTURES IN INDIA

MASTERS OF COMMERCE
(BANKING & FINANCE)

PART 2 (SEM-3)
(2016-2017)

Submitted:
In Partial Fulfillment of the requirements
For the Award of the Degree of
MASTERS OF COMMERCE
(BANKING & FINANCE)
BY
JIGNA M. BHANUSHALI
ROLL NO : 05
1

CERTIFICATE
This is to certify that MS. JIGNA M. BHANUSHALI of M.Com (BANKING
AND FINANCE) Semester- 3(2016-17) has successfully completed the project
on Currency futures in India under the guidance of Mr. Ravikant B.S.

________________

________________

Course Coordinator

Principal

________________
Project Guide/Internal Examiner
_______________
External Examiner
Date:

DECLARATION

I JIGNA M. BHANUSHALI student of class in M.com (BANKING

& FINANCE) PART 2 (SEM-3), ROLL NO.05 , academic year
2016-2017 Studying at S.K. SOMAIYA COLLEGE OF ARTS,
SCIENCE AND COMMERCE, hereby declare that the work done
on the project Entitled Currency Futures In India is true and
original and any Reference used in this project is duly acknowledged.

Date:
Place:
_________________
Student Signature
JIGNA BHANUSHALI
Roll No. 05

ACKNOWLEDGEMENT

Talent and capabilities are of course necessary but opportunities and good
guidance is very important things without which no person can climb those
infant ladders towards progress.
With regard to my project I would like to thank each and every one who offered
help, guidance and support whenever required.
I take immense pleasure in thanking Mr. Ravikant B.S. and other staff for their
support and guidance in the project work.
I am extremely grateful to my Mr. Ravikant B.S. for his valuable guidance and
kind suggestions.
Finally and yet importantly I would like to express my heartfelt thanks to my
beloved parents and friends for their blessings, my classmates for their help and
wishes for the successful completion of this project.

_______________
JIGNA M. BHANUSHALI

INDEX
No.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.

Particulars
Introduction
Objective of study
Defination of currency future in India
Currency derivatives
Types of financial derivatives
Utility of currency derivatives
Overview of foreign exchange market in India
Currency derivatives products
Need for exchange traded traded currency future
Future terminology
Strategies used in currency futures
Uses of currency futures
Trading process and settlement process
Regulatory framework of future currency
Comparison of forward and future currency

Page No.
6
7
8
9-11
12-14
15-16
17-18
19-20
21
22-24
25-27
28-31
32
33-34
35-36

16.
17.
18.
19.

contract
Hedging with currency futures
Conclusion
Findings
Bibliography

37-41
42
43
44

INTRODUCTION

Each country has its own currency through which both national and
international transactions are performed. All the international business
transactions involve exchange of one currency for another. The currency units
of one country are exchanged with the currency of another country. The price of
5

one currency in terms of another currency is known as Exchange-rate. The

foreign exchange market of a country provides the mechanism of exchanging
different currencies with one another and thus, facilitating transfer of purchasing
power from one currency to another. With the multiple growths of international
trade and finance all over the world, trading in foreign currency 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.
A Currency Future Contract provides a simultaneous right and obligation to buy
and sell a particular currency at a specified future date, at a specified price and a
standard quantity. The foreign currency futures were started for the first time in
the year 1972 at the International Money Market a division of Chicago
Mercantile Exchange of Chicago. The major currencies which at this exchange
launched were British Pound, Canadian Dollar, Deutsche Marks, French Franc,
Japanese Yen, Swiss Franc and Australian Dollars. Currency Future contract are
similar to other future contracts like that of commodities, interest rates and
metals etc. In the other words, in currency future market, the different
currencies are sold and purchased at the specified future date, at predetermined
price and at a specified quantity on a particular recognized exchange.

OBJECTIVES OF STUDY

The primary objective of the study is first to gain some practical knowledge
regarding the functioning of Currency Derivatives and how are they traded in
the market. Also it is necessary to understand there primary functions and
knowledge about various future derivatives instruments.
6

The other objectives were:

To study the Importance of Currency Derivatives.

To study the role of working of future and options market.

To study the process and functions of Currency Derivatives .To explore

the methodology and types of Derivatives provided in India.

To study the purpose, process, principle, functions of the Currency

Derivatives.

To study the different types of methods/techniques used to evaluate them.

To study the level of evaluations.

know the challenges which are faced in present market scenario.

DEFINITION OF CURRENCY FUTURES IN INDIA

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

CURRENCY DERIVATIVES
A currency future, also known as FX future, 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 purchase date. On NSE the price of a future contract is
8

in terms of INR per unit of other currency e.g. US Dollars. Currency future
contracts allow investors to hedge against foreign exchange risk. Currency
Derivatives are available on four currency pairs viz. US Dollars (USD), Euro
(EUR), Great Britain Pound (GBP) and Japanese Yen (JPY). Currency options
are currently available on US Dollars.

Currency Derivatives: What to Know Before You Venture In

Currency derivative offer investors an option to trade in major foreign

currencies pegged to the Indian rupee. Leading stock exchanges of India offer
futures trading contracts in different foreign currencies. A currency future, also
known as FX future, 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
purchase date.

Currency future contracts allow investors to hedge against foreign exchange risk
and gain from two-way movement of rupee against other currencies. The
trading volumes in the currency futures contracts have increased over the years,
with daily average turnover jumping to Rs 12,705 crore on the NSE in 2014-15,
from Rs 1,167 crore in 2008-09 when it was launched.

Currency derivatives are available on four currency pairs: US dollar, euro,

British pound and Japanese yen.

How to Trade

Currency derivative contracts are traded in pairs like rupee-dollar, rupee-British

pound and rupee-euro with a contract size of 1,000. The rupee-yen contract has
a lot size of 1,00,000. For example, if the one dollar is at 62.4950, then the
contract size will be at Rs 62,495 (62.4950*1000).

These contracts are quoted till the fourth decimal point. For example, traders
have a view that the dollar value will increase against the rupee, then they take a
long position (buy) in the rupee-dollar contract.

If a trader buys a dollar derivative contract at rate of 62.4950, then the total
contract value (lot size of 1,000) becomes Rs 62,495. Suppose, during the
course of trade the rate of dollar moves up to 62.4951 then the contract value
10

will jump to Rs 62,495.10. Hence, the upward or downward movement in the

fourth decimal number results in a gain or loss of 10 paise for traders.

The currency pairs are available to traders at a margin which means they pay
only some per cent value of the contract, rather than the full value, making it a
lucrative trading option among the traders. The margins for these contracts are
decided by brokers based on exchange guidelines. On an average, traders can
buy the contracts by paying a margin of 3-5 per cent of the total value of the
contract size.

Unlike stock and index future contracts, the contracts of the currency pairs
expire two working days prior to the last business day of the expiry month at
12:30 pm.

The price fluctuations in the currency contracts have a linkage to the economic
indicators of the particular country of which a person is trading the currency.
Trade balance, inflation, interest rates and political risks affect the movement of
the currency futures contracts.

11

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
12

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,
13

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

14

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 riskthe 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

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
15

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
16

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.

17

OVERVIEW OF THE FOREIGN EXCHANGE MARKET IN INDIA

During the early 1990s, India embarked on a series of structural reforms in the
foreign exchange market. The exchange rate regime, that was earlier pegged,
was partially floated in March 1992 and fully floated in March 1993. The
unification of the exchange rate was instrumental in developing a marketdetermined exchange rate of the rupee and was an important step in the progress
towards total current account convertibility, which was achieved in August
1994.
Although liberalization helped the Indian forex market in various ways, it led to
extensive fluctuations of exchange rate. This issue has attracted a great deal of
concern from policy-makers and investors. While some flexibility in foreign
exchange markets and exchange rate determination is desirable, excessive
volatility can have an adverse impact on price discovery, export performance,
sustainability of current account balance, and balance sheets. In the context of
upgrading Indian foreign exchange market to international standards, a welldeveloped foreign exchange derivative market (both OTC as well as Exchangetraded) is imperative.
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,
18

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.
Subsequently, RBI and SEBI jointly constituted a Standing Technical
Committee to analyze the Currency Forward and Future 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 also issued circulars in this regard on August 06,
2008.
Currently, India is a USD 34 billion OTC market, where all the major currencies
like USD, EURO, YEN, Pound, Swiss Franc etc. are traded. With the help of
electronic trading and efficient risk management systems, Exchange Traded
Currency Futures will bring in more transparency and efficiency in price
discovery, eliminate counterparty credit risk, provide access to all types of
market participants, offer standardized products and provide transparent trading
platform. Banks are also allowed to become members of this segment on the
Exchange, thereby providing them with a new opportunity.

19

CURRENCY DERIVATIVE PRODUCTS

Derivative contracts have several variants. The most common variants are
forwards, futures, options and swaps.

We take a brief look at various

derivatives contracts that have come to be used.

FORWARD :

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

price for a contract to be carried through on the future agreed date and is
intended to free both the purchaser and the seller from any risk of loss
which might incur due to fluctuations in the price of underlying asset.
A forward contract is customized contract between two entities, where
settlement takes place on a specific date in the future at todays preagreed price. The exchange rate is fixed at the time the contract is
entered into. This is known as forward exchange rate or simply forward
rate.

FUTURE :

20

A currency futures contract provides a simultaneous right and obligation

to buy and sell a particular currency at a specified future date, a specified
price and a standard quantity. In another word, a future contract is an
agreement between two parties to buy or sell an asset at a certain time in
the future at a certain price. Future contracts are special types of forward
contracts in the sense that they are standardized exchange-traded
contracts.
SWAP :
Swap is private agreements between two parties to exchange cash flows
in the future according to a prearranged formula. They can be regarded
as portfolio of forward contracts.
The currency swap entails swapping both principal and interest between
the parties, with the cash flows in one direction being in a different
currency than those in the opposite direction. There are a various types of
currency swaps like as fixed-to-fixed currency swap, floating to floating
swap, fixed to floating currency swap.
In a swap normally three basic steps are involve___
(1) Initial exchange of principal amount
(2) Ongoing exchange of interest
(3) Re - exchange of principal amount on maturity.

OPTIONS :
Currency option is a financial instrument that give the option holder a
right and not the obligation, to buy or sell a given amount of foreign
exchange at a fixed price per unit for a specified time period ( until the
21

expiration date ). In other words, a foreign currency option is a contract

for future delivery of a specified currency in exchange for another in
which buyer of the option has to right to buy (call) or sell (put) a
particular currency at an agreed price for or within specified period. The
seller of the option gets the premium from the buyer of the option for the
obligation undertaken in the contract. Options generally have lives of up
to one year, the majority of options traded on options exchanges .

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.
22

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.
FUTURE TERMINOLOGY
SPOT PRICE :

The price at which an asset trades in the spot market. The transaction in
which securities and foreign exchange get traded for immediate delivery.
Since the exchange of securities and cash is virtually immediate, the term,
cash market, has also been used to refer to spot dealing. In the case of
USDINR, spot value is T + 2.

FUTURE PRICE :
The price at which the future contract traded in the future market.

CONTRACT CYCLE :
The period over which a contract trades. The currency future contracts in
Indian market have one month, two month, three month up to twelve
month expiry cycles. In NSE/BSE will have 12 contracts outstanding at
any given point in time.

23

 VALUE DATE / FINAL SETTELMENT DATE :

The last business day of the month will be termed the value date /final
settlement date of each contract. The last business day would be taken to
the same as that for inter bank settlements in Mumbai. The rules for inter
bank settlements, including those for known holidays and would be
those as laid down by Foreign Exchange Dealers Association of India
(FEDAI).
SPOT PRICE :

The price at which an asset trades in the spot market. The transaction in
which securities and foreign exchange get traded for immediate delivery.
Since the exchange of securities and cash is virtually immediate, the term,
cash market, has also been used to refer to spot dealing. In the case of
USDINR, spot value is T + 2.

FUTURE PRICE :

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

CONTRACT CYCLE :

The period over which a contract trades. The currency future contracts in
Indian market have one month, two month, three month up to twelve

24

month expiry cycles. In NSE/BSE will have 12 contracts outstanding at

any given point in time.
VALUE DATE / FINAL SETTELMENT DATE :

The last business day of the month will be termed the value date /final
settlement date of each contract. The last business day would be taken to
the same as that for inter bank settlements in Mumbai. The rules for inter
bank settlements, including those for known holidays and would be
those as laid down by Foreign Exchange Dealers Association of India
(FEDAI).

25

STRATEGIES USED IN CURRENCY FUTURE

An important tool in the global financial markets, hedging is used in every asset
class to mitigate losses. This can be utilised by anyone, whether it is an
individual or corporates, to overcome the negative impact of price volatility.
For the corporates in which the business activity is dependent on import and
export of commodities, there is an automatic exposure to foreign exchange and,
hence, the need for hedging is higher. In the current context, since the world
markets are interlinked, they eventually affect and impact the movement of
currencies.
Hedging, in any asset class, is ultimately a strategy to decrease or transfer risk
in order to protect one's portfolio or business from uncertainty in prices. In case
of hedging in the foreign exchange market, a participant who is entering a trade
with the intention of protecting the existing position from an unexpected
currency move, is said to have created a forex hedge.
With the help of a forex hedge, a participant who is long in a foreign currency
pair, can protect himself from the downside risk. On the other hand, a hedger
who is short on a foreign currency pair will protect his existing position from
the upside risk.
The strategy to create a hedge would depend on the following parameters: (a)
risk component (b) risk tolerance and (c) to plan and execute the strategy.
From the point of view of Indian importers and exporters, we have tried to
explain this strategy with some illustrations. It will help us gauge better as to
why and how one should hedge, and the manner in which an importer and/or
exporter can hedge his currency risk.
26

The impact of the movement in the USD-INR currencies affects both importers
and exporters. In other words, an importer will benefit when the rupee
appreciates, while the exporter will gain when the rupee depreciates against the
US dollar. The cost of import reduces when the rupee gains strength, thus
benefiting an importer, and at the same time creating a loss for the exporter,
since a stronger rupee will reduce the export remittances when converted to
Indian rupees.
In order to reduce the risks associated with these uncertain movements in the
financial markets, both importers and exporters can utilise the derivatives
platform of currency futures. By creating an equal and opposite position in the
derivatives market, a hedge can be created.
How hedging works for an importer
Suppose an oil importer wants to purchase oil worth $1,00,000 and places his
order on 15 March 2013, with the delivery date being three months away. At the
time of placing the contract in the spot market, one US dollar is worth, say, Rs
54.50. However, suppose the Indian rupee depreciates to Rs 57 per dollar when
the payment is due in June 2013, the value of the payment for the importer goes
up to Rs 57,00,000 rather than Rs 54,50,000.
In this case, if the importer hedges the currency risk, the losses can be reduced.
Here's how the hedging strategy for the importer would work:

Had the importer not hedged his position, he would have suffered a loss of Rs
2,50,000 (Rs 57,00,000 - Rs 54,50,000). However, by creating a hedge position
on the futures platform, his losses were reduced to Rs 50,000.
27

How an exporter can use hedging

A jeweller, who is exporting gold jewellery worth US$50,000 in March 2013,
wants protection against a possible appreciation in the Indian rupee in June
2013 (spot Rs 54.50), when he receives his payment. When he is required to
make the payment in June 2013, suppose the rupee appreciates to 53. If, in this
situation, he wants to lock in the exchange rate for the above transaction, his
strategy would be as follows:

Sell US$50,000 in spot market @54.50 in June 2013. Assume that initially the
Indian rupee depreciated, but later appreciated to 53 per USD as foreseen by the
exporter at end of June 2013.

Had the exporter not hedged his position, he would have suffered a loss of Rs
25,000, but by creating a hedge he has made a profit of Rs 25,000 in the futures,
offsetting his business loss. Hence, exposure management is essential, given the

28

premise of a volatile foreign exchange market. Hedging in the currency

markets, therefore, holds prime importance.

USES OF CURRENCY FUTURES

Hedging:
Presume Entity A is expecting a remittance for USD 1000 on 27 August
08. Wants to lock in the foreign exchange rate today so that the value of
inflow in Indian rupee terms is safeguarded. The entity can do so by
selling one contract of USDINR futures since one contract is for USD
1000.
Presume that the current spot rate is Rs.43 and USDINR 27 Aug 08
contract is trading at Rs.44.2500. Entity A shall do the following:
Sell one August contract today. The value of the contract is Rs.44,250.
Let us assume the RBI reference rate on August 27, 2008 is Rs.44.0000.
The entity shall sell on August 27, 2008, USD 1000 in the spot market
and get Rs. 44,000. The futures contract will settle at Rs.44.0000 (final
settlement price = RBI reference rate).
The return from the futures transaction would be Rs. 250, i.e. (Rs.
44,250 Rs. 44,000). As may be observed, the effective rate for the
remittance received by the entity A is Rs.44. 2500 (Rs.44,000 +
29

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.

30

 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
31

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.

32

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:

TRADER
( BUYER )

TRADER
( SELLER )

Sales order

Purchase order
MEMBER
( BROKER )

Transaction on the floor (Exchange)

MEMBER
( BROKER )

Informs
CLEARING
HOUSE

It has been observed that in most futures markets, actual physical delivery of the
underlying assets is very rare and hardly it ranges from 1 percent to 5 percent.
Most often buyers and sellers offset their original position prior to delivery date
33

by taking an opposite positions. This is because most of futures contracts in

different products are predominantly speculative instruments. For example, X
purchases American Dollar futures and Y sells it. It leads to two contracts, first,
X party and clearing house and second Y party and clearing house. Assume
next day X sells same contract to Z, then X is out of the picture and the clearing
house is seller to Z and buyer from Y, and hence, this process 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.

34

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.

35

COMPARISION OF FORWARD AND FUTURES

CURRENCY CONTRACT

BASIS
Size

FORWARD
Structured as per

FUTURES
Standardized

requirement of the parties

Delivery date Tailored on individual

Standardized

needs
Method of

Established by the bank

Open auction among buyers and

transaction

or broker through

seller on the floor of recognized

electronic media

exchange.

Banks, brokers, forex

Banks, brokers, multinational

dealers, multinational

companies, institutional investors,

companies, institutional

small traders, speculators,

investors, arbitrageurs,

arbitrageurs, etc.

Participants

traders, etc.
Margins

None as such, but

Margin deposit required

compensating bank
balanced may be required
Maturity

Tailored to needs: from

Standardized

one week to 10 years

Settlement

Actual delivery or offset

36

Daily settlement to the market and

with cash settlement. No

variation margin requirements

separate clearing house

Market place

Over the telephone

At recognized exchange floor with

worldwide and computer

worldwide communications

networks

Accessibility

Delivery
Secured

Limited to large

Open to any one who is in need of

customers banks,

hedging facilities or has risk capital

institutions, etc.

to speculate

More than 90 percent

Actual delivery has very less even

settled by actual delivery

below one percent

Risk is high being less

Highly secured through margin

secured

deposit.

HEDGING WITH CURENCY FUTURES

37

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 oftenly
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 currencys 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 firms 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 form depreciating in Indian rupee= Long hedge

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
38

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 1 st November
2008. And he will have to pay 100000 USD on 1st February 2009. 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 51.000
So what he will do to protect against depreciating in Indian rupee? Suppose
spots value of 1 USD is 49.8500. Future Value of the 1USD on NSE as below:
Price Watch

39

Order Book
Contract

Best
Buy
Qty

Best
Buy
Price

Best
Sell
Price

Best
Sell
Qty

LTP

Open
Volum
Interes
e
t

USDINR
261108

464

49.8550

49.8575

712

49.855
0

USDINR
291208

189

49.6925

49.7000

612

49.730
176453 111830
0

USDINR
280109

49.8850

49.9250

49.945
0

5598

16809

USDINR
250209

100

50.1000

50.2275

50.192
5

3771

6367

USDINR
270309

100

49.9225

50.5000

49.912
5

311

892

USDINR
280409

50.0000

51.0000

50.500
0

278

USDINR
270509

51.0000

47.100
0

506

USDINR
260609

25

49.0000

50.000
0

116

USDINR
290709

48.0875

49.150
0

44

USDINR
270809

48.1625

50.5000

50.300
0

2215

USDINR
280909

48.2375

51.200
0

79

USDINR
281009

48.3100

53.1900

50.990
0

USDINR

48.3825

- 50.927

40

58506

43785

261109

Volume As On 26-NOV-2008 17:00:00

Hours IST
No. of Contracts

Rules, Byelaws &

Regulations
Membership

244645
Archives
As On 26-Nov-2008 12:00:00 Hours IST
Underlying

RBI reference
rate

USDINR

49.8500

Circulars
List of Holidays

Solution:

He should buy ten contract of USDINR 28012009 at the rate of 49.8850. Value
of the contract is (49.8850*1000*100) =4988500. (Value of currency future per
USD*contract size*No of contract).
For that he has to pay 5% margin on 5988500. Means he will have to pay
Rs.299425 at present.
And suppose on settlement day the spot price of USD is 51.0000. On settlement
date payoff of importer will be (51.0000-59.8850) =1.115 per USD. And
(1.115*100000) =111500.Rs.

Choice of the number of contracts (hedging ratio)

41

Another important decision in this respect is to decide hedging ratio HR. The value of the
futures position should be taken to match as closely as possible the value of the cash market
position. As we know that in the futures markets due to their standardization, exact match
will generally not be possible but hedge ratio should be as close to unity as possible. We
may define the hedge ratio HR as follows:

HR= VF / Vc
Where, VF is the value of the futures position and Vc is the value of the cash position.
Suppose value of contract dated 28th January 2009 is 49.8850.
And spot value is 49.8500.
HR=49.8850/49.8500=1.001.

42

CONCLUSIONS

By far the most significant event in finance during the past decade has been the
extraordinary development and expansion of

financial derivativesThese

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.

43

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.

The limitations of the study were

The analysis was purely based on the secondary data. So, any error in the
secondary data might also affect the study undertaken.
The currency future is new concept and topic related book was not
available in library and market.

The study is based only on secondary & primary data so lack of keen

observations and interactions were also the limiting factors in the proper
conclusion of the study

44

BIBLIOGRAPHY

Financial Derivatives (theory, concepts and problems) By: S.L. Gupta.

NCFM: Currency future Module.
BCFM: Currency Future Module.
Recent Development in International Currency Derivative Market by: Lucjan T. Orlowski)
Report of the RBI-SEBI standing technical committee on exchange traded currency futures)
2015
Report of the Internal Working Group on Currency Futures (Reserve Bank of India, April
2016

Websites:
www.sebi.gov.in
www.rbi.org.in
www.frost.com
www.wikipedia.com
www.economywatch.com
www.bseindia.com

45

www.nseindia.com

46