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    Currency derivatives Currency derivatives Document Transcript

    • Summer Internship Project (In Religare Securities Limited) A REPORT ON“Fundamentals of Derivatives with special reference to Currency Derivatives” Submitted to, Dr. V.J. Byra Reddy Asst. Dean, IBA, Bangalore. Submitted by, Yogesh Moule (FPB1113/072) INDUS BUSINESS ACADEMY (BATCH 2011-13)
    • Fundamentals of Derivatives with special reference to Currency Derivatives. DECLARATIONI hereby declare that I had a wonderful experience in doing this project titled“Fundamentals of Derivatives with special reference to Currency Derivatives” at“Religare Securities Ltd., Nasik” submitted in partial fulfillment of therequirements for the prestigious degree of PGDM.I hereby declare that the project done by me is true to my knowledge. The projectduration was of four months (10/05/2012 to 10/09/2012).The informationcollected by me is authentic and is done through data analysis and interpretation.The content of this report is based on information collected from differentsources and research reports.I further declare that this project report has not been submitted to any otheruniversity or institute for the award of any degree or diploma.Date: 30/09/2012 Yogesh MoulePlace: BangaloreIndus Business AcademyINDUS BUSINESS ACADEMY FPB1113/072 Page1
    • Fundamentals of Derivatives with special reference to Currency Derivatives. CERTIFICATE BY MENTORThis is to certify that the Dissertation titled “Fundamentals of Derivativeswith special reference to Currency Derivatives”by Yogesh Moulebearingthe Reg. No. FPB1113/072has been prepared under my guidance and supervision.This work has been satisfactory and is recommended for consideration towardspartial fulfillment for the PGDM program of the Indus Business Academy,Bangalore. This has not been submitted earlier to any other University orInstitution for the award of any degree/ diploma/ certificate. Date: 30/09/2012 Dr. V.J.Byra Reddy Place: Bangalore (Signature by Mentor)INDUS BUSINESS ACADEMY FPB1113/072 Page2
    • Fundamentals of Derivatives with special reference to Currency Derivatives. CERTIFICATE BY DIRECTORThis is to certify that the Dissertation titled “Fundamentals ofDerivatives with special reference to Currency Derivatives” by YogeshMoule bearing the Reg. No. FPB1113/072has been prepared under theguidance of Prof. Byra Reddy.This work has been satisfactory and isrecommended for consideration towards partial fulfillment for thePGDM program of the Indus Business Academy, Bangalore. This hasnot been submitted earlier to any other University or Institution for theaward of any degree/ diploma/ certificate.Date: 30/09/2012 Dr. Subhash SharmaPlace: Bangalore (Signature of Director)INDUS BUSINESS ACADEMY FPB1113/072 Page3
    • Fundamentals of Derivatives with special reference to Currency Derivatives.INDUS BUSINESS ACADEMY FPB1113/072 Page4
    • Fundamentals of Derivatives with special reference to Currency Derivatives. ACKNOWLEDGEMENT I take this opportunity to express my heartfelt gratitude to all thepeople who have extended their assistance and provided me the information duringthe tenure of the project. I am greatly indebted to them for their guidance andsupport throughout the project and for sparing their valuable time with me. I earnestly express to Mr. Vinay Pandey&Mr. Kiran Ahiray forgiving me this opportunity to work with Religare Securities Ltd. and also verymuch thankful to the staff of the office for their invaluable guidance, keen interest,cooperation, inspiration and of course moral support throughout my internshiptenure . This report could not have been completed without the guidanceMr.Manish Jain, CEO, INDUS BUSINESS ACADEMY,Dean Dr. Subhash Sharmaand the entire faculty at IBA. Special thanks to my project guide Dr. V.J. ByraReddy (Asst. Dean, Academics) for his expert guidance and supportthroughoutthis project. Yogesh Moule (FPB1113/072)INDUS BUSINESS ACADEMY FPB1113/072 Page5
    • Fundamentals of Derivatives with special reference to Currency Derivatives. Table of Contents1. EXECUTIVE SUMMARY .................................................................................................... 72. OBJECTIVES AND SCOPE ...................................................................................................... 9 Objectives of the study: .............................................................................................................. 9 Scope of the study ....................................................................................................................... 93. COMPANY PROFILE ............................................................................................................. 10 Vision: ....................................................................................................................................... 11 Leadership Team - Board of Directors ..................................................................................... 12 RELIGARE PRODUCT OFFERINGS .................................................................................... 134. RESEARCH METHODOLOGY.............................................................................................. 14 Type of the study ...................................................................................................................... 14 Primary data .............................................................................................................................. 14 Secondary Data: ........................................................................................................................ 145. INTRODUCTION TO DERIVATIVES............................................................................... 15 Three types of investors trade in derivatives markets ............................................................... 21 Types of Derivatives: ................................................................................................................ 236. CURRENCY DERIVATIVES ............................................................................................. 35 Factors Affecting Exchange Rates: ........................................................................................... 38 Currency Futures ....................................................................................................................... 42 NSEs Currency Derivatives Segment: ..................................................................................... 46 Base Currency/ Terms Currency: .............................................................................................. 507. FINDINGS, SUGGESTIONS & CONCLUSION ................................................................ 548. BIBLIOGRAPHY ................................................................................................................. 64INDUS BUSINESS ACADEMY FPB1113/072 Page6
    • Fundamentals of Derivatives with special reference to Currency Derivatives. 1. EXECUTIVE SUMMARY A derivative is a collective name used for a broad class of financial instruments thatderive their value from other financial instruments (known as the underlying), events orconditions. The Derivatives Market is meant as the market where exchange of derivatives takesplace. Derivatives are one type of securities whose price is derived from the underlying assets.The value of these derivatives is determined by the fluctuations in the underlying assets. Theseunderlying assets are most commonly stocks, bonds, currencies, interest rates, commodities andmarket indices. Derivatives allow financial institutions and other participants to identify, isolate andmanage separately the market risks in financial instruments and commodities for the purpose ofhedging, speculating, arbitraging price differences and adjusting portfolio risks. Derivatives offerthe possibility of large rewards; many individuals have a strong desire to invest in derivatives.Derivatives like forwards, futures, options, swaps etc. are extensively used in many developedand developing countries of the world.Financial markets are, by nature, extremely volatile andhence the risk factor is an important concern for financial agents. To reduce this risk, the conceptof derivatives comes into the picture. There are mainly three categories of traders in the Derivative market, those areHedgerswhouses futures or options market to reduce or eliminate the risk associatedwith price of anasset.Speculatorsuse futures and options contracts to get extra leverage in betting onfuturemovements in the price of an asset. They can increase both the potentialgains and potential lossesby usage of derivatives in a speculative venture.Arbitrageursare in business to take advantageof a discrepancy between prices intwo different markets. The main objectives of the study are: To study the fundamental terms used in derivativesmarket, to know in detail about what is currency derivatives, to know the price fluctuationshappening in currency derivatives market. The main findings of the study are: most of investors go through broker’s suggestionbecause they don’t have much knowledge and also they don’t know how to trade in derivatives,about 44% of the investors are professional who knows the derivative market very well. AndINDUS BUSINESS ACADEMY FPB1113/072 Page7
    • Fundamentals of Derivatives with special reference to Currency Derivatives.second highest majority lies in employees, though there is huge scope from government forderivatives still people hesitate to invest in derivatives, they even don’t know about manystrategies that they can apply to minimize their risk. Currency derivatives are getting popularnow-a-days due to their attractive return on investments. The main conclusion of the study are: the challenges of building awareness and educatingthe people about derivatives, active marketing of the product have all required significant efforts inpaving the way for a vibrant derivatives market. The market has made enormous progress in termsof technology, transparency and the trading activity.INDUS BUSINESS ACADEMY FPB1113/072 Page8
    • Fundamentals of Derivatives with special reference to Currency Derivatives. 2. OBJECTIVES AND SCOPEObjectives of the study:  To study the concept of derivatives and the purpose for which financial institutions adopt derivatives.  To understand the potentiality of the derivatives as an investment avenues.  To study the growth of Currency derivatives in Indian Capital Market.  To study the performance of Currency derivative as compared to NSE’s NIFTY. Scope of the study: From its inception, trading in Currency derivative has started gaining interest among the investors. It is been seen as an investment & risk reducing tool by individual investors as well as corporate or institutional investors. As its only been 4 years from when the trading in Currency derivative has started, there is a huge scope in this type of Derivative segment.INDUS BUSINESS ACADEMY FPB1113/072 Page9
    • Fundamentals of Derivatives with special reference to Currency Derivatives. 3. COMPANY PROFILE Religare is a financial services company in India, offering a wide range of financial products and services targeted at retail investors, high net worth individuals and corporate and institutional clients. Religare is promoted by the promoters of Ranbaxy Laboratories Limited. Religare operate from six regional offices and 25 sub-regional offices and have a presence in 330 cities and towns controlling 979 locations which are managed either directly by Religare or by our Business Associates all over India, the company has a representative office in London. While the majority of Religare offices provide the full complement of its services yet it has dedicated offices for investment banking, institutional brokerage, portfolio management services and priority client services. Religare Enterprises Limited is the holding company & its principal subsidiaries include: Religare Securities Limited (―RSL‖) Religare Finvest Limited (―RFL‖) Religare Commodities Limited (―RCL‖) Religare Insurance Broking Limited (―RIBL‖)INDUS BUSINESS ACADEMY FPB1113/072 Page10
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Vision:"To be the leading emerging markets financial services group driven byinnovation, delivering superior value for all stakeholders globally"With the worldwide economic rebalancing, emerging markets are increasingly becoming thedrivers of the global economy, offering more opportunities and calling for more capital. Religareis positioned right in the center of this emerging paradigm. We are focused on tapping theseopportunities and growing along with our key stakeholders.This vision animates Three Pillar Strategy that seeks to maximize value from our vast presencein India and to build a financial services franchise that connects the most promising emergingmarkets globally.Religare‟s Three Pillar Strategy: An Integrated Indian Financial Services Platform that leverages the robust Indian growth story, providing solid breadth and depth to the financial services sector, resulting in rapid growth of profit pools. An Emerging Markets Capital Markets Platform that intermediates the flow of capital into and out of emerging markets based on its global reach and an on-the-ground understanding of how emerging markets function. A Global Asset Management Platform that brings together niche asset managers with proven track record and capabilities in the alternatives space.INDUS BUSINESS ACADEMY FPB1113/072 Page11
    • Fundamentals of Derivatives with special reference to Currency Derivatives. Leadership Team - Board of DirectorsMr. Sunil GodhwaniChairman & Managing DirectorReligare Enterprises Limited.Mr. Sunil Godhwani, Chairman and Managing Director, Religare Enterprises Limited (REL), isthe driving force behind the group and its vision. Sunil brings to the table strong leadershipskills, vigor and a passion for excellence. He believes in nurturing a culture that isentrepreneurial, result oriented, customer focused and based on teamwork. He has given strategicdirection to Religare’s growth since his joining in 2001 and has been a key force in giving birthto Religare’s current shape and form globally. Mr. Shachindra Nath Group Chief Executive Officer Religare Enterprises Limited Mr. Anil Saxena Director & Group CFO Mr. Ravi Mehrotra Director Mr. Harpal Singh Non-Executive Director Mr. Stuart D Pearce DirectorINDUS BUSINESS ACADEMY FPB1113/072 Page12
    • Fundamentals of Derivatives with special reference to Currency Derivatives. RELIGARE PRODUCT OFFERINGSReligare has divided its product and service offering under three broad client interfacecategories:―Retail Spectrum‖, ―Wealth Spectrum‖ and ―Institutional Spectrum‖ as per following details :- Retail Spectrum Wealth Spectrum Institutional SpectrumCaters to a large number of retail To provide customized To forge and build strongclients by offering all products wealth advisory services relationships withunder one roof through our to high net worth corporate and institutionalbranch network individuals clientsand online mode To providecustomizedwealth advisory services to highnet worth individuals Equity and Commodity Wealth Advisory InstitutionalTrading Services EquityBroking Personal Financial Portfolio Investment BankingServices ManagementServi Merchant Banking o Distribution of ces mutual funds International o Transaction Advisory o Distribution of Equity o Services insurance Priority Client o Distribution of EquityServices savings products Personal Credit Arts Initiative o Personal loanservices o Loans against shares Online InvestmentINDUS BUSINESS ACADEMY FPB1113/072 Page13
    • Fundamentals of Derivatives with special reference to Currency Derivatives. 4. RESEARCH METHODOLOGYType of the study: This is a descriptive study; analysis is made on the basis of primary data and secondary data.Primary data: Data is collected by interviews and direct discussions with clients, employees and staff in the office.Secondary Data: 1. NCFM modules 2. Journals and Books 3. Websites of Religare Securities Ltd., NSE, BSE, MCX, NCDEX, etc.Data collected form NSE, BSE and other stock exchanges through Internet alongwith the previous reports and journals and NCFM course modules.In this project I have used Secondary data most of which was obtained frominternal records of the Company. Usage of Secondary data enjoys some advantagesbut it suffers some limitations too.INDUS BUSINESS ACADEMY FPB1113/072 Page14
    • Fundamentals of Derivatives with special reference to Currency Derivatives. 5. INTRODUCTION TO DERIVATIVES Derivatives are financial instruments whose price is determined by some underlyingvariables. Derivatives can be traded directly between the two parties as well as throughexchanges. There are different types of derivatives based on the type of assets that it deals insuch as commodity, equity, bond, interest rate, index and so on. Mainly there are four types ofderivatives that are traded – Future, Forward, Options and Swaps. In case of stock marketderivative trading essentially means trading in future contracts and options. In derivative trading,stocks are bought in the form of contracts and in a lot. Due to their great flexibility, derivatives are used by many different types of investors. Agood toolbox of derivatives allows the modern investor the full range of investment strategy:speculation, hedging, arbitrage and all combinations thereof. When one reads about derivativesoffering the sophisticated management of risk - this is not just marketing hype. They truly dooffer the fund management, the insurance and pension industries additional ways to achieve theirinvestment targets. The biggest advantage of derivative trading is that one can buy huge amount of stock bypaying only a part of the total value of the stock. As in derivative trading one have to buy thestocks in a lot the price of the lot is relatively lower than the total amount stock one get. So, thismeans there is a chance of making profit even by investing a comparatively less money. Derivative trading also lets short sell the stocks. That means one can sell the stocks evenbefore one actually own them. This is beneficial when one has an idea that the price of aparticular stock is going to reduce. In derivative trading one can first sell the stock at a higherprice and then buy the equal number of stocks when the price has gone down. In that way onecan make profit in derivative trading even if the price is going down. Derivatives are used for risk management, investing, and speculative purposes. Importantinstitutional users are: banks, brokers, dealers, B/Ds, mutual funds, investment companies,insurers, producers, and other organizations which have financial interests and exposures.Derivatives allow financial institutions and other participants to identify, isolate and manageINDUS BUSINESS ACADEMY FPB1113/072 Page15
    • Fundamentals of Derivatives with special reference to Currency Derivatives.separately the market risks in financial instruments and commodities for the purpose of hedging,speculating, arbitraging price differences and adjusting portfolio risks.Evolution of derivatives in Indian capital markets The precursor to exchange based derivatives in India was a kind of ―forward trading‖ insecurities in the form to call options (teji), put options (mandi) and straddles (fatak) etc. TheSecurities Contracts Regulation Act, 1956 (SCRA) was enacted, inter-alia, to prevent undesirablespeculation in securities. The contracts for ―clearing‖ commonly known as ―forward trading‖ were banned by theCentral Government through a notification issued on 27th, June1969 in exercise of the powersconferred under Section 16 of the SCRA. As the prohibition of forward trading in securities ledto a decline of traded volumes on stock markets, the Stock Exchange, Mumbai (BSE), evolved in1972 an informal system of ―forward trading‖, which allowed carry forward between twosettlement periods, which resulted in substantial increase in the turnover of the exchange.However, this also created several problems and there were payment crises from time to time andfrequent closure of the market. Later SCRA amended the bye-laws of stock exchanges tofacilitate performance of contracts in ―specified securities‖. In pursuance of this policy the stockexchanges at Bombay, Calcutta and Ahmadabad introduced a system of trading in ―specifiedshares‖ with carry forward facility after amending their bye-laws and regulations.INDUS BUSINESS ACADEMY FPB1113/072 Page16
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Types of Derivatives Products which are legally permitted To Be Traded InIndian Markets. Equity Derivatives (Index/stock future/options)-Legally permitted to be traded Through stock exchanges approved by SEBI. Commodity Trading – Commodity futures are permitted. Commodity futures are Permitted only for trading in commodities approved by the Government in Commodity Exchanges, which are recognized by Forward Markets Commission.OptionContracts in commodities trading are not permitted. Foreign Exchange Derivatives- Forward Contracts as approved by RBI permitted to be transacted by Banks and other approved foreign-exchange dealers. OTC rupee derivatives in the form of Forward Rate Agreements (FRAs/Interest Rate Swaps (IRS) – These were introduced by RBI in India in July 1999 in terms powers vested with it Foreign Exchange Management Act, 2000. These derivatives enable banks, primary dealers (PDs) and all- India financial institutions (FIs) to hedge interest rate risk for their own balance sheet management and for market making purposes. Banks /PDs/FIs can undertake different types of plain vanilla FRAs/IRS. Swaps having explicit/implicit option features such as caps/floors/collars are not permitted now. Exchange Traded Interest Rate Derivatives – were introduced by RBI/SEBI during June, 2003. These can be traded through stock exchanges by primary dealers subject to conditions stipulated by RBI/ OTC Rupee derivatives are presently not permitted.INDUS BUSINESS ACADEMY FPB1113/072 Page17
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Derivatives products traded in the Indian markets are as under; Commodities Futures for Coffee, Oil Seeds, Oil (Castor, Palmolein), Pepper, Cotton, Jute and Jute Goods are traded in the Commodities Futures. Forward Markets Commission regulates the trading of commodities futures. Index futures based on Sensex and Nifty Index are also traded under the supervision of SEBI. RBI has permitted Banks, FIs and PDs to enter into forward rate agreement(FRAs)/ interest rate swaps in order to facilitate hedging of interest rate risks and ensuring orderly development of the derivatives market; NSE become the first exchange to launch trading in options on individual securities. Trading in options on individual securities commenced from July 2, 2001. Options contracts are American style and cash settled and are available on 41 securities stipulated by the Securities & Exchange Board of India (SEBI). NSE commenced trading in futures on individual securities on November9, 2001. The futures contracts are available on 41 securities stipulated by the Securities &Exchange Board of India (SEBI).BSE also has started trading in individual stock options & futures (both index & Stocks) around the same time as NSE.INDUS BUSINESS ACADEMY FPB1113/072 Page18
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Calendar of Introduction of Derivatives Products in Indian Financial Market: OTC Exchange Traded 1980s - Currency Forwards June 2000 – Equity Index futures 1997s - Long term FC – June 2001 – Equity Index Options Rupee swaps July 2001 - Stock Options July 1999 - Interest rate June 2000 - Interest Rate Futures swaps and FRAs Nov 2002- RBI Working Group on Rupee July 2003 - FC – Rupee Derivatives options March 2003- RBI Working group on credit derivatives Product Specifications BSE-30 Sensex Futures Contract Size – Rs. 50 times the Index Tick Size – 0.1 points or Rs. 5 Expiry day – last Thursday of the month Settlement basis – cash settled Contract cycle – 3 months Active contracts – 3 nearest months Product Specification S&P CNX Nifty Futures Contract Size – Rs. 200 times the Index Tick Size – 0.05 points or Rs. 10 Expiry day – last Thursday of the month Settlement basis – cash settled Contract cycle- 3 months Active contracts – nearest monthsINDUS BUSINESS ACADEMY FPB1113/072 Page19
    • Fundamentals of Derivatives with special reference to Currency Derivatives.The following factors have been driving the growth of financial derivatives: Over the last 3 decades, Derivatives market has seen a phenomenal growth. Largevarieties of Derivative contracts have been launched at exchanges across the world. Some of thefactors driving the growth of financial Derivatives are: Increased volatility in asset prices in financial market Increased integration of national financial market with the international market Market improvement in communication facilities and sharp decline in their costs Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies, and Innovations in the derivatives markets, which optimally combine the risks and returns over a large number of financial assets, leading to higher returns, reduced risk as well as trans-actions costs as compared to individual financial assets.ECONOMIC FUNCTION OF DERIVATIVE MARKET In spite of the fear and criticism with which the derivative markets are commonly lookedat, these markets perform a number of economic functions Prices in an organized Derivatives market reflect the perception of market participants about the future and lead the prices of underlying to the perceived to the perceived future level. The prices of Derivatives coverage with the prices of the underlying at the expiration of the derivative contract. The derivatives help in discovery of future as well as current prices. The derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them. Derivatives, due to their inherent nature, are linked to the underlying cash markets. With the introduction of derivatives, the underlying market witness higher trading volumes because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk.INDUS BUSINESS ACADEMY FPB1113/072 Page20
    • Fundamentals of Derivatives with special reference to Currency Derivatives. Speculative traders shift to a more controlled environment of derivatives market. In the absence of an organized derivatives market, speculators trade in the underlying cash markets. Margining, monitoring and surveillance of the activities of various participants become extremely difficult in these kinds of mixed markets. An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity. The derivatives have a history of attracting many bright, creative well-educated people with an entrepreneurial attitude. They often energize others to create new business, new products and new employment opportunities, the benefit of which is immense. Derivatives markets help increase savings and investment in the long run. Transfer of risk enables market participants to expand their volume of activity. Derivatives thus promote economic development to the extent the later depends on the rate of savings and investment.Three types of investors trade in derivatives markets:Hedgers: Hedgers are those who protect themselves from the risk associated with the price of anasset by using derivatives. In Hedging, financial derivatives act as a financial instrument totransfer risk. A person keeps a close watch upon the prices discovered in trading and when thecomfortable price is reflected according to his wants, he sells futures contracts. Since one cantake either a long position or a short position in the futures contract, there are two basic hedgepositions. For example, from another perspective, the farmer and the miller both reduce a risk andacquire a risk when they sign the futures contract: The farmer reduces the risk that the price ofwheat will fall below the price specified in the contract and acquires the risk that the price ofwheat will rise above the price specified in the contract (thereby losing additional income that hecould have earned). The miller, on the other hand, acquires the risk that the price of wheat willfall below the price specified in the contract (thereby paying more in the future than he otherwisewould) and reduces the risk that the price of wheat will rise above the price specified in theINDUS BUSINESS ACADEMY FPB1113/072 Page21
    • Fundamentals of Derivatives with special reference to Currency Derivatives.contract. In this sense, one party is the insurer (risk taker) for one type of risk, and thecounterparty is the insurer (risk taker) for another type of risk.The benefits of hedging are: 1. It is uncomplicated to handle. 2. The risk is minimized for both parties. 3. The trades can take the risk, without actually buying the future stock.Speculators: Speculators wish to bet on future movements in the price of an asset. Derivatives can be used to acquire risk, rather than to insure or hedge against risk. Thus, some individuals and institutions will enter into a derivative contract to speculate on the value of the underlying asset, betting that the party seeking insurance will be wrong about the future value of the underlying asset. Speculators will want to be able to buy an asset in the future at a low price according to a derivative contract when the future market price is high, or to sell an asset in the future at a high price according to a derivative contract when the future market price is low. They are the second major group of futures players. These participants includeIndependent floor traders and investors. They handle trades for their personal clients or brokerage firms. Buying a futures contract in anticipation of price increases is known as .going long. Selling a futures contract in anticipation of a price decrease is known as .going short. While profits could be extremely high, potential for losses are also large.Arbitrageurs: Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. Arbitrage is a risk-less profit realized by simultaneous trading in two or more markets.INDUS BUSINESS ACADEMY FPB1113/072 Page22
    • Fundamentals of Derivatives with special reference to Currency Derivatives. In commodity market Arbitrators are the person who takes the advantage of a Discrepancy between prices in two different markets. If he finds future prices of Commodity edging out with the cash price, he will take offsetting positions in both the markets to lock in a profit. Moreover the commodity futures investor is not charged interest on the difference between margin and the full contract valueTypes of Derivatives:FORWARD: A forward contract or simply a forward is a non-standardized contract between twoparties to buy or sell an asset at a specified future time at a price agreed today. This is in contrastto a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter aforward contract. The party agreeing to buy the underlying asset in the future assumes a longposition, and the party agreeing to sell the asset in the future assumes a short position. The priceagreed upon is called the delivery price, which is equal to the forward price at the time thecontract is entered into. The forward price of such a contract is commonly contrasted with the spot price, which isthe price at which the asset changes hands on the spot date. The difference between the spot andthe forward price is the forward premium or forward discount, generally considered in the formof a profit, or loss, by the purchasing party. Forwards, like other derivative securities, can be used to hedge risk (typically currency orexchange rate risk), as a means of speculation, or to allow a party to take advantage of a qualityof the underlying instrument which is time-sensitive. The promised asset may be currency,commodity, instrument etc. It is the oldest type of all the derivatives. A forward contract istraded in an OTC market. The contract price of a forward contract is not transparent, as it is notpublicly disclosed. A forward contract is less liquid and counterparty risk is high due to itscustomized nature.INDUS BUSINESS ACADEMY FPB1113/072 Page23
    • Fundamentals of Derivatives with special reference to Currency Derivatives.FUTURES: A futures contract is a standardized contract between two parties to buy or sell aspecified asset of standardized quantity and quality at a specified future date at a price agreedtoday (the futures price). The contracts are traded on a futures exchange. Futures contracts arenot "direct" securities like stocks, bonds, rights or warrants. They are still securities, however,though they are a type of derivative contract. The party agreeing to buy the underlying asset inthe future assumes a long position, and the party agreeing to sell the asset in the future assumes ashort position. The price is determined by the instantaneous equilibrium between the forces of supplyand demand among competing buy and sell orders on the exchange at the time of the purchase orsale of the contract.In many cases, the underlying asset to a futures contract may not betraditional "commodities" at all – that is, for financial futures, the underlying asset or item can becurrencies, securities or financial instruments and intangible assets or referenced items such asstock indexes and interest rates.The future date is called the delivery date or final settlement date.The official price of the futures contract at the end of a days trading session on the exchange iscalled the settlement price for that day of business on the exchange. Futures traders are traditionally placed in one of two groups: hedgers, who have aninterest in the underlying asset (which could include an intangible such as an index or interestrate) and are seeking to hedge out the risk of price changes; and speculators, who seek to make aprofit by predicting market moves and opening a derivative contract related to the asset "onpaper", while they have no practical use for or intent to actually take or make delivery of theunderlying asset. In other words, the investor is seeking exposure to the asset in a long futures orthe opposite effect via a short futures contract. Future contract get expires at every last Thursday of every month.If you buy October month expiry future contract then you have to sell it within last Thursday ofOctober month.INDUS BUSINESS ACADEMY FPB1113/072 Page24
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Major Advantages of Futures Trading over Stock Trading: Margin is available: In future trading you get margin to buy (but can hold only up to maximum of 3 months), while in stock trading you must have that much of amount in your account to buy. Possible to do short selling: You can short sell futures- You can sell futures without buying them which is called short selling and later buy within your expiry period, to cover up your positions. This is not possible in stocks. You can’t sell stocks before buying them in delivery (you can do in intraday). You can short sell futures and can cover off within your expiry period. Brokerages are low: Brokerages offered for future trading are less as compared to stock delivery trading. Futures contracts, or simply futures, (but not future or future contracts) are exchangetraded derivatives. The exchanges clearing house acts as counterparty on all contracts, setsmargin requirements, and crucially also provides a mechanism for settlement.OPTIONS:An option is a contract between a buyer and a seller that gives the buyer of the option the right,but not the obligation, to buy or to sell a specified asset (underlying) on or before the optionsexpiration time, at an agreed price, the strike price. In return for granting the option, the seller collects a payment (the premium) from thebuyer. Granting the option is also referred to as "selling" or "writing" the option. The buyer willexercise his right only if it is favorable to him. If it is not, he will not exercise his right becausehe has no obligation. Thus, the underlying asset moves from to another only when the option isexercised. When it moves from one counterpart to another, its price (in cash) must move in theINDUS BUSINESS ACADEMY FPB1113/072 Page25
    • Fundamentals of Derivatives with special reference to Currency Derivatives.opposite direction. The amount of price in cash is fixed at the time of contract and is called thestrike price or exercise price. A call option gives the buyer of the option the right but not the obligation to buy the underlying at the strike price. A put option gives the buyer of the option the right but not the obligation to sell the underlying at the strike price. If the buyer chooses to exercise this right, the seller is obliged to sell or buy the asset atthe agreed price. The buyer may choose not to exercise the right and let it expire. The underlyingasset can be a piece of property, a security (stock or bond), or a derivative instrument, such as afutures contract. The theoretical value of an option is evaluated according to several models. Thesemodels, which are developed by quantitative analysts, attempt to predict how the value of anoption changes in response to changing conditions. Hence, the risks associated with granting,owning, or trading options may be quantified and managed with a greater degree of precision,perhaps, than with some other investments. Exchange-traded options form an important class ofoptions which have standardized contract features and trade on public exchanges, facilitatingtrading among independent parties. Over-the-counter options are traded between private parties,often well-capitalized institutions that have negotiated separate trading and clearingarrangements with each other.Option styles: Naming conventions are used to help identify properties common to many different typesof options. Mainly include: European option - an option that may only be exercised on expiration. Americanoption - an option that may be exercised on any trading day on or before expiration.INDUS BUSINESS ACADEMY FPB1113/072 Page26
    • Fundamentals of Derivatives with special reference to Currency Derivatives.The basic trades of traded stock options: These trades are described from the point of view of a speculator. If they are combinedwith other positions, they can also be used in hedging. An option contract in US markets usuallyrepresents 100 shares of the underlying security.Long call: A trader who believes that a stocks price will increase might buy the right to purchasethe stock rather than just buy the stock. He would have no obligation to buy the stock, only theright to do so until the expiration date. If the stock price at expiration is above the exercise priceby more than the premium paid, he will profit. If the stock price at expiration is lower than theexercise price, he will let the call contract expire worthless, and only lose the amount of thepremium.Long put: A trader who believes that a stocks price will decrease can buy the right to sell the stockat a fixed price. He will be under no obligation to sell the stock, but has the right to do so untilthe expiration date. If the stock price at expiration is below the exercise price by more than thepremium paid, he will profit. If the stock price at expiration is above the exercise price, he willlet the put contract expire worthless and only lose the premium paid.Short call: A trader, who believes that a stock price will decrease, can sell the stock short or insteadsell, or "write," a call. The trader selling a call has an obligation to sell the stock to the call buyerat the buyers option. If the stock price decreases, the short call position will make a profit in theamount of the premium. If the stock price increases over the exercise price by more than theamount of the premium, the short will lose money, with the potential loss unlimited.Short put: A trader who believes that a stock price will increase can buy the stock or instead sell aput. The trader selling a put has an obligation to buy the stock from the put buyer at the putbuyers option. If the stock price at expiration is above the exercise price, the short put positionwill make a profit in the amount of the premium. If the stock price at expiration is below theINDUS BUSINESS ACADEMY FPB1113/072 Page27
    • Fundamentals of Derivatives with special reference to Currency Derivatives.exercise price by more than the amount of the premium, the trader will lose money, with thepotential loss being up to the full value of the stock.SWAPS: A swap is a derivative in which two counterparties exchanges certain benefits of onepartys financial instrument for those of the other partys financial instrument. The benefits inquestion depend on the type of financial instruments involved. Specifically, the twocounterparties agree to exchange one stream of cash flows against another stream. These streamsare called the legs of the swap. The swap agreement defines the dates when the cash flows are tobe paid and the way they are calculated. Usually at the time when the contract is initiated at leastone of these series of cash flows is determined by a random or uncertain variable such as aninterest rate, foreign exchange rate, equity price or commodity price. The cash flows are calculated over a notional principal amount, which is usually notexchanged between counterparties. Consequently, swaps can be used to create unfundedexposures to an underlying asset, since counterparties can earn the profit or loss from movementsin price without having to post the notional amount in cash or collateral. Swaps can be used to hedge certain risks such as interest rate risk, or to speculate onchanges in the expected direction of underlying prices.Swap market Most swaps are traded over-the-counter (OTC), "tailor-made" for the counterparties.Some types of swaps are also exchanged on futures markets such as the Chicago MercantileExchange Holdings Inc., the largest U.S. futures market, the Chicago Board Options Exchange,Intercontinental Exchange and Frankfurt-based Eurex AG.INDUS BUSINESS ACADEMY FPB1113/072 Page28
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Types of swaps: The five generic types of swaps, in order of their quantitative importance, are: interestrate swaps, currency swaps, credit swaps, commodity swaps and equity swaps. There are alsomany other types. a. Interest rate swaps:A is currently paying floating, but wants to pay fixed. B is currently paying fixed but wants topay floating. By entering into an interest rate swap, the net result is that each party can swaptheir existing obligation for their desired obligation. Normally the parties do not swap paymentsdirectly, but rather, each sets up a separate swap with a financial intermediary such as a bank. Inreturn for matching the two parties together, the bank takes a spread from the swap payments. The most common type of swap is a ―plain Vanilla‖ interest rate swap. It is the exchangeof a fixed rate loan to a floating rate loan. The life of the swap can range from 2 years to over 15years. The reason for this exchange is to take benefit from comparative advantage somecompanies may have comparative advantage in fixed rate markets while other companies have acomparative advantage in floating rate markets. When companies want to borrow they look forcheap borrowing i.e. from the market where they have comparative advantage. However thismay lead to a company borrowing fixed when it wants floating or borrowing floating when itwants fixed. This is where a swap comes in. A swap has the effect of transforming a fixed rateloan into a floating rate loan or vice versa. b. Currency swaps A currency swap involves exchanging principal and fixed rate interest payments on aloan in one currency for principal and fixed rate interest payments on an equal loan in anothercurrency. Just like interest rate swaps, the currency swaps also are motivated by comparativeadvantage. c. Commodity swapsINDUS BUSINESS ACADEMY FPB1113/072 Page29
    • Fundamentals of Derivatives with special reference to Currency Derivatives. A commodity swap is an agreement whereby a floating (or market or spot) price isexchanged for a fixed price over a specified period. The vast majority of commodity swapsinvolve crude oil. d. Equity Swap An equity swap is a special type of total return swap, where the underlying asset is astock, a basket of stocks, or a stock index. Compared to actually owning the stock, in this caseyou do not have to pay anything up front, but you do not have any voting or other rights thatstock holders do have. e. Credit default swaps A credit default swap (CDS) is a swap contract in which the buyer of the CDS makes aseries of payments to the seller and, in exchange, receives a payoff if a credit instrument -typically a bond or loan - goes into default (fails to pay). Less commonly, the credit event thattriggers the payoff can be a company undergoing restructuring, bankruptcy or even just havingits credit rating downgraded. A CDS contract has been compared with insurance, because thebuyer pays a premium and, in return, receives a sum of money if one of the events specified inthe contract occur. Unlike an actual insurance contract the buyer is allowed to profit from thecontract and may also cover an asset to which the buyer has no direct exposure.WARRANT:INDUS BUSINESS ACADEMY FPB1113/072 Page30
    • Fundamentals of Derivatives with special reference to Currency Derivatives. In finance, a warrant is a security that entitles the holder to buy stock of the issuingcompany at a specified price, which can be higher or lower than the stock price at time of issue. Warrants and Options are similar in that the two contractual financial instruments allowthe holder special rights to buy securities. Both are discretionary and have expiration dates. Theword Warrant simply means to "endow with the right", which is only slightly different to themeaning of an Option.Structure and features Warrants have similar characteristics to that of other equity derivatives, such as options,for instance: Exercising: A warrant is exercised when the holder informs the issuer their intention to purchase the shares underlying the warrant. The warrant parameters, such as exercise price, are fixed shortly after the issue of the bond. With warrants, it is important to consider the following main characteristics: Premium: A warrants "premium" represents how much extra you have to pay for your shares when buying them through the warrant as compared to buying them in the regular way. Gearing (leverage): A warrants "gearing" is the way to ascertain how much more exposure you have to the underlying shares using the warrant as compared to the exposure you would have if you buy shares through the market. Expiration Date: This is the date the warrant expires. If you plan on exercising the warrant you must do so before the expiration date. The more time remaining until expiry, the more time for the underlying security to appreciate, which, in turn, will increase the price of the warrant (unless it depreciates). Therefore, the expiry date is the date on which the right to exercise no longer exists. Restrictions on exercise: Like options, there are different exercise types associated with warrants such as American style (holder can exercise anytime before expiration) or European style (holder can only exercise on expiration date).Warrants are longer-dated options and are generally traded over-the-counter.INDUS BUSINESS ACADEMY FPB1113/072 Page31
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Types of warrantsA wide range of warrants and warrant types are available. The reasons you might invest in onetype of warrant may be different from the reasons you might invest in another type of warrant. Equity warrants: Equity warrants can be call and put warrants. o Callable warrants: give you the right to buy the underlying securities o Put able warrants: give you the right to sell the underlying securities Covered warrants: A covered warrants is a warrant that has some underlying backing, for example the issuer will purchase the stock before hand or will use other instruments to cover the option. Basket warrants: As with a regular equity index, warrants can be classified at, for example, an industry level. Thus, it mirrors the performance of the industry. Index warrants: Index warrants use an index as the underlying asset. Your risk is dispersed—using index call and index put warrants—just like with regular equity indexes. It should be noted that they are priced using index points. That is, you deal with cash, not directly with shares. Wedding warrants: are attached to the host debentures and can be exercised only if the host debentures are surrendered Detachable warrants: the warrant portion of the security can be detached from the debenture and traded separately. Naked warrants: are issued without an accompanying bond, and like traditional warrants, are traded on the stock exchange.Other Categorization of Derivatives Products:INDUS BUSINESS ACADEMY FPB1113/072 Page32
    • Fundamentals of Derivatives with special reference to Currency Derivatives.We can also categorize derivative products based on the mode or the place of trading.1. Exchange traded derivatives: Derivatives traded on the regulated exchange are highly standardized, (example – exchange traded future & options). Options & futures contracts are standardized. In other words, the parties to the contracts do not decide the terms of futures/option contract; but they merely accept terms of contracts standardized by the Exchange. Exchange traded derivatives offer the maximum protection to the investor thanks to various regulatory measures enforced by SEBI to provide for fairness and transparency in trading.2. Over the counter derivatives: Encompass tailored financial derivatives, such as swaps, swaptions, caps and collars that are traded in the offices of the world’s leading financial institutions. These are individually agreed between two counter-parties.Commodities:A Strong Investment Option: Commodities, a known avenue for investment, had always generated economic interestespecially among investors. In recent years, commodities have emerged as an asset class on theirown, and are currently perceived to be in the Peers of stocks and shares, bonds, other securitiesand real estate. On many occasions, commodities have outperformed other asset classes and arebecoming distinctive in the investment basket of tactical investors. They are also part of the assetdiversification strategy of investors. Indian Commodity market having its roots dating back a century ago got its new globalface with the development of national commodity exchanges and has now become the best placeto park the investment money. With India being a franchiser of global commodity market, thereis renewed interest in derivatives trading. The organized Indian Commodity Market is at itsnascent stage and a large potential to provide enormous opportunities to the investors and othermarket participants.Commodity Derivative Exchanges:INDUS BUSINESS ACADEMY FPB1113/072 Page33
    • Fundamentals of Derivatives with special reference to Currency Derivatives. The commodity market is a market, where commodities are bought and sold. The main function of the commodity exchange is assurance of regular communication between buyers and sellers, when transactions are carried out with available batches of goods. Commodity Markets and Commodity Futures are a mechanism for hedging. In the commodity futures exchanges the peak value of trading have touched Rs 15,000 crore on some days with the average around of Rs 6,000 crore. Open interests in certain commodities such as gold, silver, rubber, pepper, Soya are also substantial. The modern commodity markets have their roots in the trading of agricultural products For centuries, sugar has been a highly valued and widely traded commodity. The main advantages of a call option are protection against higher prices, limited liability with no margin deposits, and the potential to benefit from lower cash prices. The National Commodity Derivatives Exchange (NCDEX) has emerged as the largest commodity futures exchange. The Government of India recognized three nation-wide multi commodity exchanges to promote a healthy, competitive futures market. It was rightly presumed that there is room for multiple players to grow in size and stature in the huge commodity economy of India.Operational Definitions:INDUS BUSINESS ACADEMY FPB1113/072 Page34
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Currency:Any form of money issued by a government or central bank and used as legal tenderand a basis for Forex trade.Currency Pair:The two currencies that make up a foreign exchange rate are known as CurrencyPair. For Example, USDINRCash Market: It isthe market in the actual financial instrument on which a futures or optionscontract is based.Stock Exchange:An association or a company or any other body corporate that provide thetrading platform for currencies.Derivative contract:A derivative is a product whose value is derived from the value of one ormore underlying variable or asset in a contractual manner. The underlying asset can be equity,foreign exchange, commodity or any other asset. The price of derivative is driven by the spotprice.Long position:A position that appreciates in value if market prices increase. When the basecurrency in the pair is bought, the position is said to be long.Short position:An investment positions that benefit from a decline in market price. When thebase currency in the pair is sold, the position is said to be short.Lot:A unit to measure the amount of the deal. The value of the deal always corresponds to aninteger number of lots. 6. CURRENCY DERIVATIVESINDUS BUSINESS ACADEMY FPB1113/072 Page35
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Foreign exchange rate is the value of a foreign currency relative to domestic currency. Theexchange of currencies is done in the foreign exchange market, which is one of the biggestfinancial markets. The participants of the market are banks, corporations, exporters, importersetc. A foreign exchange contract typically states the currency pair, the amount of the contract,the agreed rate of exchange etc.Exchange RateA foreign exchange deal is always done in currency pairs, for example, US Dollar - IndianRupee contract (USD - INR); British Pound - INR (GBP- INR), Japanese Yen - U.S. Dollar(JPY- USD), U.S. Dollar - Swiss Franc (USD-CHF) etc. Some of the liquid currencies in theworld are USD, JPY, EURO, GBP, and CHF and some of the liquid currency contracts areon USD-JPY, USD-EURO, EURO-JPY, USD-GBP, and USD-CHF. The prevailing exchangerates are usually depicted in a currency table like the one given below:Currency Table: Date: 28 June 2009 Time: 15:15 hours USD .JPY EUR IIIIR GBP USD 1.000 95.318 0.711 48.053 0.606 JPY 0.010 1.000 0.007 0.504 0.006 EUR 1.406 134.033 1.000 67.719 0.852 INR 0.021 1.984 0.015 1.000 0.013 GBP 1.651 157.43 1.174 79.311 1.000In a currency pair, the first currency is referred to as the base currency and the secondcurrency is referred to as the counter/terms/quote currency. The exchange rate tells the worth ofthe base currency in terms of the terms currency, i.e. for a buyer, how much of the termscurrency must be paid to obtain one unit of the base currency. For example, a USD-INR rateof Rs. 48.0530 implies that Rs. 48.0530 must be paid to obtain one US Dollar. Foreignexchange prices are highly volatile and fluctuate on a real time basis. In foreign exchangecontracts, the price fluctuation is expressed as appreciation/depreciation or thestrengthening/weakening of a currency relative to the other. A change of USD-INR rate fromRs. 48 to Rs. 48.50 implies that USD has strengthened/ appreciated and the INR hasINDUS BUSINESS ACADEMY FPB1113/072 Page36
    • Fundamentals of Derivatives with special reference to Currency Derivatives.weakened/depreciated, since a buyer of USD will now have to pay more INR to buy 1USDthan before.Fixed Exchange Rate Regime and Floating Exchange Rate Regime:There are mainly two methods employed by governments to determine the value of domesticcurrency vis-a-vis other currencies: fixed and floating exchange rate.Fixed exchange rate regime:Fixed exchange rate, also known as a pegged exchange rate, is when a currencys value ismaintained at a fixed ratio to the value of another currency or to a basket of currencies or toany other measure of value e.g. gold. In order to maintain a fixed exchange rate, a governmentparticipates in the open currency market. When the value of currency rises beyondthe permissible limits, the government sells the currency in the open market, therebyincreasing its supply and reducing value. Similarly, when the currency value falls beyondcertain limit, the government buys it from the open market, resulting in an increase in itsdemand and value. Another method of maintaining a fixed exchange rate is by making it illegalto trade currency at any other rate. However, this is difficult to enforce and often leads to ablack market in foreign currency.Floating exchange rate regime:Unlike the fixed rate, a floating exchange rate is determined by a market mechanism throughsupply and demand for the currency. A floating rate is often termed "self-correcting", as anyfluctuation in the value caused by differences in supply and demand will automaticallybe corrected by the market. For example, if demand for a currency is low, its value willdecrease, thus making imported goods more expensive and exports relatively cheaper. Thecountries buying these export goods will demand the domestic currency in order to makepayments, and the demand for domestic currency will increase. This will again lead toappreciation in the value of the currency. Therefore, floating exchange rate is self correcting,INDUS BUSINESS ACADEMY FPB1113/072 Page37
    • Fundamentals of Derivatives with special reference to Currency Derivatives.requiring no government intervention. However, usually in cases of extreme appreciation ordepreciation of the currency, the countrys Central Bank intervenes to stabilize thecurrency. Thus, the exchange rate regimes of floating currencies are more technically called amanaged float.Factors Affecting Exchange Rates:There are various factors affecting the exchange rate of a currency. They can be classified asfundamental factors, technical factors, political factors and speculative factors.Fundamental factors:The fundamental factors are basic economic policies followed by the government in relationto inflation, balance of payment position, unemployment, capacity utilization, trends in importand export, etc. Normally, other things remaining constant the currencies of the countriesthat follow sound economic policies will always be stronger. Similarly, countries havingbalance ofpayment surplus will enjoy a favorable exchange rate. Conversely, for countriesfacing balance of payment deficit, the exchange rate will be adverse.Technical factors:Interest rates: Rising interest rates in a country may lead to inflow of hot money in thecountry, thereby raising demand for the domestic currency. This in turn causes appreciation inthe value of the domestic currency.Inflation rate: High inflation rate in a country reduces the relative competitiveness of theexport sector of that country. Lower exports result in a reduction in demand of the domesticcurrency and therefore the currency depreciates.Exchange rate policy and Central Bank interventions: Exchange rate policy of the countryis the most important factor influencing determination of exchange rates. For example, a countrymay decide to follow a fixed or flexible exchange rate regime, and based on this, exchangeINDUS BUSINESS ACADEMY FPB1113/072 Page38
    • Fundamentals of Derivatives with special reference to Currency Derivatives.rate movements may be less/more frequent. Further, governments sometimes participate inforeign exchange market through its Central bank in order to control the demand or supply ofdomestic currency.Political factors:Political stability also influences the exchange rates. Exchange rates are susceptible to politicalinstability and can be very volatile during times of political crises.Speculation:Speculative activities by traders worldwide also affect exchange rate movements. For example,if speculators think that the currency of a country is over valued and will devalue in nearfuture, they will pull out their money from that country resulting in reduced demand for thatcurrency and depreciating its value.QuotesIn currency markets, the rates are generally quoted in terms of USD. The price of a currency interms of another currency is called quote. A quote where USD is the base currency is referredto as a direct quote (e.g. 1 USD - INR 48.5000) while a quote where USD is referred to as theterms currency is an indirect quote (e.g. 1INR = 0.021USD).USD is the most widely traded currency and is often used as the vehicle currency. Use ofvehicle currency helps the market in reduction in number of quotes at any point of time, sinceexchange rate between any two currencies can be determined through the USD quote forthose currencies. This is possible since a quote for any currency against the USD is readilyavailable. Any quote not against the USD is referred to as cross since the rate is calculatedvia the USD.INDUS BUSINESS ACADEMY FPB1113/072 Page39
    • Fundamentals of Derivatives with special reference to Currency Derivatives.For example, the cross quote for EUR-GBP can be arrived through EUR-USD quote * USD-GBP quote (i.e. 1.406 * 0.606 = 0.852). Therefore, availability of USD quote for all currenciescan help in determining the exchange rate for any pair of currency by using the cross-rate.Tick-Size:Tick size refers to the minimum price differential at which traders can enter bids and offers.For example, the Currency Futures contracts traded at the NSE have a tick size of Rs. 0.0025.So, if the prevailing futures price is Rs. 48.5000, the minimum permissible price movement cancause the new price to be either Rs. 48.4975 or Rs. 48.5025. Tick value refers to the amount ofmoney that is made or lost in a contract with each price movement.Spreads:Spreads or the dealers margin is the difference between bid price (the price at which a dealer iswilling to buy a foreign currency) and ask price (the price at which a dealer is willing to sell aforeign currency). the quote for bid will be lower than ask, which means the amount to be paidin counter currency to acquire a base currency will be higher than the amount of countercurrency that one can receive by selling a base currency. For example, a bid-ask quote forUSDINR of Rs. 47.5000 - Rs. 47.8000 means that the dealer is willing to buy USD bypaying Rs. 47.5000 and sell USD at a price of Rs. 47.8000. The spread or the profit of thedealer in this case is Rs. 0.30.Spot Transaction and Forward Transaction:INDUS BUSINESS ACADEMY FPB1113/072 Page40
    • Fundamentals of Derivatives with special reference to Currency Derivatives.The spot market transaction does not imply immediate exchange of currency, rather thesettlement (exchange of currency) takes place on a value date, which is usually two businessdays after the trade date. The price at which the deal takes place is known as the spot rate(also known as benchmark price). The two-day settlement period allows the parties to confirmthe transaction and arrange payment to each other.A forward transaction is a currency transaction wherein the actual settlement date is at aspecified future date, which is more than two working days after the deal date. The date ofsettlement and the rate of exchange (called forward rate) is specified in the contract. Thedifference between spot rate and forward rate is called forward margin". Apart from forwardcontracts there are other types of currency derivatives contracts, which are covered insubsequent chapters.Foreign Exchange Spot (cash) marketThe foreign exchange spot market trades in different currencies for both spot andforwarddelivery. Generally they do not have specific location, and mostly take place primarilybymeans of telecommunications both within and between countries.It consists of a network offoreign dealers which are often banks, financial institutions, large concerns, etc. The large banksusually make markets in different currencies.In the spot exchange market, the business is transacted throughout the world on acontinual basis.So it is possible to transaction in foreign exchange markets 24 hours aday. The standardsettlement period in this market is 48 hours, i.e., 2 days after theexecution of the transaction.Thespot foreign exchange market is similar to the OTC market for securities. There is nocentralizedmeeting place and any fixed opening and closing time. Since most of thebusiness in this marketis done by banks, hence, transaction usually do not involve aphysical transfer of currency, rathersimply book keeping transfer entry among banks.Exchange rates are generally determined bydemand and supply force in this market.The purchase and sale of currencies stem partly from theneed to finance trade in goodsand services. Another important source of demand and supplyarises from theparticipation of the central banks which would emanate from a desire to influencethedirection, extent or speed of exchange rate movements.INDUS BUSINESS ACADEMY FPB1113/072 Page41
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Currency Futures:Derivatives are financial contracts whose value is determined from one or more underlyingvariables, which can be a stock, a bond, an index, an interest rate, an exchange rate etc. Themost commonly used derivative contracts are forwards and futures contracts and options.There are other types of derivative contracts such as swaps, swaptions, etc. Currencyderivatives can be described as contracts between the sellers and buyers whose values arederived from the underlying which in this case is the Exchange Rate. Currency derivatives aremostly designed for hedging purposes, although they are also used as instruments forspeculation.Currency markets provide various choices to market participants through the spot market orderivatives market. Before explaining the meaning and various types of derivatives contracts,let us present three different choices of a market participant. The market participant may enterinto a spot transaction and exchange the currency at current time.The market participant wants to exchange the currency at a future date. Here the marketparticipant may either:  Enter into a futures/forward contract, whereby he agrees to exchange the currency in the future at a price decided now, or,  Buy a currency option contract, wherein he commits for a future exchange of currency, with an agreement that the contract will be valid only if the price is favorable to the participant.Forward Contracts:INDUS BUSINESS ACADEMY FPB1113/072 Page42
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Forward contracts are agreements to exchange currencies at an agreed rate on a specifiedfuture date. The actual settlement date is more than two working days after the deal date. Theagreed rate is called forward rate and the difference between the spot rate and the forwardrate is called as forward margin. Forward contracts are bilateral contracts (privatelynegotiated), traded outside a regulated stock exchange and suffer from counter-party risksand liquidity risks. Counter Party risk means that one party in the contract may default onfulfilling its obligations thereby causing loss to the other party.Futures ContractsFutures contracts are also agreements to buy or sell an asset for a certain price at a futuretime. Unlike forward contracts, which are traded in the over-the-counter market with nostandard contract size or standard delivery arrangements, futures contracts are exchangetraded and are more standardized. They are standardized in terms of contract sizes, tradingparameters, settlement procedures and are traded on a regulated exchange. The contract size isfixed and is referred to as lot size.Since futures contracts are traded through exchanges, the settlement of the contract isguaranteed by the exchange or a clearing corporation and hence there is no counter party risk.Exchanges guarantee the execution by holding an amount as security from both the parties.This amount is called as Margin money. Futures contracts provide the flexibility of closingout the contract prior to the maturity by squaring off the transaction in the market. Table3.1draws a comparison between a forward contract and a futures contract.Comparison of Forward and futures Contracts:INDUS BUSINESS ACADEMY FPB1113/072 Page43
    • Fundamentals of Derivatives with special reference to Currency Derivatives. ForwardContract FuturesContract NatureofContract Non- Standardizedcontract standardized/Customized contract Trading InformalOver-the-Countermarket; Tradedonanexchange Privatecontractbetweenparties Settlement Single - Pre-specified Dailysettlement,known inthe contract asDaily mark tomarket settlement and Final Settlement. Risk Counter-Partyrisk is present since Exchangeprovidesthe noguaranteeisprovided guaranteeof settlementand hence nocounter partyrisk.Hedging using Currency Futures:Hedging in currency market can be done through two positions, viz. Short Hedge and LongHedge. They are explained as under: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 futurereceipt of the base currency.Long Hedge:A long hedge involves holding a long position in the futures market. A Long position holderagrees to buy the base currency at the expiry date by paying the agreed exchange rate. Thisstrategy is used by those who will need to acquire base currency in the future to pay anyliability in the future.Speculation in Currency Futures:Futures contracts can also be used by speculators who anticipate that the spot price in the futurewill be different from the prevailing futures price. For speculators, who anticipate aINDUS BUSINESS ACADEMY FPB1113/072 Page44
    • Fundamentals of Derivatives with special reference to Currency Derivatives.strengthening of the base currency will hold a long position in the currency contracts,in order toprofit when the exchange rates move up as per the expectation. A speculator who anticipates aweakening of the base currency in terms of the terms currency, will hold a short position in thefutures contract so that he can make a profit when the exchange rate moves down.Speculation in Futures MarketSuppose the current USD-INR spot rate is INR 48.0000 per USD. Assume that the current 3-months prevailing futures rate is also INR 48.0000 per USD. Speculator ABC anticipates thatdue to decline in Indias exports, the USD (base currency) Is going to strengthen against INRafter 3 months. ABC forecasts that after three months the exchange rate would be INR 49.50per USD. In order to profit,ABC has two options:Option A: Buy 1000 USD in the spot market, retain it for three months, and sell them after 3months when the exchange rate increases: This will require an investment of Rs. 48,000 on thepart of ABC (although he will earn some Interest on Investing the USD). On maturity date,Ifthe USD strengthens as per expectation (i.e. exchange rate becomes INR 49.5000 perUSD),ABC will earn Rs. (49.50 - 48)*1000, i.e. Rs. 1500 as profit.Option B: ABC can take a long position in the futures contract - agree to buy USD after 3months@ Rs. 48.0000 per USD: In a futures contract,the parties will just have to pay only themargin money upfront. Assuming the margin money to be 10% and the contract size Is USD1000, ABC will have to Invest only Rs. 4800 per contract.With Rs. 48,000, ABC can enterinto 10 contracts. The margin money will be returned once the contract expires.After 3 months, if the USD strengthens as per the expectation, ABC will earn the differenceon settlement. ABC will earn (Rs 49.5000 - 48.0000) * 1000,i.e. Rs. 1500 per contract. SinceABC holds long position In 10 contracts, the total profit will be Rs. 15000.However, if theexchange rate does not move as per the expectation, say the USD depreciates and the exchangeINDUS BUSINESS ACADEMY FPB1113/072 Page45
    • Fundamentals of Derivatives with special reference to Currency Derivatives.rate after 3 months becomes Rs. 47.0000 per USD, then in option A, ABC will lose only Rs.(48-47) * 1000 = Rs. 1000, but In option B,ABC will lose Rs. 10000 (Rs. 1000 per contract *10 contracts).Thus taking a position in futures market, rather than in spot market, give speculators a chanceto make more money with the same investment (Rs.48,000). However,if the exchange rate doesnot move as per expectation, the speculator will lose more in the futures market than in thespot market. Speculators are willing to accept high risks in the expectation of highreturns.Speculators prefer taking positions in the futures market to the spot market because ofthe low investment required in case of futures market. In futures market, the parties are requiredto pay just the margin money upfront, but in case of spot market, the parties have to invest thefull amount, as they have to purchase the foreign currency.NSEs Currency Derivatives Segment:The phenomenal growth of financial derivatives across the world is attributed to thefulfillment of needs of hedgers, speculators and arbitrageurs by these products. In this chapterINDUS BUSINESS ACADEMY FPB1113/072 Page46
    • Fundamentals of Derivatives with special reference to Currency Derivatives. we look at contract specifications, participants, the payoff of these contracts, and finally at how these contracts can be used by various entities at the NSE. Contract specification:Underlying Rate of exchangebetweenone USD andINRTradingHours(MondaytoFriday) 09:00a.m.to 05:00p.m.ContractSize USD1000Tick Size 0.25paise orINR 0.0025TradingPeriod Maximumexpirationperiodof12 monthsContractMonths 12 near calendarmonthsFinal Settlementdate/Value date Last workingday ofthe month(subject to holidaycalendars)LastTradingDay Two workingdays priortoFinalSettlementDateSettlement CashsettledFinal SettlementPrice The reference rate fixed by RBI two workingdays priorto the finalsettlement datewillbeused for final settlement Basisoftrading The NEAT-CDSsystemsupports an orderdrivenmarket,whereinordersmatchautomatically. Ordermatchingis essentiallyon thebasisof security,itspriceand time.All quantityfieldsare INDUS BUSINESS ACADEMY FPB1113/072 Page47
    • Fundamentals of Derivatives with special reference to Currency Derivatives. incontractsand pricein Indianrupees.The exchangenotifiesthecontractsize and ticksize for eachof thecontractstradedon thissegmentfromtimetotime.Whenany orderentersthe tradingsystem,itisan activeorder.Ittriestofindamatchon theoppositeside of thebook.If itfindsa match,a tradeis generated.Ifitdoes notfinda match,theorderbecomespassive and sits in therespectiveoutstandingorderbookinthesystem. Corporatehierarchy Inthetradingsoftware,atradingmemberhas thefacilityof definingahierarchyamongstusers of thesystem.Thishierarchycomprisescorporatemanager,branchmanagerand dealer. 1) Corporatemanager:The termCorporatemanageris assignedtoauserplacedatthe highestlevelina tradingfirm.Such a usercan performall thefunctionssuchas orderand traderelatedactivities,receivingreportsfor all branchesof thetradingmemberfirmand also all dealersof thefirm.Additionally,acorporatemanagercan definelimitsfor thebranchesand dealersofthe firm.2) Branch manager: The branch manager is a term assigned to a user who is placed underthe corporate manager. Such a user can perform and view order and trade related activitiesfor all dealers under that branch. Additionally, a branch manager can define limits for thedealers under that branch.3) Dealer: Dealers are users at the lower most level of the hierarchy. A dealer must belinked either with the branch manager or corporate manager of the firm. A Dealer canperform view order and trade related activities only for oneself and does not have access toinformation on other dealers under either the same branch or other branches.INDUS BUSINESS ACADEMY FPB1113/072 Page48
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Cases given below explain activities possible for specific user categories: Corporate manager of the clearing memberCorporate manager of the clearing member has limited rights on the trading system. Acorporate manager of the clearing member can perform following functions:  On line custodian/ give up trade confirmation/ rejection for the participants  Limit set up for the trading member I participants  View market information like trade ticker, Market Watch etc.  View net position of trading member I Participants Corporate Manager of the trading memberThis is the top level of the trading member hierarchy with trading right. A corporate managerof the trading member can broadly perform following functions:  Order management and trade management for self  View market infonmation  Set up branch level and dealer level trading limits for any branch/ dealer of the trading member  View, modify or cancel outstanding orders on behalf of any dealer of the tradingmember  View, modify or send cancel request for trades on behalf of any dealer of the trading member  View day net positions at branch level and dealer level and cumulative net position atfirm level. Branch manager of trading memberThe next level in the trading member hierarchy with trading right is the branchmanager. One or more dealers of the trading member can be a branch managerINDUS BUSINESS ACADEMY FPB1113/072 Page49
    • Fundamentals of Derivatives with special reference to Currency Derivatives.for the trading member. A branch manager of the trading member can broadlyperform the following functions:  Ordermanagementand trademanagementofself  View marketinformation  Set up dealerleveltradinglimitsfor any dealerlinkedwiththebranch  View, modify or cancel the outstanding orders on behalf of any dealers linked with the branch  View, modify or send cancel request for trades on behalf of any dealer of the dealer  linked with the branch  View day net positions at branch level and dealer levelFOREIGN EXCHANGE QUOTATIONSForeign exchange quotations can be confusing because currencies are quoted in terms of othercurrencies. It means exchange rate is relative price. For example, If one US dollar is worth of Rs.45 in Indian rupees then it implies that 45Indian rupees will buy one dollar of USA, or that onerupee is worth of 0.022 US dollar which is simply reciprocal of the former dollar exchange rate.Base Currency/ Terms Currency:In foreign exchange markets, the base currency is the first currency in a currency pair.Thesecond currency is called as the terms currency. Exchange rates are quoted in per unit of the basecurrency. That is the expression Dollar-Rupee, tells you that the Dollar isbeing quoted in termsof the Rupee. The Dollar is the base currency and the Rupee is theterms currency.Exchange ratesare constantly changing, which means that the value of one currency interms of the other isconstantly in flux. Changes in rates are expressed as strengtheningor weakening of one currencyvis-à-vis the second currency. Changes are also expressed as appreciation or depreciation of onecurrency in terms of the second currency. Whenever the base currency buys more of the termscurrency, thebase currency has strengthened / appreciated and the terms currency has weakened/depreciated.For example,if Dollar – Rupee moved from Rs. 43.00 to Rs. 43.25 the Dollar hasINDUS BUSINESS ACADEMY FPB1113/072 Page50
    • Fundamentals of Derivatives with special reference to Currency Derivatives.appreciated and the Rupee has depreciated. And if it moved from 43.0000 to 42.7525 the Dollarhas depreciated and Rupee has appreciated. It has been observed that in most futures markets, actual physical delivery of theunderlying assets is very rare and hardly has it ranged from 1 percent to 5 percent. This isbecause most of futures contracts in different products are predominantly speculativeinstruments. For example, X purchases American Dollar futures and Y sells it. It leads to twocontracts, first, X party and clearing house and second Y party and clearing house. Assume nextday X sells same contract to Z, then X is out of the picture and the clearing house is seller to Zand buyer from Y, and hence, this process is goes on.REGULATORY FRAMEWORK FOR CURRENCYFUTURES 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 currencyforwards, swaps and options in the OTC market. At the same time, RBI also set up an InternalWorking Group to explore the advantages of introducing currency futures. With the expectedbenefits of exchange traded currency futures, it was decided in a joint meeting of RBI and SEBIon February 28, 2008, that an RBI-SEBI Standing Technical Committee on Exchange TradedCurrency and Interest Rate Derivatives would be constituted. To begin with, the Committee would evolve norms and oversee the implementation ofExchange traded currency futures. The Terms of Reference to the Committee was as under: 1. tocoordinate the regulatory roles of RBI and SEBI in regard to trading of Currency and InterestRate Futures on the Exchanges.2.To suggest the eligibility norms for existing and newExchanges for Currency and Interest Rate Futures trading.3.To suggest eligibility criteria for themembers of such exchanges.Currency futures were introduced in recognized stock exchanges in India in August 2008. Thecurrency futures market is subject to the guidelines issued by the Reserve Bank of India (RBI)and the Securities Exchange Board of India (SEBI) from time to time. Amendments were alsomade to the Foreign Exchange Management Regulations to facilitate introduction of thecurrency futures contracts in India. Earlier persons resident in India had access only to theINDUS BUSINESS ACADEMY FPB1113/072 Page51
    • Fundamentals of Derivatives with special reference to Currency Derivatives.over-the-counter (OTC) products for hedging their currency risk, which included - forwards,swaps, options. Introduction of exchange traded currency futures contracts has facilitatedefficient pricediscovery, counterparty risk management, wider participation (increasedliquidity) and lowered the transaction costs etc.MembershipCategories of membership (NSE)Members are admitted in the Currency Derivatives Segments in the following categories: Only Trading Membership of NSEMembership in this category entitles a member to execute trades on his own account as well asaccount of his clients in the Currency Derivatives segment. However, clearing and settlementof trades executed through the Trading Member would have to be done through a Trading-cumClearing Member or Professional Clearing Member on the Currency Derivatives Segment ofthe Exchange (Clearing and settlement is done through the National Securities ClearingCorporation Ltd. - NSCCL, a wholly owned subsidiary of the NSE). The exchange assigns aunique trading member ID to each trading member. Each trading member can have more thanone user and each user is assigned a unique User-ID.Orders by trading members on their own account are called proprietary orders and ordersentered by the trading members on behalf of their clients are called client orders. TradingMembers are required to specify in the order, whether they are proprietary orders or clientsorders. Both Trading Membership of NSE and Clearing Membership of NSCCLMembership in this category entitles a member to execute trades on his own account as well ason account of his clients and to clear and settle trades executed by themselves as well as byINDUS BUSINESS ACADEMY FPB1113/072 Page52
    • Fundamentals of Derivatives with special reference to Currency Derivatives.other trading members who choose to use clearing services of the member in the CurrencyDerivatives Segment. Professional Clearing Membership of NSCCLThese members are not trading members. Membership in this category entitles a member toclear and settle trades of such members of the Exchange who choose to clear and settletheir trades through this member. SEBI has allowed banks to become clearing memberand/or trading member of the Currency Derivatives Segment of an exchange. Self Clearing Membership of NSCCLMembership in this category entitles a member to clear and settle transactions on its ownaccount or on account of its clients only. A Self-Clearing member is not entitled to clear or settletransactions in securities for any other trading member(s). Self clearing membership may beavailed jointly with trading membership on Currency Derivatives segment and would beseparately registered with SEBI. New members and existing SEBIregistered members on othersegments of National Stock Exchange may apply for self clearing membership jointly withtrading membership of Currency Derivatives segment,subject to fulfillment of prescribedeligibility criteria. Further,existing trading members on Currency Derivatives Segment may alsoapply for self clearingmembership,subject to fulfillment of prescribed eligibility criteria.Who cannot become a member?Further to the capital and network requirements, no entity will be admitted as a member/partneror director of the member if:INDUS BUSINESS ACADEMY FPB1113/072 Page53
    • Fundamentals of Derivatives with special reference to Currency Derivatives. It has been adjudged bankrupt or a receiver order in bankruptcy has been made against him or he has been proved to be insolvent even though he has obtained his final discharge; It has compounded with his creditors for less than full discharge of debts; It has been convicted of an offence involving a fraud or dishonesty; It is engaged as a principal or employee in any business other than that of Securities, except as a broker or agent not involving any personal financial liability or for providing merchant banking, underwriting or corporate or investment advisory services, unless he undertakes to severe its connections with such business on admission, if admitted; It has been at any time expelled or declared a defaulter by any other Stock Exchange or he has been debarred from trading in securities by an Regulatory Authorities like SEBI, RBIetc; It incurs such disqualification under the provisions of the Securities Contract (Regulations) Act, 1956 or Rules made there-under so as to disentitle such persons from seeking membership of a stock exchange; It incurs such disqualification consequent to which NSE determines it to be not in public interest to admit him as a member on the Exchange, provided that in case of registered firms, body corporates and companies, the condition will apply to, all partners in case of partnership firms, all directors in case of companies; The entity is not a fit and proper person in terms of the SEBIguidelines 7. FINDINGS, SUGGESTIONS & CONCLUSION Findings:INDUS BUSINESS ACADEMY FPB1113/072 Page54
    • Fundamentals of Derivatives with special reference to Currency Derivatives. New concept of Exchange traded currency future trading is regulated by higher authority and regulatory. The whole function of Exchange tradedcurrency future is regulated by SEBI/RBI, and they established rules andregulation so there is very safe trading is emerged and counter party risk isminimized in currency Future trading. And also time reduced in Clearing andSettlement process up to T+1 day’s basis. Larger exporter and importer has continued to deal in the OTC counter evenexchange traded currency future is available in markets because, there is a limit of USD 100 million on open interest applicable to tradingmember who are banks. And the USD 25 million limit for other tradingmembers so larger exporter and importer might continue to deal in the OTCmarket where there is no limit on hedges. In India RBI and SEBI has restricted other currency derivatives exceptCurrency future, at this time if any person wants to use other instrument of currency derivatives in this case he has to use OTC. Data of USD-INR Futures Currency Prices (June 2012)Trade Date Instrument Underlying‟s Open High Low Close No. of Value (Rs. Price Price Price Price Contracts lakhs) 27-Jun-12 FUTCUR USDINR 57 57.205 56.97 57.18 964886 270612 5,51,168.18 26-Jun-12 FUTCUR USDINR 56.94 57.195 56.855 57.03 2416925 INDUS BUSINESS ACADEMY FPB1113/072 Page55
    • Fundamentals of Derivatives with special reference to Currency Derivatives. 270612 13,78,844.8525-Jun-12 FUTCUR USDINR 56.995 57.1275 56.4375 57.075 3252547 270612 18,45,275.1922-Jun-12 FUTCUR USDINR 56.6325 57.39 56.6325 57.255 2879271 270612 16,45,164.3921-Jun-12 FUTCUR USDINR 56.38 56.63 56.3225 56.4175 2727543 270612 15,40,367.8720-Jun-12 FUTCUR USDINR 56 56.2525 55.8725 56.2125 2037053 270612 11,42,043.5119-Jun-12 FUTCUR USDINR 55.9125 56.1625 55.8775 56.0425 1924063 270612 10,78,295.6518-Jun-12 FUTCUR USDINR 55.255 56.06 55.255 56.015 2607472 270612 14,53,139.6115-Jun-12 FUTCUR USDINR 55.72 55.78 55.6025 55.655 1212862 270612 6,75,713.4914-Jun-12 FUTCUR USDINR 55.76 55.9375 55.6575 55.8425 1570679 270612 8,76,708.3513-Jun-12 FUTCUR USDINR 55.8475 56.015 55.65 55.775 1672112 270612 9,33,774.2712-Jun-12 FUTCUR USDINR 55.36 56.215 55.36 55.8875 2241006 270612 12,55,570.8711-Jun-12 FUTCUR USDINR 55.4475 55.9375 55.1975 55.885 2476898 270612 13,76,888.89 8-Jun-12 FUTCUR USDINR 55.2175 55.8 55.2175 55.7175 2287441 270612 12,71,163.78 7-Jun-12 FUTCUR USDINR 55.32 55.38 55.065 55.1425 1815925 270612 10,03,094.74 6-Jun-12 FUTCUR USDINR 55.6575 55.815 55.515 55.5525 1885280 270612 10,48,900.14 5-Jun-12 FUTCUR USDINR 55.6425 56.075 55.4625 55.915 1787799 270612 9,98,208.01 4-Jun-12 FUTCUR USDINR 56.16 56.16 55.43 55.7075 2233738 270612 12,43,205.48 1-Jun-12 FUTCUR USDINR 56.5 56.61 56.01 56.1475 2831110 270612 15,91,833.80 Price fluctuations in USD-INR in a month (June 2012)INDUS BUSINESS ACADEMY FPB1113/072 Page56
    • Fundamentals of Derivatives with special reference to Currency Derivatives. 250 200 150 Close Price 100 Low Price High Price 50 Open Price 0 19-Jun-12 1-Jun-12 3-Jun-12 5-Jun-12 7-Jun-12 9-Jun-12 11-Jun-12 13-Jun-12 15-Jun-12 17-Jun-12 21-Jun-12 23-Jun-12 25-Jun-12 27-Jun-12The above graph shows the Open High Low Closeprices of USD-INR in the monthof June 2012. Data of USD-INR Futures Currency Prices (July 2012)Trade Date Instrument Underlying‟s Open High Low Close No. of Value (Rs. Price Price Price Price Contracts lakhs) 27-Jul-12 FUTCUR USDINR 55.4525 55.58 55.3575 55.3925 1108198 6,14,622.45 270712 26-Jul-12 FUTCUR USDINR 56.065 56.11 55.5 55.5625 2777183 15,52,073.35INDUS BUSINESS ACADEMY FPB1113/072 Page57
    • Fundamentals of Derivatives with special reference to Currency Derivatives. 270712 25-Jul-12 FUTCUR USDINR 56.34 56.515 56.1275 56.165 2491329 14,03,302.67 270712 24-Jul-12 FUTCUR USDINR 56.11 56.2825 55.955 56.2325 2321294 13,02,610.04 270712 23-Jul-12 FUTCUR USDINR 55.63 56.07 55.63 56.015 2427470 13,57,091.73 270712 20-Jul-12 FUTCUR USDINR 55.28 55.4075 55.1325 55.3375 1818636 10,04,790.42 270712 19-Jul-12 FUTCUR USDINR 55.34 55.505 55.1625 55.2025 1929067 10,67,568.20 270712 18-Jul-12 FUTCUR USDINR 55.1 55.5725 55.055 55.5225 2270574 12,57,344.96 270712 17-Jul-12 FUTCUR USDINR 55.0125 55.2775 54.885 55.1725 2837194 15,62,991.85 270712 16-Jul-12 FUTCUR USDINR 55 55.3875 54.8825 55.3325 2888354 15,91,793.80 270712 13-Jul-12 FUTCUR USDINR 56.025 56.025 55.205 55.26 2888309 16,03,370.20 270712 12-Jul-12 FUTCUR USDINR 55.76 56.055 55.6625 56.025 2367968 13,23,018.19 270712 11-Jul-12 FUTCUR USDINR 55.7 55.9075 55.4175 55.6125 2729065 15,17,150.94 270712 10-Jul-12 FUTCUR USDINR 56.0725 56.1 55.485 55.5275 2140620 11,94,389.42 270712 9-Jul-12 FUTCUR USDINR 55.465 56.26 55.465 56.1125 1975553 11,08,667.60 270712 6-Jul-12 FUTCUR USDINR 55.59 55.8575 55.415 55.6925 2252537 12,53,877.24 270712 5-Jul-12 FUTCUR USDINR 54.86 55.35 54.8425 55.1925 2286950 12,61,236.41 270712 4-Jul-12 FUTCUR USDINR 54.58 55.07 54.4175 54.7675 2703881 14,80,439.60 270712 3-Jul-12 FUTCUR USDINR 55.6 55.645 54.7525 54.8525 2684574 14,80,207.00 270712 2-Jul-12 FUTCUR USDINR 55.78 56.125 55.66 55.7075 2105949 11,76,645.84 270712 Price fluctuations in USD-INR in a month (July 2012)INDUS BUSINESS ACADEMY FPB1113/072 Page58
    • Fundamentals of Derivatives with special reference to Currency Derivatives. 250 200 150 Close Price 100 Low Price High Price 50 Open Price 0 2-Jul-12 4-Jul-12 6-Jul-12 8-Jul-12 18-Jul-12 10-Jul-12 12-Jul-12 14-Jul-12 16-Jul-12 20-Jul-12 22-Jul-12 24-Jul-12 26-Jul-12The above graph shows the Open High Low Close prices of USD-INR in themonth of July 2012 Following Graph indicates the fluctuations of the Turnover (in Crores) in Currency Derivatives from inception.INDUS BUSINESS ACADEMY FPB1113/072 Page59
    • Fundamentals of Derivatives with special reference to Currency Derivatives. Turnover (in crores) 35,000.00 30,000.00 25,000.00 20,000.00 15,000.00 10,000.00 5,000.00 0.00 1-May-09 1-May-10 1-May-11 1-May-12 29-Aug-08 1-Jul-09 1-Sep-09 1-Nov-09 1-Jul-10 1-Sep-10 1-Nov-10 1-Jul-11 1-Sep-11 1-Nov-11 1-Jul-12 29-Dec-08 1-Mar-09 1-Jan-10 1-Mar-10 1-Jan-11 1-Mar-11 1-Jan-12 1-Mar-12 29-Oct-08 Following Graph indicates the fluctuations of the Turnover (in Crores) in „NIFTY‟ Index from Aug. 2008 to Aug 2012. Turnover (Rs. Cr) 30000 25000 20000 15000 10000 5000 0 1-Aug-08 1-Apr-12 1-Apr-09 1-Aug-09 1-Apr-10 1-Aug-10 1-Apr-11 1-Aug-11 1-Aug-12 1-Feb-09 1-Feb-10 1-Feb-11 1-Feb-12 1-Dec-08 1-Dec-09 1-Dec-10 1-Dec-11 1-Oct-10 1-Oct-08 1-Jun-09 1-Oct-09 1-Jun-10 1-Jun-11 1-Oct-11 1-Jun-12 Comparitive CAGR calculation of TurnoverINDUS BUSINESS ACADEMY FPB1113/072 Page60
    • Fundamentals of Derivatives with special reference to Currency Derivatives.Following is the CAGR calculation of the Turnover of Currency Derivativesfrom 30 Aug.2008 - 30 Aug. 2012.(Rs. crores)CAGR = Rs. 16,769.23 ^ ¼ - 1 *100Rs. 291.05=175.5094 %Following is the CAGR calculation of the Turnover of NSE‟s NIFTY Indexfrom 29 Aug.2008 - 29 Aug. 2012.(Rs. crores)CAGR = Rs. 8374.69 ^ ¼ - 1 *100Rs. 5593.43=10.61719%From looking at the graphs and the CAGR calculations, it becomes clear that there is an increasein investors showing interest in trading in Currency Derivatives. As there are fluctuations in thetrading turnover in the derivative market ,the total trading turnover in currency derivatives hasshown tremendous growth from its inception. It showed a CAGR of 175.50 % as compared toNIFTY’s 10.61 %.INDUS BUSINESS ACADEMY FPB1113/072 Page61
    • Fundamentals of Derivatives with special reference to Currency Derivatives. SUGGESTIONS Currency Future need to change some restriction it imposed such as cutoff limit of 5 million USD, Ban on NRI’s and FII’s and Mutual Funds fromParticipating. Now in exchange traded currency future segment only one pair USD-INRis available to trade so there is also one more demand by the exportersand importers to introduce another pair in currency trading. Like POUND-INR, CAD-INR etc. In OTC there is no limit for trader to buy or short Currency futures so theredemand arises, Exchange traded currency future shouldincrease the limit for Trading Members and also at client level, in result OTCusers will divert to Exchange traded currency Futures. In India the regulatory of Financial and Securities market (SEBI) has Banon other Currency Derivatives except Currency Futures, so this restrictionseem unreasonable to exporters and importers. And according to Indianfinancial growth now it’s become necessary to introducing other currencyderivatives in Exchange traded currency derivative segment.INDUS BUSINESS ACADEMY FPB1113/072 Page62
    • Fundamentals of Derivatives with special reference to Currency Derivatives. CONCLUSIONBy far the most significant event in finance during the past decade has been the extraordinarydevelopment and expansion of financial derivatives. These instruments enhances the ability todifferentiate risk and allocate it to those investors most able and willing to take it- a process thathas undoubtedly improved national productivity growth and standards of livings.The currency future gives the safe and standardized contract to its investors and individuals whoare aware about the Forex market or predict the movement of exchange rate so they will get theright platform for the trading in currency future. Because of exchange traded future contract andits standardized nature gives counter party risk minimized. Initially only NSE had the permissionbut now BSE and MCX has also started currency future. It shows that how currency futurecovers ground in the compare of other available derivatives instruments. Not only bigbusinessmen and exporter and importers use this but individual who are interested and havingknowledge aboutForex market they can also invest in currency future.Exchange between USD-INR markets in India is very big and these exchange tradedcontract willgive more awareness in market and attract the investors.INDUS BUSINESS ACADEMY FPB1113/072 Page63
    • Fundamentals of Derivatives with special reference to Currency Derivatives. 8. BIBLIOGRAPHYWebsites: www.nse-india.com www.mcxindia.com www.ncdex.com www.wikipedia.com www.investopedia.com www.sebi.gov.in www.rbi.org.in www.moneycontrol.comLiterature: NCFM modules of National Stock Exchange Data of USD-INR prices for the month of June-July.INDUS BUSINESS ACADEMY FPB1113/072 Page64