basics of indian currency futures exchange.

2. WHAT IS CURRENCY…????
 It represents the value of an economy and its prospective at
present with comparison of another economy.
For Example:
USD/INR pair represents
$ 1 = Rs.45
This pair means one dollar if we purchase/sell we have to
give/take 45 rupees for it.
Similarly, EURINR, GBPINR, JPYINR will be defined.

3. Appreciation and depreciation of currency
 USDINR is appreciating
Earlier 1 USD = Rs.46 but now
1 USD = Rs.45.50
Explanation:
Earlier we have to give Rs.46.00 for one dollar now we
are giving Rs.45.50 per unit of dollar. We have to pay
half a rupee less that means Indian economy is better
then US economy and the value of its currency is
going up. This termed as rupee is appreciating and
dollar is depreciating.
And the pair USDINR is said to be depreciating.

4. Largest Asset Class
Major currencies: Dollar, Euro, Yen, British Pound, Swiss
Franc
Average turnover is over US$ 4 trillion (daily)
Forex derivatives accounts for 40% of ADTV
Main trading centers are London, NY, Tokyo & Singapore
High volumes low margin game with extreme Liquidity
24 hours trading
Range of factor impacting exchange rates
Participants
Introduction

5. Forex Market: 24 Hrs a day – 7 days a week
24 Hrs Market (IST)

6. INDIAN FOREX MARKET
OTC EXCHANGE TRADED
OPTIONS
SPOT
USEMCX-SX NSE
FUTURES
FORWARDS
SWAPS

7. Large banks
Central Banks
Government
Multinationals & Commercial Companies
Hedge Funds
Institutions
Retail Forex Brokers
Speculators
Participants

8. Basic Definitions simplified
Tom: One business day after deal date (T+1)
Spot: Buying a different currency for immediate delivery (T+2)
Forward: Contract between counterparties to exchange currency on
any day after spot (T+3 or later)
Base currency: In the forex market it is the first currency in any
currency pair
Quote or Term Currency: In the Forex markets, is the second
currency in any pair also called the ‘Pip’ currency.
Eg: USD/INR rate equals 62. (One dollar is worth CHF 1.1323)

9. Definations (continued)

10. Bid Price
 Price at which the market is prepared to buy a specific currency
pair in the Forex market and you can sell the base currency
(on the left side of the quotation)
(eg: in the quote USD/INR 54.1525/1550, the bid price is 54.1525. One can sell
one 1 USD for 54.1525 INR)
Ask (or offer)Price
 Price at which the market is prepared to sell a specific currency
pair in the Forex market and you can buy the base currency
(on the right side of the quotation)
(eg: in the quote USD/INR 54.1525/1550, the ask price is 54.1550. One can buy
one 1 USD for 54.1550 INR)
Basic Definitions simplified

11. Global Currency Composition
Daily Averages in billions of US
dollar and per cent
%share
US dollar/euro
US dollar/yen
US dollar/sterling
US dollar/Australian dollar
US dollar/Swiss franc
US dollar/Canadian dollar
US dollar/Swedish Krona
US dollar/other
Euro/yen
Euro/sterling
Euro/Swiss franc
Euro/other
Other Currency pairs
All currency pairs
27
13
12
6
5
4
2
19
2
2
2
4
4
100
Market Turnover By Currency Pair

12. Factors Affecting USDINR
Exchange
Rate
RBI
Intervention
Performance of
Equity Market
Policy
Decisions
Performance of
Other Asian
Currencies
Political
Factors
Capital
Flows
Fundamental
Factors
Uncertain
Events

13.  Interest Rates
Change in interest rates by Reserve Bank of India
Interest rates change by Federal Reserve (USA)
Interest rates change by European Commercial Bank
Expectation of change in interest rates
Factors Affecting Currency Market
Interest rates are positively correlated with a strong currency
When interest rates increase in a country, its currency strengthens
against other currencies

14.  Inflows of Foreign Funds
Strong economic fundamentals attract funds into the country
Political stability and clear economic direction
Country specific ratings based on economic indicators
Reverse is also true
Factors Affecting Currency Market
Foreign funds inflows are positively correlated with a strong currency
When funds enter the country, they create a demand for the local
currency (read Rupee) resulting in the currency strengthening

15. 2. Foreign Currency Derivatives

16. “Currency Derivatives’’
Swaps Options Forwards Futures
Debt, Forex , Stock & Commodity markets
• What are Derivatives?
• Markets?
What is traded on a Currency exchange?

17. In a Nut Shell: Manage Risk
• Transfer Risk
• Price Discovery
• Integration of Markets
• Increase Savings in the long run
• Speculative trading in a controlled environment
Why do we require Currency Derivatives?

18. Forwards: Customized contracts between two parties where settlement
takes place on a pre determined negotiated date price in the future
Futures: Standardized agreement between two parties to buy or sell
currency at a certain time in the future at a pre determined price.
Options: Calls & Puts
Options are of two types - calls and puts.
 Calls give the buyer the right but not the obligation to buy a given
quantity of the underlying asset, at a given price on or before a given
future date.
Puts give the buyer the right, but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given
Derivatives: Basic Definitions

19. Forward Vs. Futures
Forward Contracts
OTC
Counterparty risk
Terms changeable
Poor liquidity
Few Players
No Margins
Relationship
Skill to Structure
Future Contracts
• Exchange Traded
• Exchange assumes risk
• Terms defined by Exchange
• High Liquidity
• Many Players
• Margins
• Price Transparency
• Standard Product

20. 3. Exchange Traded Currency Futures

21. Futures contract is a standardized contract, to buy or sell a
certain underlying asset or an instrument at a certain date in
the future, at a predetermined price
Futures price: price at which a contract trades in the futures
market
Currency futures are a linear product
Settlement date is the last business day of the month
Futures Terminology

22. Expiry date is the date specified in the contract and will be two
business days prior to final settlement date
Contract Specifications are details on currency futures contracts as
stipulated by RBI-SEBI standing technical committee report on
exchange traded currency futures
Initial margin is the amount to be deposited in the margin account.
Mark- to-Market is the daily adjustment made to the margin account
based of the futures closing price.
Futures Terminology

23. Contract Specification Snapshot
Underlying USD / INR
Trading Hours 9:00 AM to 5:00 PM
Size of Contract Minimum Lot Size is US$ 1,000
Price Quotation In INR (Tick Size – INR 0.0025)
Tenor of Contract Maximum of 12 Months
Available Contracts Monthly
Settlement Mechanism In INR
Settlement Reference
Rate RBI USD/INR Reference Rate
Final Settlement Date
2 days beforeLast working day of
month, except Saturday.
Note: The above product specification is as per the RBI-SEBI Standing Technical
Committee Report on Exchange Traded Currency Futures

24. Eliminates risk caused by fluctuation in exchange rates
Liquidity to the participant where an existing contract can
be offset prior to maturity by entering into an equal and
opposite transaction
Aids Business Planning
Hedging using futures reduces volatility of returns
Hedgers could be:-
Corporates, Producers, Intermediaries in Spot Markets,
Merchandisers, Traders, Importers & Exporters etc.
Rationale behind Currency Futures

25. 4. Strategies Using Futures

26. What is meant by Hedging?
Hedging means taking a position in the future market that is opposite
to position in the physical market with a view to reduce risk
associated with unpredictable price change
A long futures hedge is appropriate when you know you will buy an
asset in the future and want to lock in the price
A short futures hedge is appropriate when you know you will sell an
asset in the future & want to lock in the price
Types of Hedges
The profit (loss) in the cash position is offset by equivalent loss (profit)
in the futures position

27. Appreciation and Depreciation of Currency
Event Importer Exporter
Appreciation of USD Loses Money Gains Money
Depreciation of INR Loses Money Gains Money
Event Importer Exporter
Depreciation of USD Gains Money Loses Money
Appreciation of INR Gains Money Loses Money
USDINR 45
USDINR 50
USDINR 40
USDINR 45
Scenario 1
Scenario 2

28. Transaction
An exporter who has executed an export order and money is to be
received on 31 Dec 13, say USD 500,000.
Spot USD/INR was as 54.20 when contract was executed.
Risk
Rupee will appreciate and export will realize USD 500,000 at a rate lower
than 54.20
Hedge Strategy
Short (Sell) 500 contracts of each expiry 31 Dec 13.
Using Futures to Hedge Currency Risk

29. Payoff of Hedge vis-à-vis the transaction:
Hypothetical Example
Spot is at 54.20 when the exporter buys future and
USDINR Dec futures at 54.80
Short (Sell) 500 USDINR futures contracts expiry Dec 2013.
On Expiry Date – 31st
Dec
Spot on
Expiry
P/L on Exchange P/L on Physical
54.50 (INR 1,50,000) INR 1,50,000
53.90 INR 1,50,000 (INR 1,50,000)
So if rupee moves either way corporate is hedged
against currency fluctuation.

30. Transaction
On 1st
April, 2013 a student enrolled for CMT-USA October 2013 test and
he needs to make his payment of USD 1000 on 15th
September, 2013.
Spot USD/INR was at 54.20 when he got enrolled.
Risk
USD may strengthen over next 6 months causing the enrolment to cost
more
Hedge Strategy
Long (Buys)1 USDINR Futures contract
Using Futures to Hedge Currency Risk

31. On April 1, 2013, an Indian Copper Exporter enters into a contract
to Export 1000 MT of Copper with payment to be received in US
Dollar (USD) on July 1, 2013.
Hedger (Copper Exporter)
The price of copper has been fixed at USD 7200/MT at the prevailing
exchange rate of 1 USD = INR 54.76
The Cost of One Tonne of copper in INR is Rs. 394272 (7200*54.76).
The exporter has a risk of Weakening USD over next three months
having negative implication on his operating margins hence
profitability and long-term sustainability……

32. COPPER EXPORTER
Is Long on USD 7200000
in the Spot market
Short (Sell) 7200 USDINR
futures contracts
Buys USDINR futures contracts
to square-off transaction
Sell USD to meet export
requirement in the spot market
Time t1
Time t2
HedgePeriod
If not hedged and INR weakens, the exporter makes a
profit and when INR strengthen, he will make a loss.
Risk Management Process…
using currency futures…

33. Hedger – Practical Implication
Date
Spot Market Futures Market
USD-INR July USD Contract
1-April-13 54.76 54.95
1-July-13 58.53 58.72
Market Entry Date Market Price Exit Date Market Price Profit / Loss
Spot
1-Apr-13
54.76 (L)
1-Jul-13
58.53 (S) 27144000
Futures 54.95 (S) 58.72 (L) -27144000
The Loss in Futures Market is set off by Profit in Spot Market.
By Hedging, we have locked-in the price i.e. Selling price in spot market Rs.
306216000 + loss from Futures market Rs. (27144000) = Rs. 279072000
Price of Copper = Rs. 7200/MT
Exported Qty. = 1000 MT
No Basis Risk : Perfect
Hedge situation exists

34. SPREADS
• What is a Spread?
Difference in price of two futures contracts
A spread involves buying one futures contract in one month and
simultaneously selling another futures contract of a different month.
• Participants: Investors / Traders
• Objective:
To earn profit from existing spread between near month futures
contract and far month futures contract.

35.  Interest Rate Differentials
 Liquidity in the banking system
 Monetary policy decisions
 Inflation
 Intra-Currency Pair Spread
 Inter-Currency Pair Spread
 Normal Market: When the price of the far month futures
contract is higher than the near month one, then it is referred
to as “normal market”.
 Inverted Market: If the price of the far month futures contract
is lower than the near month one, then it is referred to as
“inverted market”.
What influences spreads?

36. Involves buying a contract on one exchange at one price
and simultaneously selling an identical contract on
another exchange at a higher price.
Inter-market arbitrage is possible only when there are
price differences between two exchanges.
Arbitrage

37. Price difference between currency futures traded on different exchanges
results in arbitrage positions
E.g. On 2 Feb 2009, following is the USDINR Oct futures contract prices
Exchange A USD/INR 49.0750
Exchange B USD/INR 49.0275
Buy on Exchange B and simultaneously sell on Exchange A
Hold until maturity. Final settlement of both contracts at
same price of RBI reference rate
Inter Market Arbitrage

38. 5. Trading

39. Automated screen-based trading on TWS
National reach
Order driven trading system
Transparent, Objective and Fair system of order matching
Identity of the trader undisclosed
Daily Turnover limits for Buy and Sell for each User linked to deposit
Flexibility in placing orders
Complete Online Market Information
Square-off facility
Market Operations: Trading features

40. Tenors of Contracts: Period for which the contract is available for
trading also called trading cycle of the contract
Final Settlement Rate: is the Reserve Bank Reference rate on the
date of expiry.
Expiry Date: Contracts expire on last working day (except Saturday)
of the contract month. The last day for the trading of the contract shall
be two days prior to the final settlement
Terms

41. Day 1. Purchase: One contract of $1000 (Launch of new contract)
a) @ say 51.75 X1000 X (1.75%+1%) = Rs.1423.125 (margin blocked)
(Initial+ELM)
Day 2. Exchange rate weakens
a) @ say 51.95 X 1000 X (1%+2.6%) = Rs.1870..200 (margin )
(ELM+SPAN)
= 447.075 (further margin blocked)
b) M2M = 51.95 - 51.75 X 1000 = Rs.200 Payout
Margin Calculation
Extreme Loss Margin is calculated at 1% on M2M value of Gross Open Position

42. 7. Regulatory Framework

43. Acts
RBI-SEBI standing technical committee on exchange
traded currency and interest rate derivatives
Provides comprehensive guidelines on the usage of foreign
currency forwards, swaps and options in the OTC market
Recommends the introduction of exchange traded currency
futures
Constituted a technical committees on Exchange Traded Currency
and Interest Rate Derivatives
Foreign Exchange Management Act, 1999 - Provisions
Provided different guidelines and notifications for Currency
Trading under RBI’s regulation in India.
Provides the Currency Contract Specifications with limits and
regulations to be followed

44. The Foreign Exchange Management Act (FEMA) is a 1999 Indian law "to
consolidate and amend the law relating to foreign exchange with the objective of
facilitating external trade and payments and for promoting the orderly development
and maintenance of foreign exchange market in India". It was passed in the winter
session of Parliament in 1999, replacing the Foreign Exchange Regulation
Act (FERA). This act seeks to make offenses related to foreign exchange civil
offenses. It extends to the whole of India.,[1]
replacing FERA, which had become
incompatible with the pro-liberalisation policies of the Government of India. It
enabled a new foreign exchange management regime consistent with the emerging
framework of the World Trade Organisation (WTO). It is another matter that the
enactment of FEMA also brought with it the Prevention of Money Laundering Act of
2002, which came into effect from 1 July 2005.

45. 8. Accounting

46.  Accounting in case of default
 Amount not paid is adjusted against margin (Debit m2m-currency futures
account and credit currency futures account)
 Losses on the contract will be recognised on the profit & loss account.
 Disclosure Requirements AS32
 Taxation:
 Income or loss carried out on recognised exchanges is not taxed as
speculative income or loss. Thus loss can be set off against any
other income during the year (or subsequent assessment year- can
be carried fwd upto 8 years)
Accounting

47. Thank you