• 24 Hour Market because of business overlap• Trade is done by buying one currency while selling the other• 2 Segments of OTC Market o Interbank o Merchant
• Securities under the Securities Contracts Act, 1956 and hence the trading of derivatives is governed by the regulatory framework under the SC(R)A.• A product whose value is derived from the value of one or more basic variables called bases• The underlying asset can be equity, foreign exchange, commodity, interest rate or any other asset• Has a future settlement date
The factors driving the growth of financial derivatives are:• Increased volatility in asset prices in financial markets• Increased integration of national financial markets with the international financial markets• Marked improvement in communication facilities and sharp decline in their costs,• Development of more sophisticated risk management tools• 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 and lower transactions costs as compared to individual financial assets.
Unpredicted movements in exchange rates requires investors tohedge these risks. • Forwards: A customized OTC contract between two parties. • Futures: Exchange-trade forwards. • Options: Option does not buy or sell the underlying directly but buys or sells the right without obligation on the underlying. • Swaps: Swaps are agreements between two parties to exchange cash flows in the future according to a prearranged formula. • Interest rate swaps: Swapping of interest related cash flows between the parties in the same currency. • Currency swaps: Swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
A currency future, also known as FX future, is astandardized contract , traded on an exchange, to buy orsell one currency for another at a specified date in thefuture at a price that is fixed on the purchase date. Bothparties of the futures contract must fulfill their obligations onthe settlement date.
Futures have some distinct advantages over forward contracts:• Price transparency• Elimination of Counterparty credit risk.• Access to all types of market participants. The OTC market is restricted to Authorized Dealers (banks which are licensed by RBI to deal in FX), individuals and entities with FOREX exposures. Retail speculators with no exposure to FX cannot trade in OTC market.• Futures offer low cost of trading as compared to OTC market.
Hedger• Have real exposure to FX risk on account of their business• Exposure could be because of Imports/Exports• Objective is to remove FX volatility risk using currency future Has to pay $ 1 mio after What happens if IMPORTER 3 months for imports in USD strengthens? march He loses money. Has to receive $ 1 mio What happens if EXPORTER after 3 months for USD weakens? exports in march He loses money. Overall portfolio in HEDGING Participant Risk Underlying Position Hedging Position Importer INR will weaken Short in Fx Long in CF Long Hedger Exporter INR will strengthen Long in Fx Short in CF Short Hedger
Speculator• Also called as Traders• Does not have real exposure to FX risk• Takes a view on the market direction hoping to make returns by taking the price risk• Assumes the price risk that hedgers attempt to lay off in the markets
Arbitrageurs• Look for mispricing and execute simultaneous buy and sell to capture the mispricing and make profit• Do not take any view on the market direction• Neither have exposure to risk and nor they take any risk
Initial MarginThe Initial Margin requirement is based on a worst case loss of aportfolio of an individual client across various scenarios of pricechanges. Initial margin for each contract is set by the Exchange. USD/INR EUR/INR GBP/INR JPY/INR Minimum margin requirement on first 1.75% 2.8% 3.2% 4.5% day Minimum margin requirement after first 1% 2% 2% 2.3% day
Calendar SpreadWhen a CF position at one maturity is hedged by an offsettingposition at a different maturity, Rs. 250/‐ Calendar Spread Marginper Calendar Spread contract is charged.Extreme Margin LossComputed as % on the MTM value of the gross open position. USD/INR EUR/INR GBP/INR JPY/INR Extreme loss 1% 0.3% 0.5% 0.7% marginMarked-to-MarketDefault risk is reduced by marking to market. MTM value wouldbe calculated on the basis of the last half an hour weightedaverage traded price of the futures contract.
National Securities Clearing Corporation Limited (NSCCL)undertakes clearing and settlement of all trades executed on thecurrency derivatives segment of the exchange. It also acts aslegal counterparty to all trades on the currency derivativessegment and guarantees their financial settlement. • Mark-to-Market Settlement • Final Settlement of Futures