Financial Risk Management PROJECT REPORT Currency Futures Growth in India A Realty Check Under guidance of Prof. P.C.

Biswal

Group 5 Anuj Khera Dinesh Gangwar Jagdeeswara Reddy S Parwaz Alam Khan 24NMP06 24NMP13 24NMP14 24NMP19

NATIONAL MANAGEMENT PROGRAMME (NMP XXIV) MANAGEMENT DEVELOPMENT INSTITUTE GURGAON-122 001 Acknowledgment
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Contents

Introduction on Currency Futures:

Introduction on Currency Futures: Currency Futures are standardized contracts to buy or sell a currency at a future date at a rate determined in advance. The contracts are traded on regulated exchanges in accordance with the guidelines specified in the RBI-SEBI Standing Technical Committee Report on Exchange Traded Currency Futures, 2008. Currencies are the money of different countries, and currency trading is the buying and selling of these currencies. There are almost as many different currencies as there are countries, but the most popular currencies for trading are the US Dollar, the Euro, the British Pound (Sterling), and the Japanese Yen. The currency markets are some of the most popular day trading markets, and they therefore have some of the highest volume (number of contracts) and liquidity. This high volume and liquidity makes the currency markets attractive to all types of traders, including individual day traders, trading companies, financial and non financial companies, banks, and governments. Globalization and integration of financial markets, coupled with progressive increase of cross-border flow of capital, have transformed the dynamics of Indian financial markets. This has increased the need for dynamic currency risk management. The steady rise in Indias foreign trade along with liberalization in foreign exchange regime has led to large inflow of foreign currency into the system in the form of FDI and FII investments. 1.1 Need for Currency Futures Financial markets are, by nature, extremely volatile and hence the risk factor is an important concern for financial agents. To reduce this risk, the concept of derivatives comes into the picture. Derivatives are products whose values are derived from one or more basic variables called bases. These bases can be underlying assets (for example forex, equity, etc), bases or reference rates. A currency futures contract allows for three things:
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 Hedging Participants with exposure in currency can use futures to manage risk arising from unfavourable exchange rate movements Speculation/Investment Participants with a view on the Forex market can trade futures to profit from these views, just like stocks or commodities or any other asset class Arbitrage Entities with access to both Exchange traded Futures and OTC markets, or different exchanges can exploit arbitrage arising due to pricing differences. Currency futures benefits to investors as : Importers/Exporters may have some obligations in Forex market, trading in Currency Futures will help them hedge their positions. Similarly, any investor can trade in Currency Futures with or with no obligations. The counter-party risk is eliminated as the clearing corporation guarantees the trades. By ensuring that the best price is available to all categories of market participants, transactions are executed on a price time priority In Currency Futures, mark to market obligations are settled on a daily basis, unlike a forward contract, which is an agreement to transact at a forward price on a future date and no money changes hands except on the maturity date. 2. History of Currency Futures Currency futures were first created at the Chicago Mercantile Exchange (CME) in 1972, less than one year after the system of fixed exchange rates was abandoned along with the gold standard. Some commodity traders at the CME did not have access to the inter-bank exchange markets in the early 1970s, when they believed that significant changes were about to take place in the currency market. They established the International Monetary Market (IMM) and launched trading in seven currency futures on May 16, 1972. 3. Currency future derivatives in India The Currency Future in India was first time traded at NSE on August 29, 2008.
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Thereafter MCX was subsequently allowed to deal in currency future from October 31, 2008. 3.1 Rationale behind Currency futures in India The OTC transaction was happening in With the help of electronic trading and efficient risk management systems, Exchange traded currency future has helped to get transparency and efficiency in price discovery, elimination of counterparty credit risk, access to all types of market participants, standardized products and transparent trading platform. Banks are also allowed to become members of this segment on the Exchange and this provides them new opportunity in this market segment.

3.2 Exchanges engaged in Currency future in India

3.3 Available Currency futures in India US Dollar - Rupee Currency Futures Contract Euro - Rupee Currency Futures Contract-It was introduced on 29th Jan, 2010 British Pound - Rupee Currency Futures Contract-It was introduced on 29th Jan, 2010 Yen - Rupee Currency Futures Contract-It was introduced on 29th Jan, 2010

3.4 Features of Currency Futures Standardized currency futures shall have the following features: a. Only USD-INR INR/USD, INR/EUR, INR/JPY and INR/GBP contracts are allowed to be traded. b. For USD, EUR and GBP, the lot size will be 1,000 foreign currency; for JPY it will be 1,00,000 JPY (since quotation is for 100 Japanese Yen; lot size on trading system shall be 1,000 JPY) c. The contracts shall be quoted and settled in Indian Rupees. d. The maturity of the contracts shall not exceed 12 months. e. The settlement price shall be the Reserve Banks Reference Rate on the last trading day. Permission (i) Currency futures are permitted in US Dollar - Indian Rupee or any other currency pairs, as may be approved by the Reserve Bank from time to time. (ii) Only persons resident in India may purchase or sell currency futures to hedge
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an exposure to foreign exchange rate risk. 4. Benefits of currency trading in India Easy Accessibility - Small investors would get an easy access to currency futures trading on the popular exchanges Easy Affordability - Margins are very low and the contract size is very small Low Transaction Cost - As opposed to the high pay-out of commissions in

overseas forex trading, currency futures carries low costs for investors Transparency - It is possible for you to verify trade details on NSE if you have a doubt that the broker has tried to cheat you Counter-party default risk - All the trades done on the recognized exchanges are guaranteed by the clearing corporations and hence it eliminates the risks associated with counter party default. NSCCL (National Securities Clearing Corporation Limited) carries out all the notation, clearing and settlement process of currency futures trading Standardized Contracts - Exchange Traded currency futures are standardized in respect of lot size ($1000) and maturity (12 monthly contracts). Retail investors with their limited resources would find it tremendously beneficial to take positions in standardised USD INR futures contracts. Moreover, the currency futures market is used by some companies for hedging. These companies either purchase currency futures for their future payables, or sell the futures on currencies for their future receipts. Speculators may also buy or sell futures on a foreign currency as a protection against the strengthening or weakening of the US dollar. So, speculators may be able to earn profit from the rise or fall of these exchange rates. 5. Trends in Currency Future in India Currency futures trading started in India on August 29, 2008 on National Stock Exchange. This was the first time currency derivatives got listed on an exchange in India. Till this time, the currency futures trading took place over the counter and were unorganized. With the entry of the National Stock Exchange in the picture, currency trading became more organized with the NSE acting as a counter party to all the
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transactions. Soon after MCX also marked its entry into the currency derivatives market. Volumes on currency futures exchanges (mainly NSE and MCX) have consistently increased since the start of trading.

The dominant exchanges in the Currency future market are NSE and MSX-NX. The above pie-chart shows that the market share of MCX-NX is increasing and its taking the position of NSE in this field. Although both the players are holding almost half share with them.

No. of Contracts over the years Contracts traded-NSE Contracts traded-MCX-NX We can see that the currency future market is in growing phase. The high fold increase in the currency future trading is a testimony of the growth. The high in Indian rupee/dollar futures demonstrates the increased demand among our global members and their commercial and investor clients to manage their exchange rate risk or gain exposure to the Indian rupee. This also reflects towards the increasing economy of India.

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6. Comparisons with other market Even though the combined volumes figure on NSE and MCX pales in comparison to merchant and inter-bank forward transactions on the over-the-counter (OTC) market, volumes on the currency exchanges are heading close to those traded on the offshore non- deliverable forwards (NDF) market for the Rupee that is active, mainly in Singapore, London and New York. 7. Risks of trading in Currency Futures Trading in Currency futures comes with high levels of risk. Even a small adverse fluctuation in the exchange rate may result in loss of the entire deposit of someone trading in currency. Only people having an in-depth knowledge of the working of this market or have done a thorough homework about the risks involved are advised to trade in this market. 8. Opportunities Introduction of Options trading FII participation could be allowed. NRI participation could be allowed which would add to more volumes and liquidity.
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Positions larger than $5 million could be allowed - a tiny limit when compared with

size of exposure that is found in a trillion dollar economy. 9. Currency Futures the road ahead Currency futures today are offered only for rupeedollar contracts for longer periods (12 contracts) than the existing forward contracts (3 contracts 3 months, 6 months and 12 months). MCX-SX will launch 11 currency trading websites in regional languages (having launched 5 so far in Hindi, Marathi, Gujarati, Tamil and Malayalam). Liberalisation in terms of changes in the contract size, variable lot sizes and extended trading hours could help encourage larger participation. The rupee futures have a contract size of $1,000. The position limit for a client is higher of 6% of the total open interest or $ 5 million. For the trading member it is higher of 15% of the total open interest or $25 million. If the trading member is a bank it is higher of 15% of the total open interest or $ 100 million. Hence till the total open interest rises, a participant cannot increase his open interest beyond present proportion/limits. Foreign institutional investors are excluded from the market and their inclusion as participants can help in stepping up volumes significantly. 10. Conclusion With the current trend of growing market of currency futures, it is bound to grow at this rate. However, it does not seem to be going well with its pace in India as industry due to lack of awareness among retail investors and knowledge gap faced by the brokers. India is one of the country to have achieved greater turnover of the currency futures market in comparison to the currency forward market. The currency futures has a rosy future ahead, given the industry provides good support in terms of making it popular and more conversant with retail investors.

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