UNDERSTANDING CURRENCY FUTURES

Futures Contract
• Standardized derivative contract • Traded on recognized exchanges • Price and date of delivery-predetermined • Margin requirements • Eliminates counterparty risk • Transparency in pricing • Settlement through Clearing house

Currency Futures
•Standardized foreign exchange derivative contract •Traded on a recognized exchange •Underlying is the exchange rates •Traded in limited number of currencies •Price and date of delivery-predetermined

History of Currency futures
• First Currency futures- Chicago Mercantile Exchange (CME) in 1972 • International Monetary Market (IMM) launched trading in seven currency futures on May 16, 1972 • As per the latest BIS report, the OTC market accounts for more than $3 trillion of currency trading every day; this compares with the notional principal of $72 billion traded on exchanges.

Currency futures in India
• Currency futures trading was started in Mumbai August 29, 2008. • With over 300 trading members including 11 banks registered in this segment, the first day saw a very lively counter, with nearly 70,000 contracts being traded. • The first trade on the NSE was by East India Securities Ltd. • Amongst the banks, HDFC Bank carried out the first trade. The largest trade was by Standard Chartered Bank constituting 15,000 contracts. Banks contributed 40 percent of the total gross volume. • Traded in BSE, NSE and MCX exchanges

Features of Currency Futures
• Only USD-INR contracts are allowed to be traded. • Standardized contract size - $1000. • The contracts quoted and settled in Indian Rupees. • The maturity of the contracts shall not exceed 12 months. • Settled on specified future date called as settlement date. • Only resident Indians are allowed to trade in currency futures. • Future price= Spot Price + Cost of Carry.

Hedging with Currency Futures
• Importer buys the required currency futures contract, “locks in” a price for the purchase of foreign currency • Exporter sells the expected currency futures contract, thus “locks in” a price for the sale of foreign currency

Imperfections in hedging with Currency Futures
• Maturity mismatch – Mismatch in maturity date of futures contract and date of cash transaction • Size mismatch – Mismatch between size of futures contract and size of cash transaction • Hedging with currency futures may not result in perfect hedge • Final delivery of the foreign currency will take place only through the banking system

Speculation with Currency Futures
• • • • Spot rate: USD = Rs.50.20 1 month future rate: USD = Rs.50.40 Expected spot rate on maturity: USD = Rs. 50.65 Dealer buys 100 lots of currency futures contract (100,000 USD) • Value of contract: Rs.50,40,000; Margin deposit: Rs.5,40,000 • If exchange rate move up to Rs.50.65 as anticipated, dealer gains profit of Rs.15,000 (100,000* Re.0.15) • Rate of return: (15000/5,40,000)(12)(100) = 33.33%

Factors Impeding Liquidity in system
• There is a limit of $100 million on the open interest applicable to trading members who are banks and $25 million limit for other trading members. So, larger exporters and importers might continue to deal in the OTC market, where there is no limit on the hedges. • The management of margin and settlement of daily mark – to – market differences could be cumbersome for some corporate customers. • Absence of FIIs could reduce liquidity

Getting Started
• Get in touch with your broker permitted to trade in currency futures on NSE, MCX or BSE and become a member • Deposit the margin as per the tariff with the exchange • Buy/Sell the currency for the desired future period using the trading platform given by the exchange or through broker

Membership Type
• Trading Member (TM): A member with rights to trade on its own account as well as on account of its clients, but has no right to clear and settle such trades itself. • Trading-cum-Clearing Member (TCM): A member with a right to trade on its own account as well as on account of its clients. He can clear and settle the trades for self and for others through the Clearing House. • Professional Clearing Member (PCM): A PCM is entitled to clear and settle trades executed by other members of the exchange. Only corporate entities or institutions are eligible to apply for PCM.

Deposits For Membership
All values in Rupees Existing Members

Membership Stock Exchange Minimum Net Worth Minimum Liquid Asset Security Deposit (Interest Free) Cash to NSEIL Cash to Clearing corporation Non-cash to Clearing corporation 10 L MCX 1 Cr

Trading Members NSE 1 Cr BSE 1 Cr

Trading cum clearing members MCX 10 Cr NSE 10 Cr BSE 10 Cr 50 L

10 L

5L

50 L 10 L 25 L 25 L 25 L 25 L

5L

25 L 25 L

Deposits For Membership
( All Values in Rupee) Membership Stock Exchange Minimum Net Worth Minimum Liquid Asset Security Deposit (Interest Free) Cash to NSEIL Cash to Clearing corporation Non-Cash to Clearing Corporaton Processing Fee 10000 waiver 10 L 15 L 25 L 25 L 75 L MCX 1 Cr TM NSE 1 Cr BSE 1 Cr MCX 10 Cr 50L 50 L 15 L 25 L 25 L 10000 25 L 25 L waiver 25 L 25 L New Applicants TCM NSE 10 Cr 50L BSE 10 Cr 50 L 10 L 20 L 25 L 25 L 10000 25 L 25 L waiver MCX 10 Cr 50 L PCM NSE 10 Cr 50 L BSE 10 Cr 50 L

Position Limits
– Trading Member Level: The gross open positions across all contracts cannot exceed 15% of the total open interest or USD 25 million, whichever is higher For banks: cannot exceed 15% of the total open interest or USD 100 million , whichever is higher – Client Level: The gross open positions across all contracts cannot exceed 6% of the total open interest or USD 5 million, whichever is higher – Clearing Member Level: No separate position limit is prescribed at the level of the Clearing Member

Clearing House
• Each exchange has a clearing house • Clearing house arranges for delivery of asset and payment of money • Clearing house becomes the counter party to the original parties

Mode of settlement
Daily settlement: T + 1 day  Calculated on the basis of the last half an hour weighted average price.  MTM profit and loss is payable/receivable by the traders.

Final settlement: T + 2 days Contracts would be settled in cash on the final settlement date as per the reference rate of RBI. Final settlement date would be the last working day of the month (except Saturday and holiday).

Margins & Price Limits
• Minimum Initial Margin: 1.75% on day 1, 1% thereafter • Extreme Loss Margin:1% of MTM value of Open position. • Price limits: Tenure up to 6 months: +/- 3% of base price 9 months:+/- 5% of base price

Costs involved in currency futures trade
• Margin • Brokerage • Exchange transaction charges • Stamp duty • STT • Service tax • Education tax on brokerage fees

Forward Contract
A forward contract is a private contract between a buyer and a seller in which the buyer agrees to buy and the seller agrees to sell a specific quantity of a certain security or commodity (known as the underlying instrument) at the price specified in the contract.

Difference between Forward and Futures
Features Agreement Currency Future standardized contract with fixed maturity date and fixed quantity as defined by the exchange High Exchange- traded contract that is available for trading on recognized exchanges such as NSE BSE and MCX Currency Forward customized contract where the parties can negotiate terms and conditions Low Traded on OTC markets through authorized dealer network of RBI such as scheduled banks or licensed foreign exchange dealers. High and the parties bear the risk.

Accessibility Channel of trade

Default risk

Low and Clearing house bears the risk

Features Documentation Awareness of the parties Price Transparency Nature of settlement

Currency Future Minimal paperwork Trades are anonymous i.e. the buyer does not know who is the seller High (I) Exchange of asset and cash on delivery date (II) Cash settlement through a reverse trade on any day

Currency Forward More paperwork Parties to the trades are known Comparatively low Only delivery of asset

Settlement period

The specific details concerning Settlement occurs at the end settlement and delivery are quite of the contract. distinct. Frequently employed by speculators Frequently employed by hedgers to curtail volatility Privately negotiated and are standardized Required

Nature of positions

Medium of negotiation Clearing house is needed Underlying Exposure Not required

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