CERTIFICATE

Certified that Mr. Jigar J Soni. Roll No. 05 Division A. MBA Semester 3rd Batch

2007-09 have worked on the project titled “Currency Derivatives” under my guidance. This is their original work and has not been submitted elsewhere for award of any degree/diploma so far. They have put their sincere efforts to complete the project. We wish them all the best.

Date: 31/12/2008.

Dr. R.K. Balyan (Director & Dean)

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ACKNOWLEDGEMENT

On the occasion of completion and submission of project we would like to express our deep sense of gratitude to IBMR-Ahmedabad for providing us Platform of management studies. We thank to our Director Dr. R K. Balyan, and Faculty members for their moral support during the project. We are too glad to give our special thanks to our project guide Dr. Renu Choudhary for providing us an opportunity to carryout project on currency derivatives and also for their help and tips whenever needed. Without his co-operation it was impossible to reach up to this stage.

At last, I sincere regards to my parents and friends who have directly or indirectly helped me in the project.

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INTRODUCTION OF CURRENCY DERIVATIVES

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INTRODUCTION OF CURRENCY DERIVATIVES

Each country has its own currency through which both national and international transactions are performed. For example, If any Indian firm borrows funds from international financial market in US dollars for short or long term then at maturity the same would be refunded in particular agreed currency along with accrued interest on borrowed money. It means that the borrowed foreign currency brought in the country will be converted into Indian currency, and when borrowed fund are paid to the lender then the home currency will be converted into foreign lender’s currency. exchange rate. The foreign exchange markets of a country provide the mechanism of exchanging different currencies with one and another, and thus, facilitating transfer of purchasing power from one country to another. With the multiple growths of international trade and finance all over the world, trading in foreign currencies has grown tremendously over the past several decades. Since the exchange rates are continuously changing, so the firms are exposed to the risk of exchange rate movements. As a result the assets or liability or cash flows of a firm which are denominated in foreign currencies undergo a change in value over a period of time due to variation in exchange rates. This variability in the value of assets or liabilities or cash flows is referred to exchange rate risk. Since the fixed exchange rate system has been fallen in the early 1970s, specifically in developed countries, the currency risk has become substantial for many business firms. As a result, these firms are increasingly turning to various risk hedging products like [Project report on Currency Derivatives] IBMR-Ahmedabad Page 4 Thus, the currency units of a country involve an exchange of one currency for another. The price of one currency in terms of other currency is known as All the international business transactions involve an exchange of one currency for another.

foreign currency futures, foreign currency forwards, foreign currency options, and foreign currency swaps.

RESEARCH METHODOLOGY

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To analyze different currency derivatives products. To study the basic concept of Currency future To study the exchange traded currency future To understand the practical considerations and ways of considering currency future price. report submitted by RBI/SEBI committee and NCFM/BCFM modules. The research methodology adopted for carrying out the study was at the first stage theoretical study is attempted and at the second stage observed online trading on NSE/BSE.RESEARCH METHODOLOGY  TYPE OF RESEARCH In this project Descriptive research methodologies were use. any error in the secondary data might also affect the study undertaken. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 6 .  LIMITATION OF THE STUDY The limitations of the study were The analysis was purely based on the secondary data. So.  SOURCE OF DATA COLLECTION Secondary data were used such as various books.  OBJECTIVES OF THE STUDY The basic idea behind undertaking Currency Derivatives project to gain knowledge about currency future market.

The currency future is new concept and topic related book was not available in library and market. CONTENTS CHAPTER NO 1 2 SUBJECTS COVERED Introduction of currency derivatives Research Methodology  Scope of Research  Type of Research  Source of Data collection  Objective of the Study  Data collection  Limitations Introduction to The topic  Introduction of Financial Derivatives  Types of Financial Derivatives  Derivatives Introduction in India  History of currency derivatives  Utility of currency derivatives  Introduction to Currency Derivatives  Introduction to Currency Future Brief Overview of the foreign exchange market Overview of foreign exchange market in India Currency Derivatives Products Foreign Exchange Spot Market Foreign Exchange Quotations Need for exchange traded currency futures Rationale for Introducing Currency Future Future Terminology Uses of currency futures Trading and settlement Process Regulatory Framework for Currency Futures Comparison of Forward & Future Currency Contracts Analysis             Interest Rate Parity Principle [Project report on Currency Derivatives] IBMR-Ahmedabad Page 7 PAGE NO 4 7 3 8 4 20 5 41 .

 Product Definitions of currency future  Currency futures payoffs  Pricing Futures and Cost of Carry model  Hedging with currency futures Findings suggestions and Conclusions Bibliography 53 55 INTRODUCTION TO THE TOPIC [Project report on Currency Derivatives] IBMR-Ahmedabad Page 8 .

US Federal Reserve Bank The past decades has witnessed the multiple growths in the volume of international trade and business due to the wave of globalization and liberalization all over the world.a process that has undoubtedly improved national productivity growth and standards of livings. exchange rate and stock market prices at the different financial market have increased the financial risks to the corporate world. It is therefore. changes in the interest rates. to manage such risks. which are also popularly known as financial derivatives. In this respect.INTRODUCTION TO FINANCIAL DERIVATIVES “By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives…These instruments enhances the ability to differentiate risk and allocate it to those investors most able and willing to take it. Former Chairman. the demand for the international money and financial instruments increased significantly at the global level. As a result. the new financial instruments have been developed in the financial markets. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 9 .” Alan Greenspan.

Silver  Short Term Debt Securities : Treasury Bills  Interest Rates  Common shares/stock  Stock Index Value : NSE Nifty [Project report on Currency Derivatives] IBMR-Ahmedabad Page 10 . These assets can be a share. crude oil. etc. These contracts are legally binding agreements. made on the trading screen of stock exchanges. bond. sugar. interest rate. which is derivative of milk. coffee and what you have.  A very simple example of derivatives is curd. to buy or sell an asset in future. it means that some things have to be derived or arisen out of the underlying variables. A financial derivative is an indeed derived from the financial market.  Something derived. The price of curd depends upon the price of milk which in turn depends upon the demand and supply of milk. index. It means. this word has been arisen by derivation. Grain.  Derivatives are financial contracts whose value/price is independent on the behavior of the price of one or more basic underlying assets.**DEFINITION OF FINANCIALDERIVATIVES**  A word formed by derivation. cotton. Potatoes.  The Underlying Securities for Derivatives are :  Commodities: Castor seed. soybeans.  Precious Metal : Gold. rupee dollar exchange rate. Pepper.

plain. it is very difficult to classify the financial derivatives. composite. joint or hybrid. Presently there are Complex varieties of derivatives already in existence and the markets are innovating newer and newer ones continuously. For example. Swaps [Project report on Currency Derivatives] IBMR-Ahmedabad Page 11 . are available in the market. called as the underlying. the derivatives can be classified into different categories which are shown below : DERIVATIVES Financials Commodities Basics 1. Currency : Exchange Rate TYPES OF FINANCIAL DERIVATIVES Financial derivatives are those assets whose values are determined by the value of some other assets. Forwards Complex 1. so in the present context. synthetic. leveraged. various types of financial derivatives based on their different properties like. OTC traded. mildly leveraged. etc. standardized or organized exchange traded. Due to complexity in nature. simple or straightforward. the basic financial derivatives which are popularly in the market have been described. In the simple form.

jute. the underlying instrument may be treasury bills. the underlying instrument is commodity which may be wheat. sugar. or both. forward contracts. Warrants and Convertibles 2. cost of living index etc. stock index. In financial derivative. such derivatives are effectively derivatives of derivatives. Options 4. The basic difference between these is the nature of the underlying instrument or assets. gold. It is to be noted that financial derivative is fairly standard and there are no quality issues whereas in commodity derivative. bonds. crude oil. futures contracts and option contracts have been included in the basic derivatives whereas swaps and other complex derivatives are taken into complex category because they are built up from either forwards/futures or options contracts.2. foreign exchange. Another way of classifying the financial derivatives is into basic and complex. Futures 3. natural gas. turmeric. In this. stocks.Exotics (Non STD) One form of classification of derivative instruments is between commodity derivatives and financial derivatives. In fact. In commodity derivatives. cotton. pepper. the quality may be the underlying matters. silver and so on. corn.  Derivatives are traded at organized exchanges and in the Over The Counter ( OTC ) market : Derivatives Trading Forum Organized Exchanges Commodity Futures Financial Futures Options (stock and index) Over The Counter Forward Contracts Swaps [Project report on Currency Derivatives] IBMR-Ahmedabad Page 12 .

1995. SEBI approved trading in index futures contracts based on S&P CNX Nifty and BSE-30 (Sensex) index. submitted its report on March 17. SEBI set up a 24 – member committee under the chairmanship of Dr. L. the risk is controlled by exchanges through clearing house which act as a contractual intermediary and impose margin requirement. DERIVATIVES INTRODUCTION IN INDIA The first step towards introduction of derivatives trading in India was the promulgation of the Securities Laws (Amendment) Ordinance.Stock Index Future Derivatives traded at exchanges are standardized contracts having standard delivery dates and trading units. 1998. Futures contracts on individual stocks were launched in November 2001. which withdrew the prohibition on options in securities. A major difference between the two is that of counterparty risk—the risk of default by either party. OTC derivatives are customized contracts that enable the parties to select the trading units and delivery dates to suit their requirements. With the exchange traded derivatives.C. The committee recommended that the derivatives should be declared as ‘securities’ so that regulatory framework applicable to trading of ‘securities’ could also govern trading of derivatives. In contrast. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 13 . 1996 to develop appropriate regulatory framework for derivatives trading in India. Gupta on November 18. To begin with. The trading in index options commenced in June 2001 and the trading in options on individual securities commenced in July 2001. OTC derivatives signify greater vulnerability.

It is the largest regulated marketplace for FX trading. financial managers. investment banks. Today. CME Chairman Emeritus. By creating another type of market in which futures could be traded.HISTORY OF CURRENCY DERIVATIVES Currency futures were first created at the Chicago Mercantile Exchange (CME) in 1972. CME offers 41 individual FX futures and 31 options contracts on 19 currencies. currency overlay managers and individual investors. commodity trading advisors (CTAs). which were the main derivative contracts traded at CME until then. They trade in order to transact business.S. or to speculate on rate fluctuations. commercial banks. increasing the risk of doing business.The contracts were created under the guidance and leadership of Leo Melamed. proprietary trading firms. Traders of CME FX futures are a diverse group that includes multinational corporations. The concept of currency futures at CME was revolutionary. CME currency futures extended the reach of risk management beyond commodities. abandonment of the Bretton Woods agreement. which had fixed world exchange rates to a gold standard after World War II. all of which trade electronically on the exchange’s CME Globex platform. hedge funds. hedge against unfavorable changes in currency rates. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 14 . The abandonment of the Bretton Woods agreement resulted in currency values being allowed to float. The FX contract capitalized on the U. and gained credibility through endorsement of Nobel-prize-winning economist Milton Friedman.

Their use by importers hedging foreign currency payables is effective when the payment currency is expected to appreciate and the importers would like to guarantee a lower conversion rate. Their objective is to guarantee a high selling rate of a foreign currency by obtaining a derivative contract while hoping to buy the currency at a low rate in the future. Alternatively. A high degree of volatility of exchange rates creates a fertile ground for foreign exchange speculators. expecting [Project report on Currency Derivatives] IBMR-Ahmedabad Page 15 .(NCFM-Currency future Module) UTILITY OF CURRENCY DERIVATIVES Currency-based derivatives are used by exporters invoicing receivables in foreign currency. or to a joint venture with a foreign partner. They want to guarantee the rate of purchasing foreign currency for various payments related to the installation of a foreign branch or subsidiary. Multinational companies use currency derivatives being engaged in direct investment overseas. willing to protect their earnings from the foreign currency depreciation by locking the currency conversion rate at a high level. they may wish to obtain a foreign currency forward buying contract.Source: . Investors in foreign currency denominated securities would like to secure strong foreign earnings by obtaining the right to sell foreign currency at a high conversion rate. thus defending their revenue from the foreign currency depreciation.

Exporters invoicing receivables in foreign currency are the most frequent users of these contracts. although the banks may require compensating deposit balances or lines of credit.to sell the appreciating currency at a high future rate. they are exposed to the risk of currency fluctuations in the future betting on the pattern of the spot exchange rate adjustment consistent with their initial expectations. The contracts guarantee the future conversion rate between two currencies and can be obtained for any customized amount and any date in the future. Investment in foreign securities induced by higher foreign interest rates and accompanied by the forward selling of the foreign currency income is called a covered interest arbitrage. Source :-( Recent Development in International Currency Derivative Market by Lucjan T. Orlowski) [Project report on Currency Derivatives] IBMR-Ahmedabad Page 16 . In either case. The most commonly used instrument among the currency derivatives are currency forward contracts. These are large notional value selling or buying contracts obtained by exporters. A similar foreign currency forward selling contract is obtained by investors in foreign currency denominated bonds (or other securities) who want to take advantage of higher foreign that domestic interest rates on government or corporate bonds and the foreign currency forward premium. They hedge against the foreign currency depreciation below the forward selling rate which would ruin their return from foreign financial investment. importers. They normally do not require a security deposit since their purchasers are mostly large business firms and investment institutions. investors and speculators from banks with denomination normally exceeding 2 million USD. Their transaction costs are set by spread between bank's buy and sell prices. They are willing to protect themselves from the currency depreciation by locking in the future currency conversion rate at a high level.

Thus. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 17 .INTRODUCTION TO CURRENCY DERIVATIVES Each country has its own currency through which both national and international transactions are performed. currency for another. For example. It means that the borrowed foreign currency brought in the country will be converted into Indian currency. The price of one currency in terms of other currency is known as exchange rate. and when borrowed fund are paid to the lender then the home currency will be converted into foreign lender’s currency. If any Indian firm borrows funds from international financial market in US dollars for short or long term then at maturity the same would be refunded in particular agreed currency along with accrued interest on borrowed money. the currency units of a country involve an exchange of one All the international business transactions involve an exchange of one currency for another.

Since the fixed exchange rate system has been fallen in the early 1970s. so the firms are exposed to the risk of exchange rate movements. the contract is termed a “currency futures contract”. specifically in developed countries. the buyer and the seller lock themselves into an exchange rate for a specific value or delivery date.The foreign exchange markets of a country provide the mechanism of exchanging different currencies with one and another. foreign currency forwards. As a result. In other words. to buy or sell a certain underlying asset or an instrument at a certain date in the future. foreign currency options. it is a contract to exchange one currency for another currency at a specified date and a specified rate in the future. these firms are increasingly turning to various risk hedging products like foreign currency futures. INTRODUCTION TO CURRENCY FUTURE A futures contract is a standardized contract. With the multiple growths of international trade and finance all over the world. When the underlying asset is a commodity. trading in foreign currencies has grown tremendously over the past several decades. When the underlying is an exchange rate. e. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 18 . As a result the assets or liability or cash flows of a firm which are denominated in foreign currencies undergo a change in value over a period of time due to variation in exchange rates. traded on an exchange. the contract is termed a “commodity futures contract”. Oil or Wheat. and foreign currency swaps. and thus. Since the exchange rates are continuously changing.g. at a specified price. Therefore. the currency risk has become substantial for many business firms. Both parties of the futures contract must fulfill their obligations on the settlement date. facilitating transfer of purchasing power from one country to another. This variability in the value of assets or liabilities or cash flows is referred to exchange rate risk.

Step 1: Step 2: Step 3: 42.42. Currency futures are a linear product. 2475 The value of one tick on each contract is Rupees 2. 00.5 per tick = Rupees 50 [Project report on Currency Derivatives] IBMR-Ahmedabad Page 19 .42. it is essential to know both the contract size (the number of currency units being traded) and also what is the tick value.42.42. For e. One tick move on this contract will translate to Rs. In determining profits and losses in futures trading.2500.0025 Rs .42. unlike in the case of OTC markets. Tick values differ for different currency pairs and different underlying.42.0025 Rupees.42. So if a trader buys 5 contracts and the price moves up by 4 tick. and calculating profits or losses on Currency Futures will be similar to calculating profits or losses on Index futures.2500 +Rs. 00. All settlements however. go through the exchange. To demonstrate how a move of one tick affects the price. she makes Rupees 50. A tick is the minimum trading increment or price differential at which traders are able to enter bids and offers.Currency futures can be cash settled or settled by delivering the respective obligation of the seller and buyer. in the case of the USD-INR currency futures contract the tick size shall be 0.2525 depending on the direction of market movement.2600 – 42. Purchase price: Price increases by one tick: New price: Purchase price: Price decreases by one tick: New price: Rs .2500 4 ticks * 5 contracts = 20 points 20 points * Rupees 2. imagine a trader buys a contract (USD 1000 being the value of each contract) at Rs.2525 Rs .25 paise or 0.2475 or Rs.2500 –Rs.g.0025 Rs.50.

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The unification of the exchange rate was instrumental in developing a market-determined exchange rate of the rupee and was an important step in the progress towards total current account convertibility. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 21 . which was achieved in August 1994. The exchange rate regime. that was earlier pegged.BRIEF OVERVIEW OF FOREIGN EXCHANGE MARKET OVERVIEW OF THE FOREIGN EXCHANGE MARKET IN INDIA During the early 1990s. India embarked on a series of structural reforms in the foreign exchange market. was partially floated in March 1992 and fully floated in March 1993.

Exchange Traded Currency Futures will bring in more transparency and efficiency in price discovery.Although liberalization helped the Indian forex market in various ways. sustainability of current account balance. 2008. The Report of the Internal Working Group of RBI submitted in April 2008. swaps and options in the OTC market. YEN. With a view to enable entities to manage volatility in the currency market. are traded. eliminate counterparty credit risk. Banks are also allowed to become members of this segment on the Exchange. RBI and SEBI jointly constituted a Standing Technical Committee to analyze the Currency Forward and Future market around the world and lay down the guidelines to introduce Exchange Traded Currency Futures in the Indian market. Swiss Franc etc. offer standardized products and provide transparent trading platform. The Committee submitted its report on May 29. Subsequently. Source :-( Report of the RBI-SEBI standing technical committee on exchange traded currency futures) 2008. recommended the introduction of Exchange Traded Currency Futures. Further RBI and SEBI also issued circulars in this regard on August 06. provide access to all types of market participants. At the same time. excessive volatility can have an adverse impact on price discovery. a welldeveloped foreign exchange derivative market (both OTC as well as Exchange-traded) is imperative. Pound. While some flexibility in foreign exchange markets and exchange rate determination is desirable. EURO. where all the major currencies like USD. This issue has attracted a great deal of concern from policymakers and investors. In the context of upgrading Indian foreign exchange market to international standards. RBI on April 20. 2008. and balance sheets. Currently. it led to extensive fluctuations of exchange rate. export performance. India is a USD 34 billion OTC market. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 22 . thereby providing them with a new opportunity. With the help of electronic trading and efficient risk management systems. RBI also set up an Internal Working Group to explore the advantages of introducing currency futures. 2007 issued comprehensive guidelines on the usage of foreign currency forwards.

futures. We take a brief look at various derivatives contracts that have come to be used. options and swaps. The most common variants are forwards.CURRENCY DERIVATIVE PRODUCTS Derivative contracts have several variants.  FORWARD : The basic objective of a forward market in any underlying asset is to fix a price for a contract to be carried through on the future agreed date and is intended to free both [Project report on Currency Derivatives] IBMR-Ahmedabad Page 23 .

The currency swap entails swapping both principal and interest between the parties. a specified price and a standard quantity.the purchaser and the seller from any risk of loss which might incur due to fluctuations in the price of underlying asset. In a swap normally three basic steps are involve___ (1) Initial exchange of principal amount (2) Ongoing exchange of interest (3) Re . a future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. In another word. A forward contract is customized contract between two entities. They can be regarded as portfolio of forward contracts. exchange rate or simply forward rate. with the cash flows in one direction being in a different currency than those in the opposite direction. There are a various types of currency swaps like as fixed-to-fixed currency swap.  SWAP : Swap is private agreements between two parties to exchange cash flows in the future according to a prearranged formula. The exchange rate is fixed at the time the contract is entered into. where settlement takes place on a specific date in the future at today’s pre-agreed price. Future contracts are special types of forward contracts in the sense that they are standardized exchange-traded contracts.  FUTURE : A currency futures contract provides a simultaneous right and obligation to buy and sell a particular currency at a specified future date.exchange of principal amount on maturity. fixed to floating currency swap. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 24 This is known as forward . floating to floating swap.

It consists of a network of foreign dealers which are oftenly banks. In other words. and mostly take place primarily by means of telecommunications both within and between countries. The seller of the option gets the premium from the buyer of the option for the obligation undertaken in the contract. to buy or sell a given amount of foreign exchange at a fixed price per unit for a specified time period ( until the expiration date ). OPTIONS : Currency option is a financial instrument that give the option holder a right and not the obligation. Generally they do not have specific location. The large banks usually make markets in different currencies. Options generally have lives of up to one year. etc. financial institutions. the majority of options traded on options exchanges having a maximum maturity of nine months. a foreign currency option is a contract for future delivery of a specified currency in exchange for another in which buyer of the option has to right to buy (call) or sell (put) a particular currency at an agreed price for or within specified period. FOREIGN EXCHANGE SPOT (CASH) MARKET The foreign exchange spot market trades in different currencies for both spot and forward delivery. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 25 . large concerns. Longer dated options are called warrants and are generally traded OTC.

So it is possible to transaction in foreign exchange markets 24 hours a day. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 26 . extent or speed of exchange rate movements. i. The purchase and sale of currencies stem partly from the need to finance trade in goods and services. rather simply book keeping transfer entry among banks. The spot foreign exchange market is similar to the OTC market for securities. transaction usually do not involve a physical transfer of currency.e. It means exchange rate is relative price.In the spot exchange market. 2 days after the execution of the transaction. Another important source of demand and supply arises from the participation of the central banks which would emanate from a desire to influence the direction. FOREIGN EXCHANGE QUOTATIONS Foreign exchange quotations can be confusing because currencies are quoted in terms of other currencies. Since most of the business in this market is done by banks. The standard settlement period in this market is 48 hours. the business is transacted throughout the world on a continual basis.. For example. There is no centralized meeting place and no fixed opening and closing time. Exchange rates are generally determined by demand and supply force in this market. hence.

7250 ( or ) $1 = Rs. In order to separate buying and selling rate. This is a unique feature of this market. and another for selling (ask or offered rate) for a currency. Most countries use the direct method. In global foreign exchange market.02187 There are two ways of quoting exchange rates: the direct and indirect. Re/$ = 45. EXCHANGE RATE Direct The number of units of domestic Currency stated against one unit of foreign currency. one can say that rupees against dollar. It should be noted that where the bank sells dollars against rupees.022 US dollar which is simply reciprocal of the former dollar exchange rate. a small dash or oblique line is drawn after the dash. two rates are quoted by the dealer: one rate for buying (bid rate). 45. For example. 45 in Indian rupees then it implies that 45 Indian rupees will buy one dollar of USA.If one US dollar is worth of Rs. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 27 . or that one rupee is worth of 0.7250 Indirect The number of unit of foreign currency per unit of domestic currency. Re 1 = $ 0.

the base currency is the first currency in a currency pair. Traders.3500 and ready to sell at Rs 46. The difference between the buying and selling rates is called spread.3500/3550. Base Currency/ Terms Currency: In foreign exchange markets. deal in two way prices. which means that the value of one currency in terms of the other is constantly in flux.If US dollar is quoted in the market as Rs 46.3550. Exchange rates are constantly changing. For example. That is the expression Dollar-Rupee. Changes in rates are expressed as strengthening or weakening of one currency vis-à-vis the second currency. The second currency is called as the terms currency. the base currency has strengthened / appreciated and the terms currency has weakened / depreciated. usually large banks. It is important to note that selling rate is always higher than the buying rate. it means that the forex dealer is ready to purchase the dollar at Rs 46. both buying and selling. Changes are also expressed as appreciation or depreciation of one currency in terms of the second currency. Exchange rates are quoted in per unit of the base currency. tells you that the Dollar is being quoted in terms of the Rupee. are called market makers. Whenever the base currency buys more of the terms currency. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 28 . The Dollar is the base currency and the Rupee is the terms currency.

25.7525 the Dollar has depreciated and Rupee has appreciated.If Dollar – Rupee moved from 43. The Dollar has appreciated and the Rupee has depreciated. And if it moved from 43.00 to 43. NEED FOR EXCHANGE TRADED CURRENCY FUTURES [Project report on Currency Derivatives] IBMR-Ahmedabad Page 29 .0000 to 42.

The Report of the Internal Working Group of RBI submitted in April 2008. efficiency and accessibility. On the other hand. swaps and options in the OTC market. On the maturity date. Further. RATIONALE FOR INTRODUCING CURRENCY FUTURE [Project report on Currency Derivatives] IBMR-Ahmedabad Page 30 . which by assuming counterparty guarantee eliminates credit risk. At the same time. RBI on April 20. the scope for building up of mark to market losses in the books of various participants gets limited. The counterparty risk in a futures contract is further eliminated by the presence of a clearing corporation. in the case of an exchange traded futures contract. Since the profits or losses in the futures market are collected / paid on a daily basis. An individual entering into a forward contract agrees to transact at a forward price on a future date. Other advantages of an Exchange traded market would be greater transparency. RBI also set up an Internal Working Group to explore the advantages of introducing currency futures. yet differ in fundamental ways. 2007 issued comprehensive guidelines on the usage of foreign currency forwards.With a view to enable entities to manage volatility in the currency market. recommended the introduction of exchange traded currency futures. Source :-( Report of the RBI-SEBI standing technical committee on exchange traded currency futures) 2008. mark to market obligations is settled on a daily basis. The transactions on an Exchange are executed on a price time priority ensuring that the best price is available to all categories of market participants irrespective of their size. in an Exchange traded scenario where the market lot is fixed at a much lesser size than the OTC market. no money changes hands. Exchange traded futures as compared to OTC forwards serve the same economic purpose. equitable opportunity is provided to all classes of investors whether large or small to participate in the futures market. the obligation of the individual equals the forward price at which the contract was executed. Except on the maturity date.

But unlike forward contracts. no gains and losses are made out of currency exposures. (or which can be used for reference purposes in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. The rationale for establishing the currency futures market is manifold. the futures contracts are standardized and exchange traded. The standardized items in a futures contract are: •Quantity of the underlying •Quality of the underlying •The date and the month of delivery •The units of price quotation and minimum price change •Location of settlement The rationale for introducing currency futures in the Indian context has been outlined in the Report of the Internal Working Group on Currency Futures (Reserve Bank of India. the exchange specifies certain standard features of the contract.Futures markets were designed to solve the problems that exist in forward markets. But if domestic currency depreciates (appreciates) against the foreign currency. Both residents and nonresidents purchase domestic currency assets. To facilitate liquidity in the futures contracts. If the exchange rate remains unchanged from the time of purchase of the asset to its sale. A futures contract is standardized contract with standard underlying instrument. a standard quantity and quality of the underlying instrument that can be delivered. the exposure would result in gain (loss) for residents purchasing foreign assets and loss (gain) for [Project report on Currency Derivatives] IBMR-Ahmedabad Page 31 . A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. April 2008) as follows.

which is typically inter-generational in the context of exchange rates. financial planning horizon is much smaller than the long-run. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 32 . However.non residents purchasing domestic assets. there are strong arguments to use instruments to hedge currency risks. Currency futures enable them to hedge these risks. changes in exchange rate are found to have very low correlations with foreign equity and bond returns. The argument for hedging currency risks appear to be natural in case of assets. Empirically. while real exchange rates over long run are mean reverting. As such. there is a strong need to hedge currency risk and this need has grown manifold with fast growth in cross-border trade and investments flows. Therefore. the incentive to hedge currency risk may not be large. it is possible that over a long – run. which results in income flows with leads and lags and get converted into different currencies at the market rates. This in theory should lower portfolio risk. As such. and applies equally to trade in goods and services. Nominal exchange rates are often random walks with or without drift. In this backdrop. sometimes argument is advanced against the need for hedging currency risks. unpredicted movements in exchange rates expose investors to currency risks. But there is strong empirical evidence to suggest that hedging reduces the volatility of returns and indeed considering the episodic nature of currency returns.

the term. In the case of USDINR. including those for ‘known holidays’ and would be those as laid down by Foreign Exchange Dealers Association of India (FEDAI).  CONTRACT CYCLE : The period over which a contract trades. In NSE/BSE will have 12 contracts outstanding at any given point in time. two month. The currency future contracts in Indian market have one month. spot value is T + 2.FUTURE TERMINOLOGY  SPOT PRICE : The price at which an asset trades in the spot market. The last business day would be taken to the same as that for inter bank settlements in Mumbai.  VALUE DATE / FINAL SETTELMENT DATE : The last business day of the month will be termed the value date /final settlement date of each contract. Since the exchange of securities and cash is virtually immediate. cash market. The rules for inter bank settlements. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 33 .  FUTURE PRICE : The price at which the future contract traded in the future market. The transaction in which securities and foreign exchange get traded for immediate delivery. three month up to twelve month expiry cycles. has also been used to refer to spot dealing.

The last trading day will be two business days prior to the value date / final settlement date. In case of USDINR it is USD 1000. EXPIRY DATE : It is the date specified in the futures contract. Also called as lot size. basis will be positive. In a normal market. For equity derivatives carry cost is the rate of interest.  COST OF CARRY : The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This reflects that futures prices normally exceed spot prices. at the end of which it will cease to exist.  CONTRACT SIZE : The amount of asset that has to be delivered under one contract. basis can be defined as the futures price minus the spot price. There will be a different basis for each delivery month for each contract.  BASIS : In the context of financial futures.  INITIAL MARGIN : [Project report on Currency Derivatives] IBMR-Ahmedabad Page 34 . This measures the storage cost plus the interest that is paid to finance or ‘carry’ the asset till delivery less the income earned on the asset. This is the last day on which the contract will be traded.

Or in another words. futures contract is also called as daily reconnected forwards. and profit and loss is determined on each transaction. If the balance in the margin account falls below the maintenance margin. In turn customers’ account are also required to be maintained at a certain level. This is set to ensure that the balance in the margin account never becomes negative. Due to this adjustment. requires that funds charge every day. the member has to deposit the margin with the clearing house as per the rate fixed by the exchange which may vary asset to asset. all the outstanding contracts are reprised at the settlement price of that session. This procedure.  MAINTENANCE MARGIN : Member’s account are debited or credited on a daily basis. is called the maintenance margin.When the position is opened. called marking to market. It means that all the futures contracts are daily settled. the amount that must be deposited in the margin account at the time a future contract is first entered into is known as initial margin. the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day. usually about 75 percent of the initial margin. This is somewhat lower than the initial margin. The funds are added or subtracted from a mandatory margin (initial margin) that traders are required to maintain the balance in the account. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 35 .  MARKING TO MARKET : At the end of trading session.

44.44. (Rs. How can he trade based on this belief? In case he can buy dollars and hold it. the effective rate for the remittance received by the entity A is Rs.000 + Rs. buy futures Take the case of a speculator who has a view on the direction of the market.e. by investing the necessary capital. The value of the contract is Rs. he can profit if say the Rupee depreciates to Rs. The entity can do so by selling one contract of USDINR futures since one contract is for USD 1000.50.44.  Speculation: Bullish. 250. 44.2500. As may be observed. 2008 is Rs. Assuming he buys USD 10000.250.0000.42.000. The entity shall sell on August 27.44. The entity was able to hedge its exposure. it would require an investment of Rs. while spot rate on that date was Rs. 2500 (Rs.43 and ‘USDINR 27 Aug 08’ contract is trading at Rs.000. He would like to trade based on this view. The futures contract will settle at Rs.4.0000.20. Wants to lock in the foreign exchange rate today so that the value of inflow in Indian rupee terms is safeguarded. If the exchange rate moves as he [Project report on Currency Derivatives] IBMR-Ahmedabad Page 36 . 2008. 44. He expects that the USD-INR rate presently at Rs.42. is to go up in the next two-three months.USES OF CURRENCY FUTURES  Hedging: Presume Entity A is expecting a remittance for USD 1000 on 27 August 08. Presume that the current spot rate is Rs. Entity A shall do the following: Sell one August contract today. The return from the futures transaction would be Rs.44.000).250 – Rs. Let us assume the RBI reference rate on August 27.0000 (final settlement price = RBI reference rate).44.44. USD 1000 in the spot market and get Rs. i.250)/1000. 44.

Therefore the speculator may buy 10 contracts. 000.40. If the underlying price falls. The minimum contract size is USD 1000.21.42. A speculator can take exactly the same position on the exchange rate by using futures contracts.21. the futures price shall converge to the spot price (Rs. 42.42. as long as there is sufficient liquidity in the market. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 37 . sell futures Futures can be used by a speculator who believes that an underlying is over-valued and is likely to see a fall in price. If the INR. Presumably. so will the futures price.76%. How can he trade based on his opinion? In the absence of a deferral product.50 against USD.20 (each contact for USD 1000). Two months later.50) and he makes a profit of Rs. Now take the case of the trader who expects to see a fall in the price of USD-INR.1000 on an investment of Rs. futures form an attractive option for speculators. He pays a small margin on the same. Because of the leverage they provide. USD-INR rate let us say is Rs.USD is Rs.  Speculation: Bearish. there wasn't much he could do to profit from his opinion. It may please be noted that the cost of funds invested is not considered in computing this return. 42. He sells one two-month contract of futures on USD say at Rs. then he shall make a profit of around Rs. On the day of expiration. the margin may be around Rs. This works out to an annual return of 19 percent. 42.10000. The exposure shall be the same as above USD 10000. This works out to an annual return of around 4. If the underlying price rises. so will the futures price. Let us understand how this works. when the futures contract expires. Let us see how this works.42 and the three month futures trade at Rs. 000.expected in the next three months. Today all he needs to do is sell the futures. Three months later if the Rupee depreciates to Rs. (on the day of expiration of the contract). Typically futures move correspondingly with the underlying.

If the same or similar product is traded in say two different markets. For the one contract that he sold. the profit being the difference between the market prices. One of the methods of arbitrage with regard to USD-INR could be a trading strategy between forwards and futures market. Such of those entities who can trade both forwards and futures shall be able to identify any mispricing between forwards and futures. If the tenor of both the contracts is same. if any.  Arbitrage: Arbitrage is the strategy of taking advantage of difference in price of the same or similar product between two or more markets. As we discussed earlier. this works out to be Rs.the spot and the futures price converges. If in one of the markets the product is trading at higher price. If one of them is priced higher. then the entity shall buy the product in the cheaper market and sell in the costlier market and thus benefit from the price differential without any additional risk. since both forwards and futures shall be settled at the same RBI reference rate. the transaction shall result in a risk less profit. That is. the futures price and forward prices are arrived at using the principle of cost of carry. He has made a clean profit of 20 paise per dollar. any entity which has access to both the markets will be able to identify price differentials. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 38 .2000. the same shall be sold while simultaneously buying the other which is priced lower. arbitrage is striking a combination of matching deals that capitalize upon the imbalance.

TRADING PROCESS AND SETTLEMENT PROCESS Like other future trading. the future currencies are also traded at organized exchanges. The following diagram shows how operation take place on currency future market: TRADER ( BUYER ) TRADER ( SELLER ) Purchase order Sales order Transaction on the floor (Exchange) MEMBER ( BROKER ) MEMBER ( BROKER ) Informs CLEARING HOUSE [Project report on Currency Derivatives] IBMR-Ahmedabad Page 39 .

actual physical delivery of the underlying assets is very rare and hardly it ranges from 1 percent to 5 percent. 3. that an RBI-SEBI Standing Technical Committee on Exchange Traded Currency and Interest Rate Derivatives would be constituted. X purchases American Dollar futures and Y sells it. REGULATORY FRAMEWORK FOR CURRENCY FUTURES With a view to enable entities to manage volatility in the currency market. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 40 . To coordinate the regulatory roles of RBI and SEBI in regard to trading of Currency and Interest Rate Futures on the Exchanges. Most often buyers and sellers offset their original position prior to delivery date by taking an opposite positions. 2007 issued comprehensive guidelines on the usage of foreign currency forwards. first. To suggest eligibility criteria for the members of such exchanges. recommended the introduction of exchange traded currency futures. Assume next day X sells same contract to Z. X party and clearing house and second Y party and clearing house.It has been observed that in most futures markets. To begin with. swaps and options in the OTC market. RBI on April 20. With the expected benefits of exchange traded currency futures. This is because most of futures contracts in different products are predominantly speculative instruments. The Terms of Reference to the Committee was as under: 1. 2. For example. the Committee would evolve norms and oversee the implementation of Exchange traded currency futures. To suggest the eligibility norms for existing and new Exchanges for Currency and Interest Rate Futures trading. 2008. RBI also set up an Internal Working Group to explore the advantages of introducing currency futures. then X is out of the picture and the clearing house is seller to Z and buyer from Y. It leads to two contracts. it was decided in a joint meeting of RBI and SEBI on February 28. At the same time. this process is goes on. The Report of the Internal Working Group of RBI submitted in April 2008. and hence.

brokers. institutional investors. institutional investors. arbitrageurs. but compensating bank Maturity Settlement balanced may be required Tailored to needs: from one Standardized Margin deposit required FUTURES Standardized Standardized Open auction among buyers and seller on the floor of recognized exchange. multinational companies. Banks.4. To suggest surveillance mechanism and dissemination of market information. brokers. margin requirements and other risk mitigation measures on an ongoing basis. small traders. To consider microstructure issues. 6. arbitrageurs. No variation margin requirements At recognized exchange floor with worldwide communications separate clearing house Over the telephone worldwide and computer networks Market place [Project report on Currency Derivatives] IBMR-Ahmedabad Page 41 . etc. week to 10 years Actual delivery or offset with Daily settlement to the market and cash settlement. COMPARISION OF FORWARD AND FUTURES CURRENCY CONTRACT BASIS Size Delivery date Method of transaction Participants FORWARD Structured as per requirement of the parties Tailored on individual needs Established by the bank or broker through electronic media Banks. etc. 5. forex dealers. speculators. multinational companies. Margins traders. in the overall interest of financial stability. None as such. To review product design.

Accessibilit y Delivery Secured Limited to large customers banks. More than 90 percent settled by actual delivery Risk is high being less secured Open to any one who is in need of hedging facilities or has risk capital to speculate Actual delivery has very less even below one percent Highly secured through margin deposit. institutions. etc. ANALYSIS [Project report on Currency Derivatives] IBMR-Ahmedabad Page 42 .

this theoretical price is compared with the quoted futures price on January 10. 2002 is : the answer will be Rs. The forward rate is a function of the spot rate and the interest rate differential between the two currencies.7908 per dollar.46. having no restrictions on borrowing or lending of either currency the forward rate can be calculated as follows. the forward rate is the rate which neutralizes the effect of differences in the interest rates in both the currencies. any funds held will be invested in a time deposit of that currency. and spot ( Re/$ ) exchange rate was 46. Then.a.INTEREST RATE PARITY PRINCIPLE For currencies which are fully convertible. on Indian rupee and US dollar six month rate was 6 percent p. the rate of exchange for any date other than spot is a function of spot and the relative interest rates in each currency. 2002 and the relationship is observed. 2002.a. In the case of fully convertible currencies. Using the above equation the theoretical future price on January 10. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 43 . six month annual interest rate was 7 percent p. expiring on June 9. Hence. Future Rate = (spot rate) {1 + interest rate on home currency * period} / {1 + interest rate on foreign currency * period} For example. 2002. Assume that on January 10. The assumption is that.3500. adjusted for time.

[Project report on Currency Derivatives] IBMR-Ahmedabad Page 44 .

to 5 p. Quotation The currency futures contract would be quoted in rupee terms.m. the outstanding positions would be in dollar terms. currency futures contracts on US Dollar – Indian Rupee (US$-INR) would be permitted. Tenor of the contract The currency futures contract shall have a maximum maturity of 12 months. Trading Hours The trading on currency futures would be available from 9 a. Size of the contract The minimum contract size of the currency futures contract at the time of introduction would be US$ 1000. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 45 .m. Settlement mechanism The currency futures contract shall be settled in cash in Indian Rupee. The contract size would be periodically aligned to ensure that the size of the contract remains close to the minimum size. However. Available contracts All monthly maturities from 1 to 12 months would be made available.PRODUCT DEFINITIONS OF CURRENCY FUTURE ON NSE/BSE Underlying Initially.

m. The last working day would be taken to be the same as that for Interbank Settlements in Mumbai. The methodology of computation and dissemination of the Reference Rate may be publicly disclosed by RBI.m. including those for ‘known holidays’ and ‘subsequently declared holiday’ would be those as laid down by FEDAI. The contract specification in a tabular form is as under: Underlying Trading Hours (Monday to Friday) Contract Size Tick Size Trading Period Contract Months Final Settlement Value date Last Trading Day Settlement Final Settlement Price date/ USD 1000 0.25 paisa or INR 0.0025 Maximum expiration period of 12 months 12 near calendar months Last working day of the month (subject to holiday calendars) Two working days prior to Final Settlement Date Cash settled The reference rate fixed by RBI two working days prior to the final settlement date will be used for final settlement Rate of exchange between one USD and INR 09:00 a. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 46 . Final settlement day The currency futures contract would expire on the last working day (excluding Saturdays) of the month. The rules for Interbank Settlements.Settlement price The settlement price would be the Reserve Bank Reference Rate on the date of expiry. to 05:00 p.

1 shows the payoff diagram for the buyer of a futures contract. Options do not have linear payoffs. Figure 4. his [Project report on Currency Derivatives] IBMR-Ahmedabad Page 47 . Futures contracts have linear payoffs. However.e. the long futures position starts making profits. These linear payoffs are fascinating as they can be combined with options and the underlying to generate various complex payoffs.e. He has a potentially unlimited upside as well as a potentially unlimited downside.43.43. Take the case of a speculator who buys a two-month currency futures contract when the USD stands at say Rs. USD. i. Payoff for buyer of futures: Long futures The payoff for a person who buys a futures contract is similar to the payoff for a person who holds an asset. The investor bought futures when the USD was at Rs. and when the dollar depreciates.19. i. This is generally depicted in the form of payoff diagrams which show the price of the underlying asset on the X-axis and the profits/losses on the Y-axis. Their pay offs are nonlinear. when Rupee depreciates. when rupee appreciates. The underlying asset in this case is the currency.CURRENCY FUTURES PAYOFFS A payoff is the likely profit/loss that would accrue to a market participant with change in the price of the underlying asset. currently only payoffs of futures are discussed as exchange traded foreign currency options are not permitted in India. When the value of dollar moves up. If the price goes up.19. Payoff for buyer of future: The figure shows the profits/losses for a long futures position. it means that the losses as well as profits for the buyer and the seller of a futures contract are unlimited. it starts making losses. In simple words.

[Project report on Currency Derivatives] IBMR-Ahmedabad Page 48 . USD. when rupee appreciates. When the value of dollar moves down.43. The Figure below shows the payoff diagram for the seller of a futures contract. it starts making losses. his futures position starts showing losses. If the price falls.19.e. Take the case of a speculator who sells a two month currency futures contract when the USD stands at say Rs.futures position starts making profit.19 0 U L O S S Payoff for seller of futures: Short futures The payoff for a person who sells a futures contract is similar to the payoff for a person who shorts an asset.e. i. the short futures position starts 25 making profits. The underlying asset in this case is the currency. He has a potentially unlimited upside as well as a potentially unlimited downside. i. P R O F I T 43. when rupee depreciates. and when the dollar appreciates.

his futures position starts showing losses P R O F I T 43.Payoff for seller of future: The figure shows the profits/losses for a short futures position.19. his futures position starts making profit. The investor sold futures when the USD was at 43. If the price goes down. If the price rises.19 0 U L O S S [Project report on Currency Derivatives] IBMR-Ahmedabad Page 49 .

arbitragers would enter into trades to capture the arbitrage profit. From the equation above the one year forward exchange rate should be F = 44 * e^(0. Every time the observed price deviates from the fair value.07 )*1=45. we calculate the fair value of a futures contract. let us assume that one year interest rates in US and India are say 7% and 10% respectively and the spot rate of USD in India is Rs. 44.71828 The relationship between F and S then could be given as F Se^(r rf )T .= This relationship is known as interest rate parity relationship and is used in international finance.10-0. This in turn would push the futures price back to its fair value. The cost of carry model used for pricing futures is given below: F=Se^(r-rf)T where: r=Cost of financing (using continuously compounded interest rate) rf= one year interest rate in foreign T=Time till expiration in years E=2. Using the cost-of-carry logic.PRICING FUTURES – COST OF CARRY MODEL Pricing of futures contract is very simple.34 [Project report on Currency Derivatives] IBMR-Ahmedabad Page 50 . To explain this.

the traders’ oftenly use the currency futures. The value of F shall increase further as time T increases.It may be noted from the above equation. in all these situations. buying currency futures contracts) will protect against a rise in a foreign currency value whereas a short hedge (i. in order to hedge this foreign currency risk. i.e. HEDGING WITH CURENCY FUTURES Exchange rates are quite volatile and unpredictable. the firm’s profit will be affected by change in foreign exchange rates. Thus. For example. an Indian manufacturer wants to purchase [Project report on Currency Derivatives] IBMR-Ahmedabad Page 51 . For example. The general rule for determining whether a long or short futures position will hedge a potential foreign exchange loss is: Loss from appreciating in Indian rupee= Short hedge Loss form depreciating in Indian rupee= Long hedge The choice of underlying currency The first important decision in this respect is deciding the currency in which futures contracts are to be initiated.. if a trader is exporting or importing any particular product from other countries then he is exposed to foreign exchange risk. then value of F shall be greater than S. the firm can take long or short position in futures currency market as per requirement. It is noted that corporate profits are exposed to exchange rate risk in many situation. then F shall be less than S. The value of F shall decrease further as time T increase..e. If the foreign interest is lower than the domestic rate. if the firm is borrowing or lending or investing for short or long period from foreign countries. a long hedge (I. In all these situations. selling currency futures contracts) will protect against a decline in a foreign currency’s value. rather even may incur loss. Similarly.e. rf < r.e. rf > r. if foreign interest rate is greater than the domestic rate i. it is possible that anticipated profit in foreign investment may be eliminated. For example..

7000 49.2375 48. For example. So what he will do to protect against depreciating in Indian rupee? Suppose spots value of 1 USD is 49. Assume that there is no such future (between rupee and mark) available in the market then the trader would choose among other currencies for the hedging in futures.5000 47. And he predicts that the value of USD will increase against Indian rupees nearest to due date of that payment.7300 49.2000 50. This is called cross hedge.9900 50.0000 51.0875 48.3000 51.0000 48.1000 50.9250 50.9225 50. Choice of the maturity of the contract The second important decision in hedging through currency futures is selecting the currency which matures nearest to the need of that currency.2275 50. Which contract should he choose? Probably he has only one option rupee with dollar.5000 53. Future Value of the 1USD on NSE as below: Price Watch Order Book Contract USDINR 261108 USDINR 291208 USDINR 280109 USDINR 250209 USDINR 270309 USDINR 280409 USDINR 270509 USDINR 260609 USDINR 290709 USDINR 270809 USDINR 280909 USDINR 281009 USDINR 261109 Best Buy Qty 464 189 1 100 100 1 25 1 2 1 1 1 Best Buy Price 49.0000 49.3825 Best Sell Price 49.9125 50.0000 49.5000 51.3100 48. Importer predicts that the value of USD will increase more than 51.8550 49.8850 50. suppose Indian importer import raw material of 100000 USD on 1 st November 2008.1900 Best Sell Qty 712 612 2 1 5 5 5 1 2 LTP 49.9450 50.1625 48.1000 49.6925 49.8575 49.1925 49.8500. And he will have to pay 100000 USD on 1st February 2009.0000.some raw materials from Germany then he would like future in German mark since his exposure in straight forward in mark against home currency (Indian rupee).1500 50.8550 49.9275 Volume 58506 176453 5598 3771 311 6 Open Interest 43785 111830 16809 6367 892 278 506 116 44 2215 79 2 - [Project report on Currency Derivatives] IBMR-Ahmedabad Page 52 .0000 50.

As we know that in the futures markets due to their standardization. of Contracts 244645 Archives As On 26-Nov-2008 12:00:00 Hours IST Rules.0000. On settlement date payoff of importer will be (51.Rs.299425 at present.001.0000-59. We may define the hedge ratio HR as follows: HR= VF / Vc Where.8850.8500. The value of the futures position should be taken to match as closely as possible the value of the cash market position. Choice of the number of contracts (hedging ratio) Another important decision in this respect is to decide hedging ratio HR.8850*1000*100) =4988500. exact match will generally not be possible but hedge ratio should be as close to unity as possible.115 per USD.115*100000) =111500. And spot value is 49. And suppose on settlement day the spot price of USD is 51. Suppose value of contract dated 28th January 2009 is 49.8500 Solution: He should buy ten contract of USDINR 28012009 at the rate of 49. Value of the contract is (49.8850) =1. (Value of currency future per USD*contract size*No of contract). HR=49.8500=1.8850. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 53 . Means he will have to pay Rs. For that he has to pay 5% margin on 5988500.Volume As On 26-NOV-2008 17:00:00 Hours IST No.8850/49. VF is the value of the futures position and Vc is the value of the cash position. And (1. Byelaws & Regulations Membership Circulars List of Holidays Underlying USDINR RBI reference rate 49.

[Project report on Currency Derivatives] IBMR-Ahmedabad Page 54 .  New concept of Exchange traded currency future trading is regulated by higher authority and regulatory.FINDINGS  Cost of carry model and Interest rate parity model are useful tools to find out standard future price and also useful for comparing standard with actual future price. And it’s also a very help full in Arbitraging. at this time if any person wants to use other instrument of currency derivatives in this case he has to use OTC. The whole function of Exchange traded currency future is regulated by SEBI/RBI. And the USD 25 million limit for other trading members so larger exporter and importer might continue to deal in the OTC market where there is no limit on hedges. and they established rules and regulation so there is very safe trading is emerged and counter party risk is minimized in currency Future trading.  In India RBI and SEBI has restricted other currency derivatives except Currency future.  There is a limit of USD 100 million on open interest applicable to trading member who are banks. And also time reduced in Clearing and Settlement process up to T+1 day’s basis.  Larger exporter and importer has continued to deal in the OTC counter even exchange traded currency future is available in markets because.

[Project report on Currency Derivatives] IBMR-Ahmedabad Page 55 . Like POUNDINR. so this restriction seem unreasonable to exporters and importers.  In India the regulatory of Financial and Securities market (SEBI) has Ban on other Currency Derivatives except Currency Futures. Ban on NRI’s and FII’s and Mutual Funds from Participating. CAD-INR etc.SUGGESTIONS  Currency Future need to change some restriction it imposed such as cut off limit of 5 million USD.  In OTC there is no limit for trader to buy or short Currency futures so there demand arises that in Exchange traded currency future should have increase limit for Trading Members and also at client level. in result OTC users will divert to Exchange traded currency Futures.  Now in exchange traded currency future segment only one pair USD-INR is available to trade so there is also one more demand by the exporters and importers to introduce another pair in currency trading. And according to Indian financial growth now it’s become necessary to introducing other currency derivatives in Exchange traded currency derivative segment.

Not only big businessmen and exporter and importers use this but individual who are interested and having knowledge about forex market they can also invest in currency future. Initially only NSE had the permission but now BSE and MCX has also started currency future. Exchange between USD-INR markets in India is very big and these exchange traded contract will give more awareness in market and attract the investors.a process that has undoubtedly improved national productivity growth and standards of livings. The currency future gives the safe and standardized contract to its investors and individuals who are aware about the forex market or predict the movement of exchange rate so they will get the right platform for the trading in currency future. Because of exchange traded future contract and its standardized nature gives counter party risk minimized. It is shows that how currency future covers ground in the compare of other available derivatives instruments.CONCLUSIONS By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives…These instruments enhances the ability to differentiate risk and allocate it to those investors most able and willing to take it. [Project report on Currency Derivatives] IBMR-Ahmedabad Page 56 .

nseindia.sebi.frost.economywatch. Center for social and economic research) Poland Recent Development in International Currency Derivative Market by: Lucjan T.in www. April 2008) Websites: www.com [Project report on Currency Derivatives] IBMR-Ahmedabad Page 57 .org. Gupta.bseindia.in www.com www.com www.wikipedia.L. concepts and problems) By: S.BIBLIOGRAPHY Financial Derivatives (theory.com www. Orlowski) Report of the RBI-SEBI standing technical committee on exchange traded currency futures) 2008 Report of the Internal Working Group on Currency Futures (Reserve Bank of India.rbi. BCFM: Currency Future Module. NCFM: Currency future Module.gov.com www.

[Project report on Currency Derivatives] IBMR-Ahmedabad Page 58 .

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