FORIGEN EXCHANGE ASSIGNMENT

 Foreign currency trading legal in India ?

 The basic of forex trading:

As is the case in many other countries around the world, Forex
trading in permitted in India under certain regulations and guidelines.
Forex trading, the buying and selling of global currencies, is said to be
the largest and most liquid market in the world. The two currencies that
are involved in a transaction are called currency pairs and, in most
countries, often involve trading USD and other major Forex
currencies in order to truly capitalise on market activity. India’s
currency is the Indian Rupee (INR), with the Reserve Bank of India
(RBI) being the one to monitor market movement and activity in the
country. This means that it is tasked with intervening where
necessary.In early August 2021, the INR continued on an upward
trajectory, marking a six-week high prompted by gains in local stocks,
amongst other factors. Commenting on the matter, a senior trader at a
private bank was quoted as saying, “There seems to be good flows into
the market and not much resistance from the RBI so far.”

 Legalities of trading India:

Although Forex trading is permitted in India, citizens are not permitted
to do so via electronic and online Forex trading platforms. This is
different compared to other countries, as most international Forex
trading activity is conducted electronically/online. In India, however, it
is only permitted and considered legal when conducted through
specified Forex trading places with the base currency being INR. For
clarity, this simply means that trading in the country is only permitted
for currency pairs that are benchmarked against the INR. This is
believed to have been implemented after the RBI’s circulars that were
publicised in 2013. Moreover, one faces the risk of imprisonment or a
fine should they be found to be trading Forex illegally.
According to reports, and as previously mentioned, only the following
currency pairs can be traded in India: INR/USD, INR/GBP, INR/JPY,
INR/EUR, EUR/USD, GBP/USD and JPY/USD. The last three listed
currency pairs are amongst the most traded and most popular across the
globe because of their respective economies and the role the countries
play in international trade activity.

Forex trading activity is taxable in India, however, following the

introduction of the Good and Service tax (GST) in July 2017, the tax
structure has changed from earlier years. Fortunately, it has changed
for the better because the GST payable is less; according to reports, it
is now between 0.058% and 0.18% of the taxable portion of the Forex
transaction. GST is the only form of tax that applies to Forex trading
activity in India, however, the taxable value can be further subdivided
into one of three categories or thresholds. 

 WHAT PART IS ALLOWED IN INDIA ?

What are currency derivatives ?

Currency derivatives are contracts to buy or sell currencies at a future

date. The major types of currency derivatives are forward contracts,
futures contracts, options and swaps.Despite having an average daily
turnover of Rs 44,859 crores, currency derivatives in India are largely
unknown to small retail investors.The currency derivatives trading
segment in India is dominated by importers, exporters, central banks,
banks and corporations.While currency derivatives in India are
primarily used for hedging, retail investors can create wealth in the
currency derivatives segment by speculating and arbitraging.

MEANING : Currency derivatives are financial contracts (futures,

options and swaps) which have no value of their own. They derive
their value from the value of the underlying asset, in this case,
currencies.For example, assume that the current USD/INR rate is
73.2450. A 1 month USD/INR futures contract is trading at Rs
73.3650.Here, the underlying asset is the USD/INR exchange rate and
the 1 month futures contract being traded is the currency
derivative.The underlying asset and the derivatives contract have
different values. But the value of the derivative is dependent and
derived from the value of the USD/INR current exchange rate.

 What are currency future & options ?

Currency futures are exchange traded futures contracts which specify the quantity, the
date, and the price at which currencies will be exchanged in the future. Speculators
are the most active participants in the futures market but close their positions before
expiry.

So, in reality, they do not physically deliver the currencies, rather they make or lose
money based on the price changes of the futures contract.

Currency options are contracts that give the buyer the right, but not the obligation, to
buy or sell a certain currency on a future date at a pre-decided price. There are two
types of currency options: ‘Call’ option and ‘Put’ option.

The below table demonstrates the relationship between options and currency pairs.

Buy a call option The price of the currency pair is expected to rise
Buy a put option The price of the currency pair is expected to fall
Sell a call option The price of the currency pair is expected to fall
Sell a put option The price of the currency pair is expected to rise

 What are cross future & options ?

A cross currency refers to a currency pair or transaction that does not

involve the U.S. dollar. A cross currency transaction, for example,
doesn't use the U.S. dollar as a contract settlement currency. A cross
currency pair is one that consists of a pair of currencies traded
in forex that does not include the U.S. dollar. Common cross currency
pairs involve the euro and the Japanese yen. 
Cross currency pairs can be excellent tools for forex traders. Some
cross currency trades can be set up to position traders on particular
world events, such as using the EUR/GBP to bet on the
ongoing Brexit saga. The same trade would be more complex and
capital intensive setting up separate positions with the USD/GBP and
USD/EUR, but this method is still used to create exotic cross currency
pairs that are not widely traded. Common cross currency rates involve
the Japanese yen. Many traders take advantage of the carry trade where
they own a high yielding currency like the Australian dollar or the New
Zealand dollar and short the Japanese yen - the low yielding currency.

 When did they start in India ?

While currency futures were introduced in India in 2008 and currency

options in 2010, currency derivatives in India are still mostly
dominated by central banks and importers-exporters.The daily volume
of 44,859 Crores is mostly contributed by banks, corporations,
importers and exporters. But speculators and arbitrageurs have also
increased their participation in the currency markets.As more retail
investors begin to discover the scope of profit generation in the forex
market, the popularity and demand for currency derivatives in India
will witness a substantial growth.

 Contract Signification:

Currency futures & options contracts also referred to as foreign

exchange future & options or FX , future for short, are a type of future
contract to exchange a currency for another at a fixed exchange rate
exchange rate on a specific date in the future

Since the value of the contract is based on the underlying currency

exchange rate, currency futures are considered a financial derivative .
these futures are very similar to currency forwards however futures
contacts are standradized and traded on centralized exchange rather
than customized

 Forex trading for retail Investors :

individual investors can directly buy and sell foreign currencies,
much like they do with equity stocks. Currently, retail investors trade
foreign exchange (forex) via an authorised dealer bank at a cost 1-2
per cent higher than market prices. 

Though some electronic platforms of banks and multi-bank portals

allow retail investors to trade directly, it is limited to a minimum
order size. Authorised dealer banks are free to determine the charges
on forex transactions, subject to RBI’s guidelines that stipulate: 1)
banks should ensure that the charges are reasonable and are not out of
line with the average cost of providing services; 2) they are in line
with the FX Global Code — developed by market participants and a
pool of 16 central banks including RBI — that allows banks to
include a Markup, spread or charge towards the final transaction
price, provided it’s fair and reasonable. Banks also have to ensure
that customers with a low volume are not penalised. 
However, with customers raising pricing concerns, the RBI hopes
that they will be put to rest once the proposed electronic trading
platform goes live in August. The central bank is expected to issue
operational guidelines this month. 
Initially, the facility will be available only for US dollars, but more
currencies will be added gradually. The minimum order is $1,000
with multiples of $500 thereof, while the maximum order size is
$500,000. 
Forex market is broadly divided into two: inter-bank and retail
segment. 
The participants in the inter-bank segment are banks (authorised
under FEMA, 1999) and transactions are conducted through trading
platforms like Thomson Reuters, Clearing Corporation of India Ltd
(CCIL) before being settled by CCIL for cash, TOM, SPOT and
forward USD-INR transactions. Banks also fix card rates for various
forex pairs at the beginning of the day, when purchases and sales
from/to retail customers are made regardless of the intraday
movement of the currency. 
 Authorised dealers Category-1 banks may access both inter-bank and
retail markets, but retail customers can access only retail market for
trade during market hours between 9 am and 5 pm. 

 Forward currency contract ?

A forward exchange contract (FEC) is a special type of over-the-
counter (OTC) foreign currency (forex) transaction entered into in
order to exchange currencies that are not often traded in forex markets.
These may include minor currencies as well as blocked or otherwise
inconvertible currencies. An FEC involving such a blocked currency is
known as a non-deliverable forward, or NDF.

Broadly speaking, forward contracts are contractual agreements

between two parties to exchange a pair of currencies at a specific time
in the future. These transactions typically take place on a date after the
date that the spot contract settles and are used to protect the buyer from
fluctuations in currency prices.

KEY TAKEAWAYS

 A forward exchange contract (FEC) is an agreement between two

parties to effect a currency transaction, usually involving a
currency pair not readily accessible on forex markets.
 FECs are traded OTC with customizable terms and conditions,
many times referencing currencies that are illiquid, blocked, or
inconvertible.
 FECs are used as a hedge against risk as it protects both parties
from unexpected or adverse movements in the currencies' future
spot rates when FX trading is otherwise unavailable.

What are the uses of Currency Derivatives in India?

Currency derivatives in India are primarily used for:

 Hedging: By importers / exporters and other hedgers

 Speculating: By speculative traders
 Arbitraging: By arbitrage traders
How hedgers use currency derivatives?

Mr Agarwal imports 10,000 kgs of Washington apples from the US

worth Rs 14,64,900 at the current USD/INR rate of 73.2450.

If he were to make the payment today, then he will have to shell out Rs
14,64,900. But the payment has to be made after 2 months.

Mr Agarwal is worried. He is expecting the USD/INR rate to go up

from 73.2450 to 75.2450 in the next couple of months. This means that
Mr Agarwal will now end up paying Rs 15,04,900 instead of Rs
14,64,900 i.e. Rs 40,000 more!

Such losses can be disastrous for his business.

But Mr Agarwal can hedge this Rs 40,000 loss by using currency

derivatives. As he expects the USD/INR to increase, he can buy 22 lots
of currency futures of USD/INR at the current rate of 73.3650.

By buying 22 lots, he has taken a position of Rs 16,14,030 (covering

his purchase cost). Let’s say his prediction comes true and the
USD/INR rate appreciates to 75.2450. Then he will end up making a
profit of Rs 41,360 by closing his position. So, his Rs 40,000 loss is
offset by his Rs 41,360 profit.

This is how currency derivatives help importers and exporters hedge

against currency fluctuations.

How speculators use currency derivatives?

Mr Sharma, a teacher, wants to make some quick profit and decides to

try his luck at currency derivatives trading.

He is bearish about USD/INR and believes that a poor US

unemployment data will result in the USD/INR rate falling from
73.2450 to 72.2450 in the coming weeks.
So, he shorts (sells) 10 lots of USD/INR at Rs 73.2450. He has now
taken a position of Rs 7,32,450. After the data is released, there is
volatility in the USD/INR rate and USD/INR falls to 71.2450 intraday.

Mr Sharma, quickly covers his short position by buying back the 10

lots at 71.2450. He ends up making a profit of Rs 20,000 in intraday!

Speculators use various indicators and forex trading strategies to

identify profit making opportunities in the forex markets using
currency derivatives.

[Suggested Reading: Top 10 Tips for Forex Trading in India]

How arbitrageurs use currency derivatives?

In India, Currency derivatives are traded on NSE, BSE and MCX-SX

platforms. There is always a small price difference between the price of
the same currency contract between the three exchanges. Arbitrageurs
make money using this small price difference.

Mr Verma noticed that the USD/INR October futures was trading at

73.39 on NSE and at 73.35 on BSE.

So, he decided to buy 25 lots from BSE and sell them on the NSE. By
capitalising on the spread between the two exchanges, Mr Verma made
7.4% on his investment of Rs 20,000 in a matter of minutes!

Buy on BSE Rs 73.33/lot

Total position taken Rs 18,33,250
Sell on NSE Rs 73.39/lot
Total Sell Value Rs 18,34,750
Profit Rs 1,500
Less: Brokerage Rs 20
Realised Profit Rs 1,480
 Profit % 7.72%

Now that we understand how various market participants use currency

derivatives in India to their advantage.

 WHAT PARTS IS NOT ALLOWED IN INDIA ?