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ASSET LIABILITY MANAGEMENT Dinesh Merani (11)

Jaideep Chandok (20)
Jitendra Yadav (21)
Gaurav Gupta (27)
Paridhi Khemka (28)
Currency Future
• 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.
Basic Aspects of Currency Futures
• Four currency pairs are allowed to be traded (Originally in August 2008, only USD-
INR was allowed. From 19.01.2010, three more currency pairs namely, EUR-INR, GBP-
INR and JPY-INR are allowed by RBI).
• All the contracts would be cash settled in Indian Rupees
• The maximum maturity of the contracts shall be 12 months.
• All monthly maturities from one to 12 months would be made available
• Expiry day & time: All the futures contracts of four currency pairs shall expire at 12 noon,
two working days prior to the last business day of the expiry month.
• Order quotation: While US dollar, Euro and Pound Sterling will be quoted for one unit of
foreign currency in Indian rupees; for Japanese Yen, the quotation will be for 100 JPY in
Indian rupees.
• Permitted lot size: For USD, EUR and GBP, the lot size will be 1,000 foreign currency; for
JPY it will be 1,00,000 JPY
• The settlement price shall be RBI’s Reference Rate on the last trading day
• FINAL SETTLMENT DAY: The contract would expire on the last working
• day (excluding Saturdays) of the month.
Need for Currency Futures
• Importers/Exporters may have some obligations in Forex market, trading
in Currency Futures will help them hedge their positions.

• 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.
Exchanges engaged in Currency future
in India

• NSE- Started in Aug,2008

• MCX-SX-Started in October,2008

• BSE- Started in October,2008

• USE-Started in 31st Aug,2010

Indian Foreign Exchange Markets -
Participants
Market Share – Currency Future
Trading Strategies
Trading Strategies of Currency Futures

• 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

• Hedging
– Participants with exposure in currency can use futures to manage risk arising from
unfavourable exchange rate movements

• Arbitrage
– Entities with access to both Exchange traded Futures and OTC markets, or different
exchanges can exploit arbitrage arising due to pricing differences.
 Trading Strategies – Speculation/Investment
View: INR will depreciate against USD, caused by India’s sharply rising import
bill and poor FII equity flows

Trade:
USDINR 31 July contract: 43.5000
Current Spot rate (9 July 08): 43.0000
Buy 1 July contract: Value Rs. 43,500 (USD 1000 * 43.5000)
Hold contract to expiry: RBI fixing rate on 29 July 08 – 44.0000
Economic return: Profit, Rupees 500 (44,000 – 43,500)

A Currency Futures contract is exactly like a futures contract on the NIFTY or

on INFOSYTCH. A futures price “F” is traded on screen. The price is the
USDINR exchange rate at a future date.
 Trading Strategies – Short Hedging

• A short hedge involves taking a short position in the

futures market. In a currency market, short hedge is taken
by someone who already owns the base currency or is
expecting a future receipt of the base currency. An
example where this strategy can be used :
• An exporter, who is expecting a receipt of USD in the
future will try to fix the conversion rate by holding a short
position in the USD-INR contract.
 Trading Strategies – Long Hedging

• This strategy is used by those who will need to acquire

base currency in the future to pay any liability in the
future. An example where this strategy can be used:
• An importer who has to make payment for his imports
in USD will take a long position in USDINR contracts
and fix the rate at which he can buy USD in future by
paying INR
Trading Strategies - Arbitrage
Arbitrage can potentially exist between, currency futures, OTC forwards
and the non-deliverable forwards traded offshore

An arbitrage can be executed by an entity having access to any two of the

above

Corporate entities with an underlying exposure, can straddle both markets

Sell 1st month in currency futures
Buy 1 month forward in OTC markets

This scenario can exist when currency futures are trading higher than
forwards which will also be governed by interest rate differentials and
USD supply with banks

Restricted access to the OTC and NDF markets could translate to the
arbitrage gap not closing
RBI’s eligibility criteria for banks
Banks authorized by RBI as ‘Category Authorized
Dealers’ are permitted to become trading and clearing
members subject to the following minimum prudential
requirements:
• Minimum net worth of Rs 500 crore
• Minimum Capital Adequacy Ratio (CRAR) of 10 per
cent
• Net NPA (non-performing assets) should not exceed
three per cent
• Made net profit for the last three years
NSE – Trading, Settlement,
Clearing & Risk Mgmt
Trading
Membership: Trading membership of NSE and Clearing membership of
NSCCL.

Balance sheet networth: Trading member Rs. 1 Crore; Clearing member Rs

10 crores

Minimum Liquid Networth for clearing members Rs. 50 Lakhs

Separate Certification required; Members to be approved by SEBI

Foreign Institutional Investors and Non Resident Indians not permitted to

trade in the initial phase
Price Watch Window
Clearing & Settlement
Daily Clearing and Settlement
Trades processing
Position computation
Daily settlement price
Mark to market settlement
Client margin reporting

Final Clearing and Settlement

Expiry day processing
Final settlement price
Final settlement of futures contracts
Risk Management
Real time Upfront portfolio based margins
Based on 99% VaR
Client level monitoring
Initial Margin
Margins calculated using SPAN
Minimum Initial margin 1.75% on day 1, 1% thereafter
Calendar spread margins defined at Rs. 250/-
Monitored at Trading and Clearing Member level
Risk Management
Extreme Loss Margin
1% on value of gross open positions
Monitored at Clearing Member level

Positions Limits
Client : 6% of total open interest or USD 5 million whichever is higher
Trading member : 15% of total open interest or USD 25 million
whichever is higher
Issues
Standardization – it is not possible to obtain a perfect hedge in terms of amount
and timing.
Cost –forwards have no upfront cost, while margining requirements may
effectively drive the cost of hedging in futures up.
Small lots- not possible to hedge small exposures generally.
The management of margin and settlement of daily mark – to – market
differences could be cumbersome for some corporate customers.
Open Interest Limit
Trader Level
Client Level

FII & NRI not allowed

Currency futures involve some costs, like, margin, brokerage, etc. RBI’s
possible intervention in foreign exchange markets to keep the rupee stable may
some times impact the participants who have taken exposure to currency
futures.
Thank you !!