MARKET FOR CURRENCY FUTURES

T.MOHANASUNDARAM
ASST. PROFESSOR,
SCHOOL OF MANAGEMENT STUDIES,
KONGU ENGINEERING COLLEGE
Besides, Spot and Forward market, Currencies are traded in the
derivatives market. The derivative market is an integral part of
Foreign Exchange market.

The market for ‘currency futures’ and ‘currency options’ are

currency derivatives market.

These are known as the derivatives market because the prices of

these markets are driven by the spot market price.

Derivatives that trade on exchanges are called ‘Exchange Traded

Derivatives’ e.g.: Futures & Options.
Privately negotiated derivative contracts are called ‘OTC
Derivatives’
What is Futures Contract?
A Futures contract is a standardized contract with standard underlying
instrument, a standard quantity and a standard timing in settlement.

The standardized item in Futures contract are;

 Underlying asset
 Quantity of Underlying asset
 The date and month of delivery
 Units of price quotation and minimum price change (Tick price)
 Location of settlement

In Futures contract, all settlement go through the exchange. So, Futures

contracts are special types of forward contracts in the sense that they
are standardized and are generally traded on an exchange.
 Origin of currency futures
Though Foreign Exchange market involving forward contract has a long
history, the currency futures has a comparatively recent origin. It begins in
1972, when Chicago Mercantile Exchange has set up its international
market division for trading of currency futures.
Other exchanges also begins division for currency futures trade. Notable
among them are;
 Philadelphia Board of Trade
 London International Financial Futures Exchange
 Singapore International Monetary Exchange
 Sydney Futures Exchange

Trading in currency futures has started by NSE on August 29, 2008 for
USDINR. (EURINR, GBPINR, JPYINR – January 19, 2010)

The average daily volume of transactions in futures in world futures market

is keep on increasing from $20 billion in early 2002 to $500 billion by
mid-2014.
 Currency Derivatives in India

Source: NSE
For 2019-20, till 20th August 2019
 Rationale behind Currency Futures
 Futures markets were designed to address certain problems that exist
in Forward markets.
 In Forward contracts, instability arises when shocks such as;
a. Counter party default.
b. when asset prices change rapidly, the size and configuration of
counter party exposures can become unsustainably large.
so, high reliability on OTC derivatives, such as Forwards may pose a
threat to international financial stability.

If domestic currency depreciates (appreciates) against the foreign

currency, the exposure would result in Loss (gain) for the residents
purchasing foreign assets. The Currency Futures enable them to hedge
these risks.
 The main advantages of currency futures over the forwards are price
transparency, elimination of counter party credit risk, and greater
reach in terms of easy accessibility to all.

 Currency Futures are expected to bring about better price discovery

and also possibly lower transaction costs.

 Apart from pure hedgers, Currency Futures also allow arbitrages and
speculators.

 It is well-known that, exchange rate volatility has an adverse impact

on foreign trade. Apart from Forwards, Currency futures contract
also helps to overcome this barrier.
 Determining Profits and Losses in Futures Trading
 For determining Profit/Loss in futures trading, it is essential to know
both the contract size and tick value.
 A tick is the minimum trading increment or price differential at which
traders are able to enter bids and offers. Tick values differ for different
currency pairs & different underlying.
 In case of USD-INR currency futures contract, tick size shall be 0.25
paise or 0.0025 rupees.
Example:
Purchase price: Rs.62.2500 Purchase price: Rs.62.2500
Price increase by one tick: Rs.0.0025 Price decrease by one tick: Rs.0.0025
New price: Rs. 62.2525 New price: Rs.62.2475

Note: The above example do not include transaction fee & any other fees.
 Features of Currency Futures Contract

1. Size and Maturity of the contract:

Currency Futures are traded only in a limited number of currencies.
The size of the contract is standardized involving fixed amount of
different currencies. The size of the contract in NSE and MCX-SX
would be US$ 1000; Euro 1,000;GBP 1,000 and JPY 1,00,000
respectively.
Futures contract shall mature (expire) at 12:30 noon, two working
days prior to the last business day of the expiring month. Futures
contract will have 12 month trading cycle. On expiry of a near
month contract, a new contract shall be made available so that at any
point of time there shall be at least 12 monthly contracts available for
trading.
2. Use of Pits:
In Futures contract, during early days, the brokers strike the deals sitting
face to face under a trading roof, known as pits (Pit is a place where the
currencies are traded).

The brokers can trade for themselves as well as on behalf of their

customers. when they trade for themselves they are called ‘Locals’ or
‘Floor traders’.

The ‘Locals’ or ‘Floor traders’ are called as ‘Scalpers’ when they hold
their positions for not more than a few minutes.

‘Locals’ are called as ‘Day traders’ who hold their position for a
comparatively long period that is less than a full trading session.
‘Locals’ are ‘Position traders’ when they hold a position for a period
ranging from overnight to a month.

On the other hand, when the broker trade on behalf of their

customers, they are known as ‘Commission brokers’ or ‘Floor
brokers’. They charge commission from their clients. This is why
there are no bid-ask rates and the commission serves the purpose of
Spread.

The traders acting for themselves as well as on behalf of their

customers are known as ‘Dual traders’. One of the demerits of the
dual trade is that they act more for their own benefit and not so much
for their clients. Such favorable treatment for their own account at
the expense of their client is known as ‘front-running’.
3. Transactions through Clearing house:

Clearing house is a part of a trading system in futures contract

with which traders strike a deal. Suppose A and B are the traders.
If ‘A’ is a buyer of a currency, shall strike a deal with the clearing
house. If ‘B’ is a seller of a currency, shall strike a deal with the
clearing house. In fact, the obligation of the buyer and seller does
not lie with each other but with the clearing house (i.e) clearing
house becomes seller to every buyer and buyer to every seller. This
way it guarantees the performance of every transaction done on
the exchange.
4. Margin Money:
Margin money represents traders deposit with the clearing house for
the adjustment of gain/loss. This is normally in the form of cash
deposits, although liquid securities are also used. The initial margin
amount varies from one exchange to other. If it is in the form of
securities, the interest earned thereon is also paid to the traders. In
case of forward contracts, there is no margin money requirements.
The margin money has two components;
a. Initial Margin: The amount of money that must be deposited
at the time of signing of the contract.
b. Maintenance Margin: The minimum level to which the
margin is allowed to fall in case of loss. If the balance drops below the
maintenance level, additional amount known as variation margin is
deposited to restore the minimum balance.
5. Marking to the Market:
In case of forward contracts, the deal is settled on the maturity, but
in case of currency futures contract, the rates are matched every day with
the movements in the spot rates; and on this basis, gains and losses are
settled every day.This process is called marking to the market.
Example:
Suppose an investor buys US$ futures (US$ 1,000) at INR 60/US$ on a
Monday morning which is to mature on Friday. At the close of Tuesday, if
the price moves up to Rs. 60.10/US$, the investor shall profit (1000 x
0.10) INR 100 and if the prices falls to Rs.59.90, the investor will have to
bear the loss (1000 x 0.10). The amount of loss will be deducted from the
margin money. If the loss is big and as a result, the margin money falls
below a certain level, which is known as maintenance margin, the investor
receives a margin call for depositing the margin money. On the maturity
day, if the gain is earned out of the contract, that will be added to the
margin money and given to the trader.
6. Methods of Transaction:

When a trader has to enter a currency futures contract, he

informs his agent who in turn informs the commission broker at
the stock exchange. The commission broker executes the deal in
the Pit for a commission/fee. After the deal is executed, trader
deposits the margin money with the clearing house. The daily
settlement, known as ‘Marking to Market’ takes place every
working day.The final settlement is made on the maturity date.
 Types of Order
 A limit order: Stipulates a particular price at which a deal is to be made.
 A Fill or Kill Order: Here, the commission broker s instructed to fill an
order immediately at a specific price. The order is cancelled if it is not
transacted quickly.
 The all- or – none order: A condition used on a buy or sell order to
instruct the broker to fill the order completely or not at all. Here, the
commission broker can not transacts different parts of the deal at different
price.
 On –the-open order: Involves transaction with in a few minutes of
opening of the stock exchange.
 On-the-close order: Involves transaction during the closure of the stock
exchange.
 Stop – Order: Involves a reversing trade when the price hits a prescribed
limit. Its purpose is to protect against losses on the existing position.
 Costs in Futures Deal

 Brokerage commission: Charged by commission brokers.

 Floor trading & Clearing fee: Charged by the stock exchange and its
associate clearing house.

 Delivery cost: Related to the delivery of currencies but since the

actual delivery of currencies are rarely takes place, such cost are not
common.
 Forward vs. Futures contract
S. No Features Futures contract Forward contract

Standardized Product (Products Customized product to suit the

1. Product
which are tradable product list in FC). individual requirement.

2. Contract size Fixed / Standard. Tailored to individual needs.

Customized to suit the individual

3. Maturity Standard maturity periods.
requirement.
Method of Through Over the counter (OTC)
4. Through recognized stock exchange.
Transaction deal.
Underlying Shall trade with out any underlying in Underlying exposure to foreign
5.
exposure the foreign currency. currency is required.
Margin money to be deposited with
6. Security deposit Not required.
the clearing house
Regulated by the rules of stock
7. Regulation Self-Regulated
exchange
 S. No Features Futures contract Forward contract

Mark to Market – settled on daily

8. Settlement Settled on maturity.
basis

No. of people
9. Multi – party contract Bi – lateral contract
involved

Clearing house for daily No clearing house as the deal

10 Clearing house
settlement. is settled on maturity.

Open to any one who needs Limited to customers who

11. Access
hedging or speculation deal in foreign trade.

Counterparty risk is eliminated Counterparty risk exists in

12. Counterparty risk
by stock exchange. forward contract.
 Hedging in Currency Futures Market
Traders make use of currency futures in order to hedge their foreign
exchange risk.

Suppose, a Indian importer importing goods from USA for $1.0 million
needs this amount for making payments to the exporter. He will
purchase US$ futures contract to buy US$ which would lock in the price
to be paid to the exporter in terms of US$ at a future settlement date.
By holding a futures contract, the importer does not have to worry
about any change in the spot rate of US$ over time.

On the other hand, if the Indian exporter exports goods to a US firm

and has to receive US$ for the exports, the exporter would Buy a US$
futures contract to sell US$. This way the exporter will be locking in the
price of the export to be received in terms of US$. This will protect
from the loss that may appear in case of depreciation of the US$ over
time.
 Hedging is taking a position in the futures market. A position that is
opposite to the already existing position in the cash market.
 The objective is to lock a particular currency pair rate and not to be
subjected to favorable as well as unfavorable movement in the
exchange rate.
 Gain (Loss) in cash market + Loss (Gain) in Futures market = Risk
mitigation by locking in USD/INR rate.
 A Long futures hedge is appropriate when you know you will buy
any foreign currency in the future date in cash market and want to
lock in the price. (Import situation)
 A Short futures hedge is appropriate when you know you will sell
any foreign currency in the future date in cash market and want to
lock in the price. (Export situation)
 The profit (Loss) in the cash position is off set by the equivalent loss
(Profit) in the future position.
 Example of Long Hedge by an Importer:
An edible oil refiner wants to import soya beans worth USD
1,00,000. The importer is exposed to the risk of INR depreciation
against USD. This could potentially increase his import bill. An
importer places an order on July 28,2015, with the payment date
being three months ahead. i.e. October 2015. The spot rate of
USD/INR at the time of booking the import in July is Rs.63.50. If
the rupee depreciates by October, this can result in loss for the
importer. On the other hand, if the rupee appreciates, this results in
Profit for the importer. The importer decides to hedge against
USD/INR volatility using exchange traded currency futures.
Trading Strategy:
1. Spot rate of USD/INR on July 15,2015 is Rs.63.50
2. October USD/INR futures is also trading at Rs.63.50
Hedge Strategy: Buy 100 lots of Oct USD/INR futures contracts on
July 28, 2015@ 63.50 which is expiring on October 26, 2015.

USD/INR settlement P/L in exchange traded P/L in Cash market for

rate on Oct 26, 2015 currency futures purchase of USD

Scenario 1: Rs.68/US$ (68-63.50) * 100 lots (63.50 – 68) * 100 lots *

*$1000 = Profit of INR $1000 = Loss of INR
4,50,000 4,50,000

Scenario 2: Rs.60/US$ (60-63.50)*100 lots * (63.50 – 60) * 100 lots *

$1000 = Loss of INR 3, $1000 = Profit of INR
50,000 3,50,000
 Example of Short Hedge by an Exporter
A diamond jewellery exporter has got an export order worth USD
2,50,000 on August 20, 2015, for the delivery of jewellery against
payment in end of December 2015. The exporter is exposed to the
risk of INR appreciation against USD. This could potentially decrease
his revenues from the export. The spot rate of USD/INR at the time
of booking the export in August is Rs.65.50. If the rupee appreciates
by December, this can result in loss to the exporter. On the other
hand, if the rupee depreciates, this is favorable (Profit) for the
exporter. The exporter decides to hedge against USD/INR volatility
using exchange traded currency futures.
Trading strategy:
1. Spot rate of USD/INR on August 20,2015, is 65.50
2. December USD/INR futures is trading at 66.00
 Hedge Strategy: Sells 250 lots of USD/INR futures contracts on
August 20, 2015 @ 66, which is expiring on December 29, 2015.
USD/INR settlement rate P/L in exchange traded P/L in Cash market for
on Dec 29, 2015 currency futures purchase of USD

Scenario 1: Rs.63/US$ (66-63) * 250 lots *$1000 = (63 – 65.50) * 250 lots *
Profit of INR 7,50,000 $1000 = Loss of INR
6,25,000

Scenario 2: Rs.69/US$ (66-69) * 250 lots *$1000 = (69-65.50) * 250 lots

Loss of INR 7,50,000 *$1000 = Profit of INR
8,75,000
Basis risk:

Basis = Spot price of the hedged asset – Future price of the hedged asset.

Basis risk is the market risk mismatch between a position in the spot
contract and the corresponding futures contract.

The risk that offsetting investments in a hedging strategy will not

experience price changes in entirely opposite directions from each other.
This imperfect negative correlation between the two investments creates
the potential for excess gains or losses in a hedging strategy, thus adding
risk to the position.
It is important to note that Futures on most contract are not a perfect
hedge. This is because, Forward market can be tailored made to any
size and maturity, the futures can not be, insofar as both size and
maturity deal are fixed.

If the maturity of the futures contract mismatches, Futures hedging is

known as delta hedge. If the maturity matches but the size of the
futures contract does not match, one can go for cross hedge. If both
size and maturity do not match, the hedger can go for a delta-cross
hedge.
Delta Hedge
Delta hedge exists when the maturity does not coincide with
the hedgers need for the currency.

Suppose, the value of import made on September 1 is US$

1,00,000. The amount is to be paid on December 1. In
futures hedge, 3 month maturity falls on December 26,
which is 25 days after the committed date. Even in case of 2
months contract, days are still left for maturity during which
the exchange rate differential may occur. However, it can be
nearly a perfect hedge, if there is no change in the interest
rate differential. This is because there is virtually no basis risk
arises.
Cross Hedge
Cross hedge exists when the amount of futures contract does
not tally with the actual amount to be hedged.

Suppose, the value of import is EUR62,500 and the payment

has to be made on Dec 26. Here, the maturity matches, but
the size of contract does not. In this case, the size of payment
matches with that of the British pound futures ( in CME) The
importer can go for buying pound in the futures market if
there is a high degree of correlation between EUR and
British pound. The futures hedge can be made as almost
perfect hedge by this way.
Delta Cross Hedge

Delta cross hedge is a combination of delta hedge and the cross

hedge. It is a case when there is both maturity and size mismatch.
In such case, it is difficult to eliminate the basis risk. As a result, the
futures risk is not a perfect hedge. The hedger can however go
simultaneously for a cross hedge and a delta hedge in order to make
the hedge a perfect one as far as possible.
 Speculation with Currency Futures
Speculators accepts exchange rate risk in the hope of making profit.
Speculators make use of currency futures for reaping profits. Speculators
believe that futures spot rates will be different from the Quoted future
rate.

When speculators expects the future spot rate of a particular foreign

currency moves up beyond those mentioned futures contract, they buy
currency futures denominated in that particular currency.

On the other hand, if the spot rate of the particular foreign currency is
expected to depreciate below the rate mentioned in the currency futures
contract, the speculators will sell currency futures in that currency.

It is important to note that all these transactions involve cost that is to be

deducted from the gain. These transaction cost is very nominal but is
significant for the speculators.
Intra-Currency Spread

Speculators can buy or sell futures of the same currency for two
different delivery dates if the rates of those two dates are different.
This is known as intra-currency-spread.
To make the example simple, let us ignore any marking to market.
Suppose, US$ is expected to appreciate than the quoted September
futures rate of Rs. 65.00/US$ (expecting future spot rate to be Rs.
65.50) and then it is expected to depreciate by November at a faster
rate than the quoted futures rate of Rs.64/US$ (expecting future
spot rate to be Rs. 63.50/US$). In this case, a speculator will buy a
US$ futures contract for September delivery and sell the futures
contract for November delivery. The speculator will gain Rs. 0.50
(65.50 - 65.00) in the September delivery and Rs. 0.50 (64.00 –
63.50) in the November delivery. The net gain will be Rs.1,000 (i.e.
0.5 * 1000 + 0.5 * 1000) per lot.
If the November contract moves against his expectation and the
November spot price is Rs. 64.20, then the investor will lose
0.20/US$ in November contract which reduces his total profit to
Rs.300 [0.50/US$ profit from September contract – 0.20 Loss
from November contract] i.e. Rs. 500 – Rs. 200 = Rs.300.

Inter – Currency Spread:

Inter-currency spread exists when a speculator buys/sells two or
more currencies for the same delivery date.
If GBP (£) September futures contract is available at Rs.100/£ and
Euro (€) September futures contract is available at Rs. 75/€. GBP is
expected to appreciate and Euro is expected to depreciate. In such
situation, a speculator will buy the GBP futures contract and sell
Euro futures contract for the September maturity.
Question:
If, Contrary to the expectations, Pound depreciates Rs.98 and Euro
depreciates to Rs.70. Find out the gain/loss to the speculator from
the inter-currency spread?
Ans:
Loss on GBP futures contract: Rs.2 (i.e. Rs.100 – Rs. 98) x
1000 = Rs. 2000.
Gain on the Euro futures contract = Rs.5 (Rs. 75-Rs.70) x
1000 = Rs. 5000.
Net gain = Rs.5000 – Rs.2000 = Rs.3000.