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8/3/2019 FRM Project

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Contents

Introduction on Currency Futures:

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Introduction on Currency Futures:

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.

Currencies are the money of different countries, and currency trading is the buying

and selling of these currencies. There are almost as many different currencies as there

are countries, but the most popular currencies for trading are the US Dollar, the Euro,

the British Pound (Sterling), and the Japanese Yen. The currency markets are some of

the most popular day trading markets, and they therefore have some of the highest

volume (number of contracts) and liquidity. This high volume and liquidity makes the

currency markets attractive to all types of traders, including individual day traders,

trading companies, financial and non financial companies, banks, and governments.

Globalization and integration of financial markets, coupled with

progressive increase of cross-border flow of capital, have

transformed the dynamics of Indian financial markets. This hasincreased the need for dynamic currency risk management. The

steady rise in Indias foreign trade along with liberalization in

foreign exchange regime has led to large inflow of foreign

currency into the system in the form of FDI and FII investments.

1.1 Need for Currency Futures

Financial markets are, by nature, extremely volatile and hence the risk factor is an

important concern for financial agents. To reduce this risk, the concept of derivatives

comes into the picture. Derivatives are products whose values are derived from one or

more basic variables called bases. These bases can be underlying assets (for example

forex, equity, etc), bases or reference rates. A currency futures contract allows for three

things:

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Hedging Participants with exposure in currency can use futures to manage risk arising

from unfavourable exchange rate movements

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

Arbitrage Entities with access to both Exchange traded Futures and OTC markets, or

different exchanges can exploit arbitrage arising due to pricing differences.

Currency futures benefits to investors as :

Importers/Exporters may have some obligations in Forex market, trading in

Currency Futures will help them hedge their positions. Similarly, any investor can trade

in Currency Futures with or with no obligations.

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.

2. History of Currency Futures

Currency futures were first created at the Chicago Mercantile Exchange (CME) in

1972, less than one year after the system of fixed exchange rates was abandoned

along with the gold standard. Some commodity traders at the CME did not have access

to the inter-bank exchange markets in the early 1970s, when they believed that

significant changes were about to take place in the currency market. They established

the International Monetary Market (IMM) and launched trading in seven currency futures

on May 16, 1972.

3. Currency future derivatives in India

The Currency Future in India was first time traded at NSE on August 29, 2008.

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Thereafter MCX was subsequently allowed to deal in currency future from October 31,

2008.

3.1 Rationale behind Currency futures in India

The OTC transaction was happening in With the help of electronic trading and

efficient risk management systems, Exchange traded currency future has helped to get

transparency and efficiency in price discovery, elimination of counterparty credit risk,

access to all types of market participants, standardized products and transparent

trading platform. Banks are also allowed to become members of this segment on the

Exchange and this provides them new opportunity in this market segment.

3.2 Exchanges engaged in Currency future in India

3.3 Available Currency futures in India

US Dollar - Rupee Currency Futures Contract

Euro - Rupee Currency Futures Contract-It was introduced on 29th Jan, 2010

British Pound - Rupee Currency Futures Contract-It was introduced on 29th Jan,

2010 Yen - Rupee Currency Futures Contract-It was introduced on 29th Jan, 2010

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3.4 Features of Currency Futures

Standardized currency futures shall have the following features:

a. Only USD-INR INR/USD, INR/EUR, INR/JPY and INR/GBP contracts are

allowed to be traded.

b. For USD, EUR and GBP, the lot size will be 1,000 foreign currency; for JPY it

will be 1,00,000 JPY (since quotation is for 100 Japanese Yen; lot size on trading

system shall be 1,000 JPY)

c. The contracts shall be quoted and settled in Indian Rupees.

d. The maturity of the contracts shall not exceed 12 months.

e. The settlement price shall be the Reserve Banks Reference Rate on the last

trading day.

Permission

(i) Currency futures are permitted in US Dollar - Indian Rupee or any other

currency pairs, as may be approved by the Reserve Bank from time to time.

(ii) Only persons resident in India may purchase or sell currency futures to hedge

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an exposure to foreign exchange rate risk.

4. Benefits of currency trading in India

Easy Accessibility - Small investors would get an easy access to currency futures

trading on the popular exchanges

Easy Affordability - Margins are very low and the contract size is very small

Low Transaction Cost - As opposed to the high pay-out of commissions in

overseas forex trading, currency futures carries low costs for investors

Transparency - It is possible for you to verify trade details on NSE if you have a doubt

that the broker has tried to cheat you

Counter-party default risk - All the trades done on the recognized exchanges are

guaranteed by the clearing corporations and hence it eliminates the risks associated

with counter party default. NSCCL (National Securities Clearing Corporation Limited)

carries out all the notation, clearing and settlement process of currency futures trading

Standardized Contracts - Exchange Traded currency futures are standardized in

respect of lot size ($1000) and maturity (12 monthly contracts). Retail investors with

their limited resources would find it tremendously beneficial to take positions in

standardised USD INR futures contracts.

Moreover, the currency futures market is used by some companies for hedging. These

companies either purchase currency futures for their future payables, or sell the futures

on currencies for their future receipts.

Speculators may also buy or sell futures on a foreign currency as a protection against

the strengthening or weakening of the US dollar. So, speculators may be able to earn

profit from the rise or fall of these exchange rates.

5. Trends in Currency Future in India

Currency futures trading started in India on August 29, 2008 on National Stock

Exchange. This was the first time currency derivatives got listed on an exchange in

India. Till this time, the currency futures trading took place over the counter and were

unorganized. With the entry of the National Stock Exchange in the picture, currency

trading became more organized with the NSE acting as a counter party to all the

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transactions. Soon after MCX also marked its entry into the currency derivatives market.

Volumes on currency futures exchanges (mainly NSE and MCX) have consistently

increased since the start of trading.

The dominant exchanges in the Currency future market are NSE and MSX-NX. The

above pie-chart shows that the market share of MCX-NX is increasing and its taking the

position of NSE in this field. Although both the players are holding almost half share with

them.

No. of Contracts over the years

Contracts traded-NSE Contracts traded-MCX-NX

We can see that the currency future market is in growing phase. The high fold increase

in the currency future trading is a testimony of the growth. The high in Indian

rupee/dollar futures demonstrates the increased demand among our global members

and their commercial and investor clients to manage their exchange rate risk or gainexposure to the Indian rupee. This also reflects towards the increasing economy of

India.

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6. Comparisons with other market

Even though the combined volumes figure on NSE and MCX pales in comparison

to merchant and inter-bank forward transactions on the over-the-counter (OTC) market,

volumes on the currency exchanges are heading close to those traded on the offshore

non- deliverable forwards (NDF) market for the Rupee that is active, mainly in

Singapore, London and New York.

7. Risks of trading in Currency Futures

Trading in Currency futures comes with high levels of risk. Even a small adverse

fluctuation in the exchange rate may result in loss of the entire deposit of someone

trading in currency. Only people having an in-depth knowledge of the working of this

market or have done a thorough homework about the risks involved are advised to trade

in this market.

8. Opportunities

Introduction of Options trading

FII participation could be allowed.

NRI participation could be allowed which would add to more volumes and liquidity.

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Positions larger than $5 million could be allowed - a tiny limit when compared with

the

size of exposure that is found in a trillion dollar economy.

9. Currency Futures the road ahead

Currency futures today are offered only for rupeedollar contracts for longer periods

(12 contracts) than the existing forward contracts (3 contracts 3 months, 6 months and

12 months). MCX-SX will launch 11 currency trading websites in regional languages

(having launched 5 so far in Hindi, Marathi, Gujarati, Tamil and Malayalam).

Liberalisation in terms of changes in the contract size, variable lot sizes and extended

trading hours could help encourage larger participation. The rupee futures have a

contract size of $1,000. The position limit for a client is higher of 6% of the total open

interest or $ 5 million. For the trading member it is higher of 15% of the total open

interest or $25 million. If the trading member is a bank it is higher of 15% of the total

open interest or $ 100 million. Hence till the total open interest rises, a participant

cannot increase his open interest beyond present proportion/limits.

Foreign institutional investors are excluded from the market and their inclusion as

participants can help in stepping up volumes significantly.

10. Conclusion

With the current trend of growing market of currency futures, it is bound to grow at this

rate. However, it does not seem to be going well with its pace in India as industry due to

lack of awareness among retail investors and knowledge gap faced by the brokers.

India is one of the country to have achieved greater turnover of the currency

futures market in comparison to the currency forward market. The currency futures has

a rosy future ahead, given the industry provides good support in terms of making it

popular and more conversant with retail investors.

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