curency derivatives

8/6/2019 Curency Derivatives

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�Business risk : It includes strategic risk ,macro economic risk ,

competition risk and technological innovation risk.

Financial risk: This is caused due to financial market activities and

includes liquidity risk and credit risk



� Lending/ Borrowing of cash

� Serving as avenues for savings andinvestments

� Providing insurance

� Providing means for hedging for the risk-averse



� Hedgers : trade with an objective to minimize the risk in trading

� Speculators :Speculators use derivatives to bet on the future direction of

the markets. They take calculated risks but the objective is to gain when the pricesmove as per their expectation.

Based on the duration for which speculators hold a position they are further beclassified as

Scalpers (for minutes)

day traders ( for a day)

position traders (for a long period may be a week, a month or a year).

� Arbitrageurs : Arbitrageurs try to make risk-less profit by

simultaneously entering into transactions in two or more markets or two ormore contracts.



� Foreign exchange rate is the value of a foreign currency relative todomestic currency.

� In a currency pair, the first currency is referred to as the basecurrency and the second currency is referred to as the

¶counter/terms/quote· currency. The exchange rate tells the worthof the base currency in terms of the terms currency, i.e. for abuyer, how much of the terms currency must be paid to obtain oneunit of the base currency.



� F ixed exchange rate regime :Fixed exchange rate, also known

as a pegged exchange rate, is when a currency's value is maintained at a fixed ratioto the value of another currency or to a basket of currencies or to any othermeasure of value e.g. gold.

� F loating exchange rate regime :a floating exchange rate is

determined by a market mechanism through supply and demand for the currency.

� if demand for a currency is low, its value will decrease, thus making importedgoods more expensive and exports relatively cheaper. The countries buying theseexport goods will demand the domestic currency in order to make payments, and

the demand for domestic currency will increase. This will again lead toappreciation in the value of the currency. Therefore, floating exchange rate is selfcorrecting



� fundamental factors, technical factors, politicalfactors and speculative factors.

� Fundamental factors: The fundamental factors are basic economic

policies followed by the government in relation to inflation, balance of paymentposition, unemployment, capacity utilization, trends in import and export, etc.

� Technical factors:� Interest rates:

� Inflation rate

� Exchange rate policy and Central Bank interventions.

� Political factors: Political stability also influences the exchange rates.

� Speculation: Speculative activities by traders worldwide also affectexchange rate movements.



� In currency markets, the rates are generally quoted in terms of USD

� Quotes: The price of a currency in terms of another currency is called

¶quote·.

� Direct Quotes :A quote where USD is the base currency is referred to asa ¶direct quote· (e.g. 1 USD ² INR 48.5000).

� Indirect Quotes :while a quote where USD is referred to as the terms

currency is an ¶indirect quote· (e.g. 1 INR = 0.021 USD).

� Any quote not against the USD is referred to as ¶cross· since the rate is calculated

via the USD.



Tick size refers to the minimum price differential at which

traders can enter bids and offers. For example, the CurrencyFutures contracts traded at the NSE have a tick size of Rs. 0.0025.So, if the prevailing futures price is Rs. 48.5000, the minimum

permissible price movement can cause the new price to be eitherRs. 48.4975 or Rs. 48.5025. Tick value refers to the amount ofmoney that is made or lost in a contract with each pricemovement.



� Spreads or the dealer·s margin is the difference between bid price (the price

at which a dealer is willing to buy a foreign currency) and ask price (the price atwhich a dealer is willing to sell a foreign currency).

� A bid-ask quot e for USDINR of Rs. 47.5000 ² Rs. 47.8000 means that the dealer iswilling to buy USD by paying Rs. 47.5000 and sell USD at a price of Rs. 47.8000.The spread or the profit of the dealer in this case is Rs. 0.30.



� The spot market transaction does not imply immediateexchange of currency, rather the settlement (exchangeof currency) takes place on a value date, which isusually two business days after the trade date. The

price at which the deal takes place is known as the spotrate (also known as benchmark price). The two-daysettlement period allows the parties to confirm thetransaction and arrange payment to each other.

� A forward transaction is a currency transactionwherein the actual settlement date is at a specified

future date, which is more than two working days afterthe deal date. The date of settlement and the rate ofexchange (called forward rate) is specified in thecontract. The difference between spot rate and forwardrate is called ´forward marginµ.



� Currency derivatives can be described as contracts between the sellersand buyers whose values are derived from the underlying which in thiscase is the Exchange Rate.

� The market participant wants to exchange the currency at a future date.Here the market participant may either:

Enter into a futures/forward contract, whereby he agrees to exchangethe currency in the future at a price decided now, or,Buy a currencyoption contract, wherein he commits for a future exchange of currency,with an agreement that the contract will be valid only if the price isfavorable to the participant.



� Forward Contracts: Forward contracts are agreements to

exchange currencies at an agreed rate on a specified future date. The actualsettlement date is more than two working days after the deal date. The agreedrate is called forward rate and the difference between the spot rate and the

forward rate is called as forward margin. Forward contracts are bilateralcontracts (privately negotiated), traded outside a regulated stock exchangeand suffer from counter -party risks and liquidity risks.



� Future Contracts: Futures contracts are also agreements to buy

or sell an asset for a certain price at a future time.

� Unlike forward contracts, which are traded in the over -the-countermarket with no standard contract size or standard delivery arrangements,

futures contracts are exchange traded and are more standardized. Theyare standardized in terms of contract sizes, trading parameters, settlementprocedures and are traded on a regulated exchange. The contract size isfixed and is referred to as lot size.

� Since futures contracts are traded through exchanges, the settlement ofthe contract is guaranteed by the exchange or a clearing corporation and

hence there is no counter party risk. Exchanges guarantee the executionby holding an amount as security from both the parties. This amount iscalled as Margin money. Futures contracts provide the flexibility ofclosing out the contract prior to the maturity by squaring off thetransaction in the market.



Interest rate parity theory: the currency margin is dependent

mainly on the prevailing interest rate (for investment for the given timeperiod) in the two currencies. The forward rate can be calculated by thefollowing formula:

Where, F and S are future and spot currency rate. Rh and Rf are simpleinterest rate in the home and foreign currency respectively.Alternatively, ifwe consider continuously compounded interest rate then forward rate can be

calculated by using the following formula:

Where rh and rf are the continuously compounded interest ratefor the home currency and foreign currency respectively, T is

the time to maturity



x Product Specification� T rading Hours: T he trading on currency futures is available from 9 a.m. to 5

p.m. from Monday to Friday.� Size of the contract: T he minimum contract size of the currency futures contract

at the time of introduction is USD 1000.

� Quotation: T he currency futures contracts are quoted in Rupee terms. However,the outstanding positions are in US Dollar terms.� T enor of the contract: T he currency futures contracts have a maximum maturity

of 12 months.� Available contracts : All monthly maturities from 1 to 12 months are available.� Settlement mechanism: T he currency futures contracts are settled in cash in

Indian Rupee.� Settlement price: T he settlement price is the Reserve Bank of India Reference Rate

on the last trading day.� F inal settlement day: F inal settlement day is the last working day (subject to

holiday calendars) of the month and the reference rate fixed by RBI twodays prior to the final settlement date is used for final settlement



� Categories of membershi p(NSE)

� Only Trading Membership of NSE

� Both Trading Membership of NSE and Clearing

Membership of NSCCL.� Professional Clearing Membership of NSCCL



USD-INR future contract specification



� Clearing entities

� NSCCL undertakes the Clearing and Settlement activities.

� Clearing members:� Clearing members are trading cum clearing members (TM-CM) and

Professional Clearing members (PCM).

� Clearing banks:� Clearing banks handle the Funds settlement.A separate Bank account needs to be

opened by each clearing member with a NSCCL designated clearing bank for the

purpose of funds settlement.



� The trading of currency futures is subject to maintaining initial, extremeloss, and calendar spread margins.

� M inimum M argins: The minimum margin percentage is 1.75% on the first day ofcurrency futures trading and 1 %thereafter.

� E xtreme Loss margins :The applicable extreme loss margin is 1% on the mark tomarket value of the gross open positions or as may be specified by the relevantauthority from time to time.



� aily Settlement price for mark to marketsettlement of futures contracts :� Daily settlement price for futures contracts is the closing price of such contracts

on the trading day.

� F inal Settlement : The final settlement of futures contracts is effected on

T+2 day basis as per the timelines specified by the clearing corporation. The finalsettlement date is the contract expiry date.

curency derivatives

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