Currency Futures

CURREN CY FUTURE S

SU BM ITTED BY: SH OB HI T CH AND AK 08 BS0003162 SEC J

W hat i s Cur renc y Futur es ? Currency futures are standardised foreign exchange contracts traded on approved stock exchanges to buy or sell one currency against another on a specified date in the future at a specified price (exchange rate). The price is fixed on the purchase date. This price can be different from the price that is quoted in the spot foreign exchange markets. This will help investors to hedge against foreign exchange risk arising due to price fluctuations in the particular currency in a future date. Say, an investor is expecting a cash flow denominated in foreign currency on a future date, he can lock in the current exchange rate by entering into an Offsetting currency future position, this expires on the date of the cash flow.

Ho w is it Dif fer ent fr om E xchange Contr act ? This is different from forward exchange contracts. Forward exchange contracts are private agreements between two parties and are not as rigid in their stated terms and conditions. There can be a chance that one of the parties may default on his side of the agreement. This is not exchange traded, where as futures contracts are exchange traded and the clearing house guarantee the transactions (principle of novation). This drastically lowers the probability of default to almost nil. In the present globalised and integrated business environment, entities irrespective of the nature of their business are impacted by currency risk directly or indirectly.

W hen was it inducted ? Corporations, banks, traders and individuals can hedge their foreign exchange risks, from 29th August, 2008, the date from which the future commences on National Stock Exchange. MCX ( Multi Commodity Exchange) has also received in – principle approval from SEBI (Securities and Exchange board of India) for launching Currency futures through its subsidiary – MSEX (MCX Stock Exchange Ltd). Many other stock exchanges like BSE ( Bombay Stock Exchange) is also waiting for approval. The mock trading of currency futures has already begun at NSE from 20th August, 2008.

W hy Is it nece ss ar y? The exchange traded currency derivatives market – with introduction of currency futures - will provide an excellent opportunity to hedge currency risk for different kinds of participants. It is also hoped that Currency Options will also be introduced as the market stabilizes. Trades done at (NSE) National Stock Exchange are cleared, settled and risk managed by (NSCCL) National Securities Clearing Corporation. NSCCL is set up as a separate and independent entity whose practices and principles followed are globally benchmarked. Parents paying for their children education, students raising funds for themselves, persons getting remittance from abroad and even out - going travellers can benefit from the scheme.

An Examp le: One buys USD 10000 today and that he requires to meet the travel overseas expenses two months later at Rs.42.50. He would pay Rs.425000/- . With the opportunity cost for two months (on margin money 5%), this could eventually work out to Rs 42.70 to the dollar. It will be good if after two months the dollar is quoting above Rs 42.70. It depends how one predicts the movement of currency correctly. For the above requirement, one has to buy 10 dollar – rupee contracts (each contact equals to USD 1000) of two months expiry at say Rs 42.50 to a notional value of Rs. 425000/-, but would

have to pay Rs.21250/- - the margin amount of 5% immediately. At the end of 2 months if USD has moved to Rs 43.50, there would be benefit of Rs. 10000/- (43.50 – 42.50 * 1000) and if the USD moves to Rs 41.00, a loss of Rs 15000/- (42.50 – 41 *10000) – ignoring opportunity cost on the margin money. Load on opportunity cost can be calculated to find out the actual profit/ loss. A screen Shot of CME:-

W hat o ther cur renc ies wor k in futur es? Many of the most popular futures markets that are based upon currencies include the following :

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EUR - The Euro to US Dollar currency future

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GBP - The British Pound to US Dollar currency future

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CHF - The Swiss Franc to US Dollar currency future

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AUD - The Australian Dollar to US Dollar currency future

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CAD - The Canadian Dollar to US Dollar currency future

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RP - The Euro to British Pound currency future

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RF - The Euro to Swiss Franc currency future

Other currencies in futures are South African Rand , Hungarian Forint, Polish Zloty, Czech Koruna, Brazilian Real, Swedish Krona

W hat ar e the detai ls ?

As per the RBI (Reserve Bank of India) and SEBI (Securities Exchange Board of India) guidelines only USD – INR (Indian Rupee) currency futures will be traded on the exchange. NRIs and FIIs are not eligible to trade in currency futures. Other details: 1. Contract Size – USD 1000 2. Tick Size – 0.25 paise 3. Contract traded and settled in INR 4. There will be 12 monthly contract sstarting with the current month onwards 5. Near month contract will trade till 12 noon on the second day prior to the last business day in the month 6. The final settlement will be on the last business day of the month and shall be based on the RBI’s reference rate on the last trading day of the month 7. The daily trading hours for the contract will be from 9 am to 5 pm. 8. The trade in the currency futures will co-exist with the prevalent OTC (over the counter) market for forwards RBI and SEBI jointly constituted a Standing Technical Committee to inter-alia evolve norms and oversee implementation of Exchange Traded Currency Derivatives. The Committee submitted its report on Exchange Traded Currency Futures on May 29, 2008. Further RBI and SEBI also issued circulars in this regard on August 06,2008. The above report, laid down the framework for the launch of Exchange Traded Currency Futures in terms of the eligibility norms for existing and new Exchanges and their Clearing Corporations/Houses. RBI has also amended FEMA - 1999 sections suitably inserting sub sections towards currency futures: (i) in regulation 2, after clause (v), the following clause shall be inserted, namely:"(v.a) 'Currency Futures’ means a standardized foreign exchange derivative contract traded on a recognized stock exchange to buy or sell one currency against another on a specified future date, at a price specified on the date of contract but does not include a forward contract." Daily trade volume in the OTC market for rupee is about USD 34 billion involving Banks and their clients. This figures exceeds the combined daily turnover of both NSE and BSE. A partial market shift will see significant business growth for the stock exchanges and the Broking community.HNI (High Net worth) investors wishing to diversify risk can also take an exposure in this market.

How do you calculate profit or loss? Currency Futures Trading - Profit and Loss Now, in order to calculate our profit or loss on a contract it is vital that we have the following information as follows : The contract size - this is the number of currency units being traded and also called trade unit - for the Euro above, the contract size is 125,000. ( remember that e-mini contract sizes will be different) Tick value - the tick value is the smallest trading increment for the contract. Tick values vary among various currency futures contracts so please make sure you know beforehand ( if in doubt ask, but these will always be shown by the exchange in their 'specification' sheet. ) For the Euro shown above the tick value is 0.0001 So is we buy a Euro FX futures contract at 1.4607, and sell some time later at 1.4615, then our profit ( in US dollars) is as follows : 1.4615 - 1.4607 * 125,000 *0.0001 = $100 In other words each tick price movement represents a $12.50 increase or decrease in the value of our futures contract. Equally had we bought 5 contracts then our profit would have been $500. As with the spot market it is just as easy to sell short, in this case we sell a contract to open if we believe prices will fall, and buy to close. Had we sold a contract at 1.4615 and the price had fallen and we then bought to close our position at 1.4602, then our profit would be : 1.4615 - 1.4602 * 125,000 *0.0001 = $162.50

W hat ar e the dr awbac ks ? A few factors can impede liquidity in this segment: 1. There is a limit of USD 100 million on the open interest applicable to trading members who are banks and the USD 25 million limit for other trading members. So, larger exporters and importers might continue to deal in the OTC market, where there is no limit on the hedges. 2. The management of margin and settlement of daily mark – to – market differences could be cumbersome for some corporate customers. 3. Absence of FIIs could also reduce liquidity , whereas FIIs are already active in DGCX (Dubai Gold and Commodity Exchange), that was opened a year ago. Closing the door to them will reduce liquidity/ opportunity and business for domestic exchanges and intermediaries.

Now of course there is always a flip side to trading, and with lower risk comes lower rewards. In addition trading spreads is going to cost twice as much in commissions. Spreads involve two different futures contracts, and both sides are assessed commissions and exchange fees. Commissions in the futures market are generally charged on a per contract basis, and therefore trading a spread involves twice the cost of trading outright futures positions.

W hat can be conc luded ? Taking into account the nascent stage of the launching of the derivative in the Indian Bourse. The cautious action of the Regulators are understandable. Scope will be widened with trading volume and number of trades in this section. this is not the place to start if you are a novice - trading currency futures requires experience, knowledge and a complete understanding of both the market and the risks. OK - that's about it on currency futures - if you are planning to start as a novice in futures, then I would suggest two things. Firstly, start with the smallest contract available, and secondly start with a spread trade. This will reduce your exposure and risk to the lowest possible level. Naturally there are many ways to trade both as a hedge and as pure speculation - for myself I tend to be more of a speculator, but there are an infinite number of ways to use futures contracts either on their own or in combination with your spot trading - ultimately the choice is yours.

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Article by Shri PK Dalai, Faculty, IMAGE An Alternative To Trading In The FX Retail Markets, Article by Anna Scott Thomas. http://www.vcapfutures.com/futures-trading/currency-futures.asp