1

CHAPTER
No.
CONTENTS P No.
1. INTRODUCTION

Introduction to currency derivatives
Objectives
Scope
Research Methodology
Source of Data
Limitation
Hypothesis

2
2. Review of Literature 14
3. Company Profile 18
4. Theoretical Framework 27
5. Brief Overview of Foreign Exchange Market 39
6. Analysis 54
7. Finding, Suggestions and conclusions 75
8 Bibliography 79


2






Chapter 1














3











INTRODUCTION OF CURRENCY DERIVATIVES
The current currency rate mechanism has evolved over thousands of years of the
world community trying with various mechanism of facilitating the trade of goods and
services. Initially, the trading of goods and services was by barter system where in goods
were exchanged for each other. For example, a farmer would exchange wheat grown on his
farmland with cotton with another farmer. Such system had its difficulties primarily because
of non-divisibility of certain goods, cost in transporting such goods for trading and difficulty
in valuing of services. For example, how does a dairy farmer exchange his cattle for few liters
of edible oil or one kilogram of salt? The farmer has no way to divide the cattle! Similarly,
suppose wheat is grown in one part of a country and sugar isgrown in another part of the
country, the farmer has to travel long distances every time he has to exchange wheat for
sugar. Therefore the need to have a common medium of exchange resulted in the innovation
of money
With time, countries started trading across borders as they realized that everything
cannot be produced in each country or cost of production of certain goods is cheaper in
certain countries than others. The growth in international trade resulted in evolution of
foreign exchange (FX) i.e., value of one currency of one country versus value of currency of
other country. Each country has its own brand alongside its flag. When money is branded it
is called currency. Whenever there is a cross-border trade, there is need to exchange one


4
brand of money for another, and this exchange of two currencies is called foreign exchange
or simply forex (FX).
The introduction of currency derivatives in India is a landmark decision which is
likely to be a boon for importers, exporters and companies with foreign exchange exposure.
These derivative products have a wide range with their special features suiting to the needs
and requirements of the individuals. As currency derivative is new to India, it is time to have
a broad understanding of them which are mostly couched in jargons and technical terms.
Thus the very subject raises a kind of aversion for the common people. The currency
derivatives are contracts just like any other derivatives viz., Stock, Index etc. Unlike the
stock, the underlying in this case is currencies. The value of the currencies determine the
values of the currency derivatives.
As it is universally accepted that market risks are ones which can not eliminated in
absolute terms. But their management is perfectly possible. The currency derivatives are
efficient tools for management of risks in money and forex markets. The need to protect the
exposure against unforeseen and unpredictable movement in currency and interest rates has
led to the emergence of these kinds of derivatives. Thus external borrowings or receivables or
payments in foreign currencies come within the purview of management under it .As we all
know the exporters and importers incur huge obligations in terms of foreign currencies and
they can guard their interest by buying appropriate product
With the multiple growths of international trade and finance all over the
world, trading in foreign currencies has grown tremendously over the past several decades.
Since the exchange rates are continuously changing, so the firms are exposed to the risk of
exchange rate movements. As a result the assets or liability or cash flows of a firm which are
denominated in foreign currencies undergo a change in value over a period of time due to
variation in exchange rates.





5





OBJECTIVES OF THE STUDY:-
The basic idea behind undertaking Currency Derivatives project to
gain knowledge about currency future market.

To study the basic concept of Currency future
To study the exchange traded currency future

To understand the practical considerations and ways of considering
currency future price.
To analyze different currency derivatives products.

SCOPE OF THE STUDY:-
Globalization of the financial market has led to a manifold increase in investment.
New markets have been opened; new instruments have been developed; and new services
have been launched. Besides, a number of opportunities and challenges have also been
thrown open.


6
Online currency trading is new as compared to equity market in India. Mainly three
exchanges are involved in online commodities trading MCX, NSE and ise-india. Hence, the
scope of Currency market is very wide in the market.
RESEARCH METHODOLOGY:-

In this project Descriptive research methodologies were use.
The research methodology adopted for carrying out the study was at the
first stage theoretical study is attempted and at the second stage observed online trading on
NSE/BSE.
SOURCE OF DATA COLLECTION:-
Secondary data were used such as various books, report submitted by
RBI/SEBI committee and NCFM/BCFM modules.

LIMITATION OF THE STUDY:-
The analysis was purely based on the secondary data. So, any error in the
secondary data might also affect the study undertaken.
The currency future is new concept and topic related book was not available in
library and market.


HYPOTHESIS :-
It has been said in the past that derivatives are k ind of a side show, where the
main event takes place in the money and capital markets. One could attend the side show
without taking part in the main event and vice- versa. With respect to derivative and
money/capital markets, that is simply not true todey. Derivatives are so widely used that even
if one has no intension of using them, it is important to understand how they are used by
others and what effects, positive and negative; they could have on money and capital


7
markets.
..Peter L. Bernstien
The futures market holds a great importance in the economy and, therefore, it becomes
imperative that we analyse this important market and seek answers to a few basic questions.
The main theme of the study is to assess the progress of the currency futures in India with a
compact view over the volatility of the currency futures. In order to study the growth of the
currency futures, the number of contracts traded and open interest at NSE and MCX have
been inclusively compared. A correlation between the two was calculated and the result
depicted that they have a significant relationship with a correlation cofficient of 0.83 in case
of NSE. A plot of that correlation is shown in Figure 1.
Attempt has also been made to check whether the daily returns of the NSE and MCX
on currency futures are normally distributed and the data have been used for the
Kolmogorov- Smirnov Test to test the hypothesis that the returns are normally distributed.
Kolmogorov- Smirnov Test is a non-parametric test and it is used to determine whether the
distribution is homogeneous. With the measure of skewness and kurtosis it has been found
that the returns are normally distributed and, thus, the null hypothesis is accepted.
The hypothesis tested in the study is as follows:
H0: The returns of the currency futures are normally distributed.
H1: The returns of the currency futures are not normally distributed
FIGURE 1: PLOTTED GRAPH OF CORRELATION BETWEEN OPEN INTEREST
AND CONTRACTS TRADED AT NSE:-



8
III.QUANTITATIVE ANALYSIS :-
The growth of the currency futures in India has been assessed by measuring the growth in
two variables which are open interest and contracts traded. A correlation between the two
was calculated and the result depicted that they have a significant relationship with a
correlation cofficient of 0.83 in case of NSE






TABLE 2: CORRELATION BETWEEN OPEN INTEREST AND CONTRACTS
TRADED IN NSE:-
Linear Correlation
Number of points = 320
Correlation coefficient (r) = 0.8324
95% confidence interval: 0.7953 to 0.863
Coefficient of determination (r squared) = 0.6928
Test: Is r significantly different than zero?
The two-tailed P value is < 0.0001, considered extremely significant.
The growth of the open interest and contracts traded are explained below
Open interest is the total number of outstanding contracts that are held by the market
Participants at the end of the day. It is also considered as the number of futures contracts that
have not yet been exercised, expired or fulfilled by delivery. It is often used to confirm the
trends and trends reversals for futures markets. It measures the flow of money into the futures
market. A seller and a buyer forms one contract and hence in order to determine the total
open interest in the market we need to know either the total of buyers or the sellers and not


9
the sum of both. the open interest position that is reported each day represents the increase or
decrease in the number of contracts for that day. An increasing open interest means that the
new money is flowing in the market .Marketplace and the present trend will continue. If the
open interest is declining it implies that the market is liquidating and the prevailing price
trend is coming to an end. The leveling off of open interest following a sustained price
advance is often an early warning of the end to an up trending or bull market. The
interpretations which can made on the basis of the open interest may be shown with the help
of the following table
Price Open Interest Interpretation
Rising Rising Market is Strong
Rising Falling Market is weakening
Falling Rising Market is Weak
Falling Falling Market is Strengthening
I. Figure 2 shows the daily movement in the open interest of currency futures in both NSE
and MCX. It depicts that the open interest in both NSE and MCX have been increasing with a
steady speed since the currency futures are been traded. The open interest in the NSE was
406200 on 31st Dec. 2009 as compared to 16332 on 28th Aug. 2008 and that on MCX it was
425451 on 31
st
Dec. 2009 as compared to 17331 on 7th Oct. 2008. It can be seen that in terms
of the open interest, the growth of the MCX is more as compared to the NSE.

FIGURE 2
The trend as depicted by figure 1 it is found that the growth of open interest in both
NSE and MCX was down during March 2009 to August 2009 which is the indicator that it


10
was affected by the global recession experienced by the Indian economy. Figure 3, which
shows the open interest at the end of each month, also depicts that there was a fall in the open
Interest during the period of January-July 2009. Hence, it can be said that this slackening in
trade was due to the global recession. However, the market has recovered itself and a good
growth is being experienced

FIGURE 3
II. CONTRACTS TRADED:-
The number of contracts traded on a stock exchange shows the total volume of contracts
traded. An increase in the number of contracts traded on an stock exchange expresses the
growth of trade in that particular stock exchange for a particular currency future. The number
contracts traded in the NSE increased to 1444150 contracts on 31st Dec. 2009 from 65798
contracts on 28th Aug. 2008, and from 59952 contracts on 7th Oct. 2008 to 1556411
contracts on 31st Dec. 2009 in the MCX. Figure 4 clearly depicts the growing trend in the
daily volumes traded in both NSE and MCX. It can also be noticed over here that the number
of contracts traded in MCX have been more than that traded in the NSE.


11

FIGURE 4
III. MONTHLY TURNOVER
The monthly turnover of both the stock exchanges (NSE and MCX) have also
experienced an upward trend in the year 2009 with a total of Rs. 48395 crore in Jan. 2009 and
Rs. 319195 crore in Nov. 2009. Figure 5 depicts the clear picture of the currently moving
trend in both the stock exchanges. This too says that the currency futures trading at MCX is
growing faster than that at NSE.

NORMALITY IN THE DAILY CHANGES IN VALUE OF RUPEE
The distribution of the changes in the value of Rupee is not symmetric as the skewness is not
mzero in any case. Presence of positive skewness in Dec. 2008, Feb. 2009, Mar. 2009, Apr.
2009, June 2009, July 2009, Aug. 2009, Sept. 2009, Nov. 2009 and Dec. 2009 means that the
distribution has a right tail and the negative skewness in rest of the months means that the
distribution has a left tail. In case of kurtosis, it can be concluded that the distribution was
normal only during May 2009 and during the rest of the period it was not normally
distributed. A detailed statistic is given in the Table 1.


12
TABLE 1: DESCRIPTIVE STATISTICS OF DAILY CHANGES IN THE VALUE OF
RUPEE (MONTH-WISE)
Period No. of Obs. Mean S.D. Min Max Skewness Kurtosis
Sept. 08 20 0.1575 0.3774 -0.92 0.69 -1.28 2.32
Oct. 08 15 0.1433 0.4404 -0.58 0.73 -0.2846 -1.18
Nov. 08 17 0.0518 0.6189 -1.44 1.22 -0.3942 1.04
Dec. 08 20 -0.082 0.5413 -1.1 1.1 0.4118 0.24
Jan. 09 19 0.0153 0.2841 -0.52 0.43 -0.2313 -1.15
Feb. 09 16 0.105 0.2712 -0.21 0.69 1.0553 0.14
Mar. 09 18 -0.0444 0.3574 -0.63 0.54 0.008 -0.17
Apr. 09 15 -0.0053 0.3327 -0.62 0.53 0.0068 -0.67
May. 09 19 -0.1258 0.4296 -1.38 0.49 -1.2914 3.04
Jun. 09 21 0.042 0.2734 -0.38 0.53 0.0373 -0.82
Jul. 09 22 0.0032 0.2793 -0.56 0.71 0.464 0.91
Aug. 09 19 0.0532 0.2055 -0.33 0.41 0.0656 -0.37
Sept. 09 18 -0.0383 0.185 -0.39 0.33 0.2875 -0.38
Oct. 09 17 -0.0394 0.3477 -0.56 0.4 -0.1591 -1.71
Nov. 09 19 -0.0295 0.2227 -0.41 0.54 0.4711 1.15
Dec. 09 20 0.0115 0.1108 -0.2 0.23 0.0388 -0.06

Contrary to the statistical results based on skewness and kurtosis, the Kolmogorov-Smirnov
test says that the distribution is normal in every case. The detailed results are given in the
Table 2


Dec
. 09
Nov.
09
Oct.
09
Sep
t.
09
Aug.
09
Jul.
09
Jun.
09
M
ay
09
Ap
r.0
9
Mar
. 09
Feb
. 09
Ja
n.
09
De
c.
08
No
v.
08
Oc
t.
08
Sep
t.
08
N 20 19 17 18 19 22 21 19 15 18 16 19 20 17 15 20
Normal
mean
Parameters
a,,b
.011
5
-
.0295
-.0394 -
.038
3
.0532 .003
2
.041
9
-
.12
58
-
.00
53
-
.044
4
.105
0
.01
53
-
.08
20
.051
8
.14
33
.157
5
Std.
Deviation
.110
80
.2227
0
.34773 .184
97
.2054
8
.279
29
.273
36
.42
964
.33
273
.357
41
.271
24
.28
408
.54
129
.618
91
.44
042
.377
41


13
Most
Extreme
Differences
Absolute
.111 .133 .184 .186 .108 .112 .133 .17
6
.11
2
.106 .213 .13
3
.17
6
.132
.14
2
.163
Positive .111 .133 .159 .186 .108 .112 .133 .08
7
.11
2
.106 .213 .13
3
.17
6
.122
.10
4
.093
Negative -.089 -.130
.184
-.121 -.076 -
.071
-
.130
-
.17
6
-
.09
4
-
.088
-
.123
-
.12
1
-
.07
2
-
.132
-
.14
2
-
.163
Kolmogoro
v-Smirnov
Z
.494 .578 .758 .790 .472 .527 .608 .76
8
.43
6
.451 .853 .58
2
.78
9
.544
.55
2
.730

a. Test distribution is Normal.
b. Calculated from data

CONCLUSIONS AND SUGGESTIONS
The Indian currency futures market has experienced an impressive growth since its
introduction. The upward trend of the volumes and open interest for currency futures in both
NSE and MCX explains the whole story in detail. The growth was only the reason for the
introduction of three other currency futures in January this year. In the coming future it is
expected that the market participants will find some more currency futures introduced into
the market. Currently on 26 th March, 2010 the SEBI allowed the United Stock Exchange of
India to launch currency futures. It became the fourth currency future exchange after NSE,
BSE a nd MCX. The two exchanges (NSE and MCX) are currently clocking an average daily
turnover of over Rs 20,000 crore in currency products while it was just Rs 2,400 crore in
January last year. It can be thus concluded that the currency futures market will get more
success in the coming future and the economy and the risk hedgers will definitely be
benefited from this trade. The correlation test also explained that the relationship between the
open interest and traded volumes is very much significant and that the change in the value of
currency is normally distributed thus illustrating that the risk is minimum in the currency
futures contracts. The risk involved is comparatively low in this case and currency futures has
proved to be a good tool for hedging the risk involved in the currency of a country (currency


14
risk). It is hoped that the currency futures market will develop faster and it will be a good
choice for all the market participants in the near future and it will find its way in the Indian
economy.















Chapter 2



15














Literature Review:-
The introduction of currency futures markets enable the traders to transact in
large volumes at much lower transaction costs relative to the cash market. This results in an


16
increase in order flow to futures markets, reasons of which are unresolved on both theoretical
and on empirical front. A future market has two contrasting effects:
If the speculators observe a noisy but informative signal, the hedgers react to the noise in
the speculative trades, producing an increase in volatility.
The futures market improves risk sharing and therefore reduces price volatility. Opponents
of speculative trading activity have generally argued that increased trading in futures leads to
unnecessary price volatility in the underlying cash markets. Some researchers suggest that the
participation of speculative traders in the systems that allow high degrees of leverage lowers
the quality of the information in the market, e.g. Figlewski (1981) and Stein (1987). Cox
(1976), among others, notes that uninformed traders could play a stabilizing role in the cash
markets. Others question the role of future markets as representative of an institutional
alternative for accurate price forecasting,e.g. Martin and Garcia (1981). In contrast, models
developed by Danthine (1978 )argue that the futures markets improve market depth and
reduce volatility because the cost to informed traders of responding to mispricing is reduced.
Froot and Perold (1991) extend Kyles (1985) model to show that market depth is increased
by more rapid dissemination of market-wide information and the presence of market makers
in the futures market in addition to the cash market. Ross (1989) assumes that there exists an
economy that is devoid of arbitrage and proceeds to provide a condition under which the
noarbitrage situation will be sustained. It implies that the variance of the price change will be
equal to the rate of information flow. The implication of this is that the volatility of the asset
price will increase as the rate of information flow increases.
Thus, if futures increase the flow of information, then in the absence of
arbitrage opportunity, the volatility of the spot price must change. It has also been suggested
that the futures markets have become an important medium of price discovery in cash
markets, e.g. Schwarz and Laatsch (1991). Questions pertaining to the impact of derivative
trading activity on cash market volatility have been empirically addressed in two ways.First,
researchers have attempted to establish the impact of derivatives trading on cash markets by
comparing cash market volatilities during the pre and post-futures trading eras. The majority
of studies on this area suggests that speculative (derivatives) markets either add to the
stability, or do not impact the volatility of cash markets e.g. Simpson and Ireland (1985),
Edward (1988), Skinner (1989). Second, researchers have examined the relationship between


17
speculative (derivative) trading activity and cash markets by directly evaluating the impact
of futures trading activity on the behavior of cash market e.g. Samanta (2007).
Edward (1988) and Bessembinder and Seguin (1992) provide evidence that
futures trading activity improves the stability in equity indices. In case of currency futures the
study of the relationship between futures trading and the variability of the underlying cash
market is complicated by the nature of exchange rate movements. The exchange rates move
like random walk but the changes do not, e.g. Meese and Rogoff (1983) and Manasanton
(1986). Under these conditions, the applicability of traditional volatility measures, such as the
absolute change in prices, provides inconsistence estimates in the study of the trading-activity
versus exchange rate-volatility relationship. A financial time series like this can not be
modeled in the normal way. To model such time series, time varying volatility models is
required. Engel (1982) first time proposed to incorporate time varying nature of volatility
using ARCH process. The work of Engle (1982) was made better by Bollerslev (1986), who
incorporated GARCH models to overcome some of the lacunas of ARCH models like
overfitting and breach of non-negativity constraints. Many researchers have found GARCH
family of models outperforming other models.
Different researchers used different markets and different methods to
communicate the same thing of applicability of GARCH family of models for modeling
conditional volatility.On US-based data the studies are Akgiray (1989), Pagan and Schwert
(1980), Brails Ford and Faff (1996) and Brooks (1998). On Europe based data the study is
Corhay and Rad (1994). On Asian Countries based data the study is Andersen and
Bollserslev (1998). All the researchers have found that GARCH family of models provide
more accurate forecast of volatility of returns of the financial assets. Out of three special
features of financial time series data (leptokurtic distribution, volatility clustering and
leverage effect) the leptokurtic and volatility clustering nature of the financial return data has
been captured by GARCH models but asymmetric behavior has not been captured. To solve
the issue Nelson (1991), Zakoian (1994) and GJR (1993) proposed EGARCH, TARCH and
GJR models respectively which can capture these tendencies of asymmetric nature of
financial data (Engle and Victor 1993) too.
Chapter 3 :-



18








19
2. COMPANY PROFILE

Religare is an emerging markets financial services group with a presence
across Asia, Africa, Middle East, Europe, and the Americas. In India, Religares largest
market, the group offers a wide array of products and services including broking, insurance,
asset management, lending solutions, investment banking and wealth management. With
10,000-plus employees across multiple geographies, Religare serves over a million clients,
including corporate and institutions, high net worth families and individuals, and retail
investors.
RELIGARE Securities Ltd. (RSL) is a wholly owned subsidiary of
RELIGARE Financial Services Ltd. (RFSL), a Company promoted by the late Dr. Parvinder
Singh, Ex-CMD of Ranbaxy Laboratories Ltd.

The primary focus of Religare Securities Ltd. is to cater to services in Capital
Market Operations to Institutional Investors. The Company is a member of the National
Stock Exchange (NSE) and OTCEI. The growing list of financial institutions with whom
RSL is empanelled as approved Broker is a reflection of the high levels of services
maintained by the Company.

As on date the Company is empanelled with UTI, IDBI, IFCI, SBI, BOI-MF,
Punjab National Bank, PNB-MF, Oriental Insurance, GIC, UTI-Offshore, ICICI Can bank
MF, Punjab & Sind Bank, Pioneer ITI, SUN F&C, IDBI Principal, Prudential ICICI, ING
Baring and J M Mutual Fund.

RELIGARE was founded with the vision of providing integrated financial care
driven by the relationship of trust. The bouquet of services offered by RELIGARE includes
Broking (Stocks and Commodities), Depository Participant Service, Advisory on Mutual
Fund Investments and Portfolio Management Services.

RELIGARE is a pioneer in the concept of partnership to reach multiple
locations in order to effectively service its large base of individual clients. Besides the reach
of Industry : Finance - General



20

BSE Code : 532915
Book Closure : 11/08/2010
Group : Religare
NSE Code : RELIGARE
Market Cap : Rs. 6,897.44 Cr.
ISIN No : INE621H01010
Market Lot : 1
Face Value : Rs. 10.00

RELIGARE, the clients of the company greatly benefit by its strong research
capability, which encompasses fundamentals as well as technical knowledge.

GROUP :
RELIGARE in recent years has expanded its reach in health care and financial
services wherein it has multiple specialty hospital and labs which provide health care services
and multiple financial services such as secondary market equity services, portfolio
management services, depository services etc.

RELIGARE financial services group comprises of Religare Securities
Limited, RELIGARE Comdex Limited and RELIGARE Finvest Limited which provide
services in Equity, Commodity and Financial Services business & Religare Insurance
Advisory Ltd.

RELIGARE SECURITIES LIMITED:-

1. Member of National Stock Exchange of India and Bombay Stock
Exchange of India.
2. Depository Participant with National Securities Depository
Limited (NSDL) and Central Depository Services Limited (CDSL).
3. A SEBI approved Portfolio Manager.



21
RSL provides platform to all segments of the investor to leverage the immense
opportunity offered by equity investing in India either on their own or through managed
funds in Portfolio Management.
The ARN No. of the Religare Securities Ltd. is 33764. The ARN No. is required by to
be available with the broker who deals on behalf of investors or sell the mutual funds of the
different companies present in the market.
Currency Broking:
Religare Securities Limited (RSL), the broking arm of REL, offers a comprehensive
range of services which include equity broking and currency futures and options broking.
Exchange-driven currency trading has shown remarkable growth over the past few years. It is
the basis for cross-border diversification and business deals. It is our strong belief that a
valuable broking franchise is one that has a very high level of client retention and can provide
differentiated services based on client needs.

At Religare, we enable our clients to seize investment opportunities in the currency market by
facilitating futures and options trades in four currency pairs:
US$-Indian Rupee
Euro-Indian Rupee
Pound Sterling-Indian Rupee
Japanese Yen-Indian Rupee









22


Religare Enterprises Limited
Religare Securities Limited
Equity Broking
Online Investment Portal
Portfolio Management Services
Depository Services

Religare Commodities Limited
Commodity Broking

Religare Capital Markets Limited
Investment Banking
Proposed Institutional Broking

Religare Realty Limited
In house Real Estate Management Company

Religare Hichens Harrison
**

Corporate Broking
Institutional Broking
Religare Finvest Limited
Lending and Distribution business
Proposed Custodial business

Religare Insurance Broking Limited
Life Insurance
General Insurance
Reinsurance

Religare Arts Initiative Limited
Business of Art
Gallery launched - arts-i

Religare Venture Capital Limited
Private Equity and Investment Manager

Religare Asset Management*
Derivatives Sales
Corporate finance




23
MISSION:-
To be India's first Multinational providing complete financial services solution
across the globe
VISION:-
Providing integrated financial care driven by the relationship of trust and
confidence.
PRODUCTS:

Products Subscription
fees
Enrolment
Deposit
R-ALLY

NIL NIL
R-ALLY Lite (Browser Based)

NIL Rs. 5,000
R-ALLY Pro (Application Based) Rs. 1,800 NIL

Trading in Equities with Religare truly empowers you for your
investment needs. We ensure you have a superlative trading experience through -
A highly process driven, diligent approach
Powerful Research & Analytics and
One of the "best-in-class" dealing roomsFurther, Religare also has one of the largest
retail networks. Now, you can walk into any of our branches and connect to our
highly skilled and dedicated relationship managers to get the best services.



24
The Religare Edge :-
Pan India footprint
Powerful research and analytics supported by a pool of highly skilled research
analysts
Ethical business practices
Offline/Online delivery models
Single window for all investment needs through your unique CRN.
BROKERAGE :-
INTRADAY:- 3 paisa (.3%) (NEGOTIABLE)
DELIVERY :- 30 paisa (.03%) (NEGOTIABLE)
SERVICES:-




Arts
Initiative

Investment
Banking

Wealth
Advisory
Services

Personal
Credit


Insurance

Mutual
Fund

Commodity

Equity

REL


25
Organization Structure of Religare Securities:








26
Competitions of Religare :-

There are several financial security companies playing their roles in Indian equity market.
But Religare faces competitions from these few companies.

ICICI Direct.com

Share Khan (SSKI)

Kotak Securities.com

India Bulls

HDFC Securities

5paisa.com

Motital Oswal

IL&FS

Karvy






27
Chapter 4

Theoritical framework of

















28
About Financial Derivatives:-
DEFINITION OF FINANCIAL DERIVATIVES:-
A word formed by derivation. It means, this word has been arisen by derivation.

Something derived; it means that some things have to be derived or arisen out of the
underlying variables. A financial derivative is an indeed derived from the financial
market.

Derivatives are financial contracts whose value/price is independent on the behavior
of the price of one or more basic underlying assets. These contracts are legally
binding agreements, made on the trading screen of stock exchanges, to buy or sell an
asset in future. These assets can be a share, index, interest rate, bond, rupee dollar
exchange rate, sugar, crude oil, soybeans, cotton, coffee and what you have.

A very simple example of derivatives is curd, which is derivative of milk. The price
of curd depends upon the price of milk which in turn depends upon the demand and
supply of milk.


The Underlying Securities for Derivatives are :
Commodities: Castor seed, Grain, Pepper, Potatoes, etc.
Precious Metal : Gold, Silver
Short Term Debt Securities : Treasury Bills
Interest Rates
Common shares/stock
Stock Index Value : NSE Nifty
Currency : Exchange Rate.





29
TYPES OF FINANCIAL DERIVATIVES:
Financial derivatives are those assets whose values are determined by the value of
some other assets, called as the underlying. Presently there are Complex varieties of
derivatives already in existence and the markets are innovating newer and newer ones
continuously. For example, various types of financial derivatives based on their different
properties like, plain, simple or straightforward, composite, joint or hybrid, synthetic,
leveraged, mildly leveraged, OTC traded, standardized or organized exchange traded, etc. are
available in the market. Due to complexity in nature, it is very difficult to classify the
financial derivatives, so in the present context, the basic financial derivatives which are
popularly in the market have been described. In the simple form, the derivatives can be
classified into different categories which are shown below :

DERIVATIVES



Financials Commodities

Basics Complex
1. Forwards 1. Swaps
2. Futures 2.Exotics (Non STD)
3. Options
4. Warrants and Convertibles



30
One form of classification of derivative instruments is between commodity derivatives and
financial derivatives. The basic difference between these is the nature of the underlying
instrument or assets. In commodity derivatives, the underlying instrument is commodity
which may be wheat, cotton, pepper, sugar, jute, turmeric, corn, crude oil, natural gas,
gold, silver and so on. In financial derivative, the underlying instrument may be treasury
bills, stocks, bonds, foreign exchange, stock index, cost of living index etc. It is to be
noted that financial derivative is fairly standard and there are no quality issues whereas in
commodity derivative, the quality may be the underlying matters. Another way of
classifying the financial derivatives is into basic and complex. In this, forward contracts,
futures contracts and option contracts have been included in the basic derivatives whereas
swaps and other complex derivatives are taken into complex category because they are
built up from either forwards/futures or options contracts, or both. In fact, such derivatives
are effectively derivatives of derivatives.

Derivatives are traded at organized exchanges and in the Over The Counter ( OTC
) market :
Derivatives Trading Forum

Organized Exchanges Over The Counter

Commodity Futures Forward Contracts
Financial Futures Swaps
Options (stock and index)
Stock Index Future
Derivatives traded at exchanges are standardized contracts having standard delivery
dates and trading units. OTC derivatives are customized contracts that enable the parties
to select the trading units and delivery dates to suit their requirements.



31
A major difference between the two is that of counterparty riskthe risk of default
by either party. With the exchange traded derivatives, the risk is controlled by
exchanges through clearing house which act as a contractual intermediary and impose
margin requirement. In contrast, OTC derivatives signify greater vulnerability.

DERIVATIVES INTRODUCTION IN INDIA:-
The first step towards introduction of derivatives trading in India was the
promulgation of the Securities Laws (Amendment) Ordinance, 1995, which withdrew the
prohibition on options in securities. SEBI set up a 24 member committee under the
chairmanship of Dr. L.C. Gupta on November 18, 1996 to develop appropriate regulatory
framework for derivatives trading in India, submitted its report on March 17, 1998. The
committee recommended that the derivatives should be declared as securities so that
regulatory framework applicable to trading of securities could also govern trading of
derivatives.
To begin with, SEBI approved trading in index futures contracts based on S&P
CNX Nifty and BSE-30 (Sensex) index. The trading in index options commenced in June
2001 and the trading in options on individual securities commenced in July 2001. Futures
contracts on individual stocks were launched in November 2001.











32
HISTORY OF CURRENCY DERIVATIVES:-
Currency futures were first created at the Chicago Mercantile Exchange (CME) in
1972.The contracts were created under the guidance and leadership of Leo Melamed, CME
Chairman Emeritus. The FX contract capitalized on the U.S. abandonment of the Bretton
Woods agreement, which had fixed world exchange rates to a gold standard after World War
II. The abandonment of the Bretton Woods agreement resulted in currency values being
allowed to float, increasing the risk of doing business. By creating another type of market in
which futures could be traded, CME currency futures extended the reach of risk management
beyond commodities, which were the main derivative contracts traded at CME until then. The
concept of currency futures at CME was revolutionary, and gained credibility through
endorsement of Nobel-prize-winning economist Milton Friedman.
Today, CME offers 41 individual FX futures and 31 options contracts on 19
currencies, all of which trade electronically on the exchanges CME Globex platform. It is the
largest regulated marketplace for FX trading. Traders of CME

FX futures are a diverse group that includes multinational corporations, hedge funds,
commercial banks, investment banks, financial managers, commodity trading advisors
(CTAs), proprietary trading firms; currency overlay managers and individual investors. They
trade in order to transact business, hedge against unfavorable changes in currency rates, or to
speculate on rate fluctuations.
Source: - (NCFM-Currency future Module)









33
UTILITY OF CURRENCY DERIVATIVES:-
Currency-based derivatives are used by exporters invoicing receivables in foreign
currency, willing to protect their earnings from the foreign currency depreciation by locking
the currency conversion rate at a high level. Their use by importers hedging foreign currency
payables is effective when the payment currency is expected to appreciate and the importers
would like to guarantee a lower conversion rate. Investors in foreign currency denominated
securities would like to secure strong foreign earnings by obtaining the right to sell foreign
currency at a high conversion rate, thus defending their revenue from the foreign currency
depreciation. Multinational companies use currency derivatives being engaged in direct
investment overseas. They want to guarantee the rate of purchasing foreign currency for
various payments related to the installation of a foreign branch or subsidiary, or to a joint
venture with a foreign partner.
A high degree of volatility of exchange rates creates a fertile ground for foreign
exchange speculators. Their objective is to guarantee a high selling rate of a foreign currency
by obtaining a derivative contract while hoping to buy the currency at a low rate in the future.
Alternatively, they may wish to obtain a foreign currency forward buying contract, expecting
to sell the appreciating currency at a high future rate. In either case, they are exposed to the
risk of currency fluctuations in the future betting on the pattern of the spot exchange rate
adjustment consistent with their initial expectations.
The most commonly used instrument among the currency derivatives are currency
forward contracts. These are large notional value selling or buying contracts obtained by
exporters, importers, investors and speculators from banks with denomination normally
exceeding 2 million USD. The contracts guarantee the future conversion rate between two
currencies and can be obtained for any customized amount and any date in the future. They
normally do not require a security deposit since their purchasers are mostly large business
firms and investment institutions, although the banks may require compensating deposit
balances or lines of credit. Their transaction costs are set by spread between bank's buy and
sell prices.
Exporters invoicing receivables in foreign currency are the most frequent users of
these contracts. They are willing to protect themselves from the currency depreciation by
locking in the future currency conversion rate at a high level. A similar foreign currency


34
forward selling contract is obtained by investors in foreign currency denominated bonds (or
other securities) who want to take advantage of higher foreign that domestic interest rates on
government or corporate bonds and the foreign currency forward premium. They hedge
against the foreign currency depreciation below the forward selling rate which would ruin
their return from foreign financial investment. Investment in foreign securities induced by
higher foreign interest rates and accompanied by the forward selling of the foreign currency
income is called a covered interest arbitrage.
Source :-( Recent Development in I nternational Currency Derivative Market by Lucjan T.
Orlowski)

Exchanges Trading in Currency Derivatives
MCX Stock Exchange Ltd. (MCX SX):-
MCX Stock Exchange Ltd. (MCX SX) commenced operations in the currency derivatives
segment on 7th October, 2008, within the regulatory framework of Securities & Exchange
Board of India (SEBI) and Reserve Bank of India (RBI). The all-India electronictrading
platform of MCX-SX offers participants the benefits of high liquidity, trade transparency,
easy online accessibility and counterparty guarantee through MCX SX Clearing
Corporation Ltd. (MCX-SX CCL), established on the lines of global clearing corporations.
MCX-SX has emerged as the first exchange in India to provide currency futures rates on a
real-time basis through mobile across all service providers, to publish a primer on currency
futures trade for guidance of interested participants and to launch websites in various
regional languages. MCX SX has also signed MOUs with varioustrade associations across
India. For more information please visit www.mcx-sx.com.
National Stock Exchange (NSE)
National Stock Exchange (NSE) commenced operations in 1994 and provides a nationwide
electronic trading platform for various types of securities for investors under one roof. These
instruments are available for trading under different segments: Wholesale Debt Market
Segment; Capital Market Segment, Futures and Options Segment and Currency Derivatives


35
Segment. Derivatives trading at NSE commenced in the year 2000, and the product
base includes trading in futures and options on S&P CNX Nifty Index, CNX IT Index, Bank
Nifty Index, CNX Nifty Junior Index, CNX 100 Index, Nifty Midcap 50 Index, S&P CNX
Index; futures and options on around 200 single stocks; and currency futures on the USDINR
contracts presently. NSEs trading presence is now in over 1,500 cities across India. NSE
ranks 3rd in the world, in terms of number of transactions executed on a stock exchange; 2nd
in the world, in terms of the number of contracts traded in Single Stock Futures; 3rd in the
world, in terms of number of contracts traded, in Stock Index Futures; and 2nd in Asia, in
terms of number of contracts traded, in equity derivatives instrument. For more information
please visit www.nseindia.com.
United Stock Exchange (USE)
United Stock Exchange (USE), Indias newest stock exchange, represents the
commitment of all 21 Indian public sector banks, respected private banks and corporate
houses to build an institution that is on its way to becoming an enduring symbol of Indias
modern financial markets. USE also boasts of Bombay Stock Exchange, as a strategic
partner. As Asias oldest stock exchange, BSE lends decades of unparalleled expertise in
exchange technology, clearing & settlement, regulatory structure and governance.
Leveraging the collective experience of its founding partners, USE has developed a
trustworthy and state of the art exchange platform that provides a truly world class trading
experience. For more information please visit www.useindia.com










36
INTRODUCTION TO CURRENCY DERIVATIVES:-
Each country has its own currency through which both national and
international transactions are performed. All the international business transactions
involve an exchange of one currency for another.
For example,
If any Indian firm borrows funds from international financial market in US
dollars for short or long term then at maturity the same would be refunded in particular
agreed currency along with accrued interest on borrowed money. It means that the
borrowed foreign currency brought in the country will be converted into Indian currency,
and when borrowed fund are paid to the lender then the home currency will be converted
into foreign lenders currency. Thus, the currency units of a country involve an exchange
of one currency for another.
The price of one currency in terms of other currency is known as
exchange rate.
The foreign exchange markets of a country provide the mechanism of exchanging
different currencies with one and another, and thus, facilitating transfer of purchasing
power from one country to another.
With the multiple growths of international trade and finance all over the world,
trading in foreign currencies has grown tremendously over the past several decades. Since
the exchange rates are continuously changing, so the firms are exposed to the risk of
exchange rate movements. As a result the assets or liability or cash flows of a firm which
are denominated in foreign currencies undergo a change in value over a period of time due
to variation in exchange rates.

This variability in the value of assets or liabilities or cash flows is referred to
exchange rate risk. Since the fixed exchange rate system has been fallen in the early 1970s,
specifically in developed countries, the currency risk has become substantial for many
business firms. As a result, these firms are increasingly turning to various risk hedging
products like foreign currency futures, foreign currency forwards, foreign currency options,
and foreign currency swaps.


37
INTRODUCTION TO CURRENCY FUTURE
A futures contract is a standardized contract, traded on an exchange, to buy or sell a
certain underlying asset or an instrument at a certain date in the future, at a specified price.
When the underlying asset is a commodity, e.g. Oil or Wheat, the contract is termed a

commodity futures contract

. When the underlying is an exchange rate, the contract is termed

a

currency futures contract

. In other words, it is a contract to exchange one currency for

another currency at a specified date and a specified rate in the future.
Therefore, the buyer and the seller lock themselves into an exchange rate for a
specific value or delivery date. Both parties of the futures contract must fulfill their
obligations on the settlement date
Currency futures can be cash settled or settled by delivering the respective obligation
of the seller and buyer. All settlements however, unlike in the case of OTC markets, go
through the exchange.
Currency futures are a linear product, and calculating profits or losses on Currency
Futures will be similar to calculating profits or losses on Index futures. In determining
profits and losses in futures trading, it is essential to know both the contract size (the
number of currency units being traded) and also what is the 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 and different
underlying. For e.g. in the case of the USD-INR currency futures contract the tick size
shall be 0.25 paise or 0.0025 Rupees. To demonstrate how a move of one tick affects the
price, imagine a trader buys a contract (USD 1000 being the value of each contract) at
Rs.42.2500. One tick move on this contract will translate to Rs.42.2475 or Rs.42.2525
depending on the direction of market movement.
Purchase price: Rs .42.2500
Price increases by one tick: +Rs. 00.0025
New price: Rs .42.2525
Purchase price: Rs .42.2500
Price decreases by one tick: Rs. 00.0025
New price: Rs.42. 2475


38
The value of one tick on each contract is Rupees 2.50. So if a trader buys 5
contracts and the price moves up by 4 tick, she makes Rupees 50.
Step 1: 42.2600 42.2500
Step 2: 4 ticks * 5 contracts = 20 points
Step 3: 20 points * Rupees 2.5 per tick = Rupees 50























39
Chapter 5

BRIEF OVERVIEW OF FOREIGN
EXCHANGE MARKET







40
OVERVIEW OF THE FOREIGN EXCHANGE MARKET IN INDIA:-
During the early 1990s, India embarked on a series of structural reforms in the
foreign exchange market. The exchange rate regime, that was earlier pegged, was partially
floated in March 1992 and fully floated in March 1993. The unification of the exchange rate
was instrumental in developing a market-determined exchange rate of the rupee and was
an important step in the progress towards total current account convertibility, which was
achieved in August 1994.
Although liberalization helped the Indian foreign market in various ways, it led to
extensive fluctuations of exchange rate. This issue has attracted a great deal of concern from
policy-makers and investors. While some flexibility in foreign exchange markets and
exchange rate determination is desirable, excessive volatility can have an adverse impact on
price discovery, export performance, sustainability of current account balance, and balance
sheets. In the context of upgrading Indian foreign exchange market to international standards,
a well- developed foreign exchange derivative market (both OTC as well as Exchange-
traded) is imperative.
With a view to enable entities to manage volatility in the currency market, RBI on
April 20, 2007 issued comprehensive guidelines on the usage of foreign currency forwards,
swaps and options in the OTC market. At the same time, RBI also set up an Internal Working
Group to explore the advantages of introducing currency futures. The Report of the Internal
Working Group of RBI submitted in April 2008, recommended the introduction of Exchange
Traded Currency Futures.
Subsequently, RBI and SEBI jointly constituted a Standing Technical Committee to
analyze the Currency Forward and Future market around the world and lay down the
guidelines to introduce Exchange Traded Currency Futures in the Indian market. The
Committee submitted its report on May 29, 2008. Further RBI and SEBI also issued circulars
in this regard on August 06, 2008.
Currently, India is a USD 34 billion OTC market, where all the major currencies like
USD, EURO, YEN, Pound, Swiss Franc etc. are traded. With the help of electronic trading
and efficient risk management systems, Exchange Traded Currency Futures will bring in
more


41

transparency and efficiency in price discovery, eliminate counterparty credit risk, provide
access to all types of market participants, offer standardized products and provide transparent
trading platform. Banks are also allowed to become members of this segment on the
Exchange, thereby providing them with a new opportunity.
Source :-( Report of the RBI -SEBI standing technical committee on exchange traded
currency futures) 2008.


CURRENCY DERIVATIVE PRODUCTS:-
Derivative contracts have several variants. The most common variants are
forwards, futures, options and swaps. We take a brief look at various derivatives contracts
that have come to be used.
FORWARD :
The basic objective of a forward market in any underlying asset is to fix a price for a
contract to be carried through on the future agreed date and is intended to free both the
purchaser and the seller from any risk of loss which might incur due to fluctuations in the
price of underlying asset.
A forward contract is customized contract between two entities, where settlement
takes place on a specific date in the future at todays pre-agreed price. The exchange rate is
fixed at the time the contract is entered into. This is known as forward exchange rate or
simply forward rate.
FUTURE :
A currency futures contract provides a simultaneous right and obligation to
buy and sell a particular currency at a specified future date, a specified price and a standard
quantity. In another word, a future contract is an agreement between two parties to buy or
sell an asset at a certain time in the future at a certain price. Future contracts are special types
of forward contracts in the sense that they are standardized exchange-traded contracts.


42
SWAP: Swap is private agreements between two parties to exchange cash flows in the
future according to a prearranged formula. They can be regarded as portfolio of forward
contracts.
The currency swap entails swapping both principal and interest between the
parties, with the cash flows in one direction being in a different currency than those in the
opposite direction. There are a various types of currency swaps like as fixed-to-fixed
currency swap, floating to floating swap, fixed to floating currency swap.

In a swap normally three basic steps are involve:-
(1) Initial exchange of principal amount
(2) Ongoing exchange of interest
(3) Re - exchange of principal amount on maturity.
OPTIONS :
Currency option is a financial instrument that give the option holder a right
and not the obligation, to buy or sell a given amount of foreign exchange at a fixed price per
unit for a specified time period ( until the expiration date ). In other words, a foreign
currency option is a contract for future delivery of a specified currency in exchange for
another in which buyer of the option has to right to buy (call) or sell (put) a particular
currency at an agreed price for or within specified period. The seller of the option gets the
premium from the buyer of the option for the obligation undertaken in the contract. Options
generally have lives of up to one year, the majority of options traded on options exchanges
having a maximum maturity of nine months. Longer dated options are called warrants and
are generally traded OTC.
FOREIGN EXCHANGE SPOT (CASH) MARKET:-
The foreign exchange spot market trades in different currencies for both spot and
forward delivery. Generally they do not have specific location, and mostly take place
primarily by means of telecommunications both within and between countries. It consists of
a network of foreign dealers which are oftenly banks, financial institutions, large concerns,
etc. The large banks usually make markets in different currencies.


43
In the spot exchange market, the business is transacted throughout the world on a
continual basis. So it is possible to transaction in foreign exchange markets 24 hours a day.
The standard settlement period in this market is 48 hours, i.e., 2 days after the execution of
the transaction.
The spot foreign exchange market is similar to the OTC market for securities. There is
no centralized meeting place and no fixed opening and closing time. Since most of the
business in this market is done by banks, hence, transaction usually do not involve a physical
transfer of currency, rather simply book keeping transfer entry among banks.Exchange rates
are generally determined by demand and supply force in this market. The purchase and sale
of currencies stem partly from the need to finance trade in goods and services. Another
important source of demand and supply arises from the participation of the central banks
which would emanate from a desire to influence the direction, extent or speed of exchange
rate movements.
FOREIGN EXCHANGE QUOTATIONS
Foreign exchange quotations can be confusing because currencies are quoted in terms of
other currencies. It means exchange rate is relative price.
For example,
If one US dollar is worth of Rs. 45 in Indian rupees then it implies that 45
Indian rupees will buy one dollar of USA, or that one rupee is worth of 0.022 US dollar
which is simply reciprocal of the former dollar exchange rate.
EXCHANGE RATE

Direct Indirect
The number of units of domestic The number of unit of foreign
Currency stated against one unit currency per unit of domestic
of foreign currency. currency.
Re/$ = 45.7250 ( or ) Re 1 = $ 0.02187
$1 = Rs. 45.7250


44
There are two ways of quoting exchange rates: the direct and indirect.
Most countries use the direct method. In global foreign exchange market, two rates are
quoted by the dealer: one rate for buying (bid rate), and another for selling (ask or
offered rate) for a currency. This is a unique feature of this market. It should be noted
that where the bank sells dollars against rupees, one can say that rupees against dollar. In
order to separate buying and selling rate, a small dash or oblique line is drawn after the
dash.
For example-
If US dollar is quoted in the market as Rs 46.3500/3550, it means that the
forex dealer is ready to purchase the dollar at Rs 46.3500 and ready to sell at Rs 46.3550.
The difference between the buying and selling rates is called spread It is important to note
that selling rate is always higher than the buying rate. Traders, usually large banks, deal in
two way prices, both buying and selling, are called market makers.
Base Currency/ Terms Currency:
In foreign exchange markets, the base currency is the first currency in a currency pair. The
second currency is called as the terms currency. Exchange rates are quoted in per unit of the
base currency. That is the expression Dollar-Rupee, tells you that the Dollar is being quoted
in terms of the Rupee. The Dollar is the base currency and the Rupee is the terms currency.
Exchange rates are constantly changing, which means that the value of one currency in
terms of the other is constantly in flux. Changes in rates are expressed as strengthening or
weakening of one currency vis--vis the second currency. Changes are also expressed as
appreciation or depreciation of one currency in terms of the second currency. Whenever the
base currency buys more of the terms currency, the base currency has strengthened /
appreciated and the terms currency has weakened / depreciated.
For example,
If Dollar Rupee moved from 43.00 to 43.25. The Dollar has appreciated and
the Rupee has depreciated. And if it moved from 43.0000 to 42.7525 the Dollar has
depreciated and Rupee has appreciated.



45
NEED FOR EXCHANGE TRADED CURRENCY FUTURES:-
With a view to enable entities to manage volatility in the currency market, RBI on
April 20, 2007 issued comprehensive guidelines on the usage of foreign currency forwards,
swaps and options in the OTC market. At the same time, RBI also set up an Internal Working
Group to explore the advantages of introducing currency futures. The Report of the Internal
Working Group of RBI submitted in April 2008, recommended the introduction of exchange
traded currency futures. Exchange traded futures as compared to OTC forwards serve the
same economic purpose, yet differ in fundamental ways. An individual entering into a
forward contract agrees to transact at a forward price on a future date. On the maturity date,
the obligation of the individual equals the forward price at which the contract was executed.
Except on the maturity date, no money changes hands. On the other hand, in the case of an
exchange traded futures contract, mark to market obligations is settled on a daily basis. Since
the profits or losses in the futures market are collected / paid on a daily basis, the scope for
building up of mark to market losses in the books of various participants gets limited.The
counterparty risk in a futures contract is further eliminated by the presence of a clearing
corporation, which by assuming counterparty guarantee eliminates credit risk.
Further, in an Exchange traded scenario where the market lot is fixed at a much lesser size
than the OTC market, equitable opportunity is provided to all classes of investors whether
large or small to participate in the futures market. The transactions on an Exchange are
executed on a price time priority ensuring that the best price is available to all categories of
market participants irrespective of their size. Other advantages of an Exchange traded
market would be greater transparency, efficiency and accessibility.
Source :-( Report of the RBI -SEBI standing technical committee on exchange traded
currency futures) 2008.







46
RATIONALE FOR INTRODUCING CURRENCY FUTURE:-
Futures markets were designed to solve the problems that exist in forward markets. A futures
contract is an agreement between two parties to buy or sell an asset at a certain time in the
future at a certain price. But unlike forward contracts, the futures contracts are standardized and
exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain
standard features of the contract. A futures contract is standardized contract with standard
underlying instrument, a standard quantity and quality of the underlying instrument that can be
delivered, (or which can be used for reference purposes in settlement) and a standard timing of
such settlement. A futures contract may be offset prior to maturity by entering into an equal and
opposite transaction.
The standardized items in a futures contract are:
Quantity of the underlying
Quality of the underlying
The date and the month of delivery
The units of price quotation and minimum price change
Location of settlement
The rationale for introducing currency futures in the Indian context has been outlined
in the Report of the Internal Working Group on Currency Futures (Reserve Bank of India, April
2008) as follows;
The rationale for establishing the currency futures market is manifold. Both residents
and non-residents purchase domestic currency assets. If the exchange rate remains unchanged
from the time of purchase of the asset to its sale, no gains and losses are made out of currency
exposures. But if domestic currency depreciates (appreciates) against the foreign currency, the
exposure would result in gain (loss) for residents purchasing foreign assets and loss (gain) for
non residents purchasing domestic assets. In this backdrop, unpredicted movements in
exchange rates expose investors to currency risks.



47
Currency futures enable them to hedge these risks. Nominal exchange rates are often
random walks with or without drift, while real exchange rates over long run are mean reverting.
As such, it is possible that over a long run, the incentive to hedge currency risk may not be
large. However, financial planning horizon is much smaller than the long-run, which is
typically inter-generational in the context of exchange rates. As such, there is a strong need to
hedge currency risk and this need has grown manifold with fast growth in cross-border trade
and investments flows. The argument for hedging currency risks appear to be natural in case of
assets, and applies equally to trade in goods and services, which results in income flows with
leads and lags and get converted into different currencies at the market rates. Empirically,
changes in exchange rate are found to have very low correlations with foreign equity and bond
returns. This in theory should lower portfolio risk. Therefore, sometimes argument is advanced
against the need for hedging currency risks. But there is strong empirical evidence to suggest
that hedging reduces the volatility of returns and indeed considering the episodic nature of
currency returns, there are strong arguments to use instruments to hedge currency risks.















48
FUTURE TERMINOLOGY:-
SPOT PRICE :
The price at which an asset trades in the spot market. The transaction in
which securities and foreign exchange get traded for immediate delivery. Since the
exchange of securities and cash is virtually immediate, the term, cash market, has also
been used to refer to spot dealing. In the case of USDINR, spot value is T + 2.
FUTURE PRICE :
The price at which the future contract traded in the future market.
CONTRACT CYCLE :
The period over which a contract trades. The currency future
contracts in Indian market have one month, two month, and three month up to twelve
month expiry cycles. In NSE/BSE will have 12 contracts outstanding at any given
point in time.
VALUE DATE / FINAL SETTELMENT DATE :
The last business day of the month will be termed the value date /final
settlement date of each contract. The last business day would be taken to the same as
that for inter bank settlements in Mumbai. The rules for inter bank settlements,
including those for known holidays and would be those as laid down by Foreign
Exchange Dealers Association of India (FEDAI).
EXPIRY DATE :
It is the date specified in the futures contract. This is the last day on which
the contract will be traded, at the end of which it will cease to exist. The last trading
day will be two business days prior to the value date / final settlement date.
CONTRACT SIZE :
The amount of asset that has to be delivered under one contract. Also
called as lot size. In case of USDINR it is USD 1000.





49
BASIS :
In the context of financial futures, basis can be defined as the futures price minus the
spot price. There will be a different basis for each delivery month for each contract.
In a normal market, basis will be positive. This reflects that futures prices normally
exceed spot prices.
COST OF CARRY :
The relationship between futures prices and spot prices can be
summarized in terms of what is known as the cost of carry. This measures the storage
cost plus the interest that is paid to finance or carry the asset till delivery less the
income earned on the asset. For equity derivatives carry cost is the rate of interest.

INITIAL MARGIN :
When the position is opened, the member has to deposit the margin with
the clearing house as per the rate fixed by the exchange which may vary asset to asset.
Or in another words, the amount that must be deposited in the margin account at the
time a future contract is first entered into is known as initial margin.

MARKING TO MARKET :

At the end of trading session, all the outstanding contracts are reprised at
the settlement price of that session. It means that all the futures contracts are daily
settled, and profit and loss is determined on each transaction. This procedure, called
marking to market, requires that funds charge every day. The funds are added or
subtracted from a mandatory margin (initial margin) that traders are required to
maintain the balance in the account. Due to this adjustment, futures contract is also
called as daily reconnected forwards.





50
MAINTENANCE MARGIN :
Members account are debited or credited on a daily basis. In turn
customers account are also required to be maintained at a certain level, usually about
75 percent of the initial margin, is called the maintenance margin. This is somewhat
lower than the initial margin.
This is set to ensure that the balance in the margin account
never becomes negative. If the balance in the margin account falls below the maintenance
margin, the investor receives a margin call and is expected to top up the margin account to
the initial margin level before trading commences on the next day.
TRADING PROCESS AND SETTLEMENT PROCESS :-
Like other future trading, the future currencies are also traded at organized exchanges.
The following diagram shows how operation take place on currency future market:

It has been observed that in most futures markets, actual physical delivery of the underlying
assets is very rare and hardly has it ranged from 1 percent to 5 percent. Most often buyers and
TRADER
(BUYER)
TRADER
(SELLER)
MEMBER
(BROKER)
MEMBER
(BROKER)
CLEARING
HOUSE
Purchase order Sales order
Transaction on the floor (Exchange)
Informs


51
sellers offset their original position prior to delivery date by taking an opposite positions.
This is because most of futures contracts in different products are predominantly speculative
instruments. For example, X purchases American Dollar futures and Y sells it. It leads to two
contracts, first, X party and clearing house and second Y party and clearing house. Assume
next day X sells same contract to Z, then X is out of the picture and the clearing house is
seller to Z and buyer from Y, and hence, this process is goes on.
REGULATORY FRAMEWORK FOR CURRENCY FUTURES:-
With a view to enable entities to manage volatility in the currency market, RBI on April 20,
2007 issued comprehensive guidelines on the usage of foreign currency forwards, swaps and
options in the OTC market. At the same time, RBI also set up an Internal Working Group to
explore the advantages of introducing currency futures. The Report of the Internal Working
Group of RBI submitted in April 2008, recommended the introduction of exchange traded
currency futures. With the expected benefits of exchange traded currency futures, it was
decided in a joint meeting of RBI and SEBI on February 28, 2008, that an RBI-SEBI
Standing Technical Committee on Exchange Traded Currency and Interest Rate Derivatives
would be constituted. To begin with, the Committee would evolve norms and oversee the
implementation of Exchange traded currency futures. The Terms of Reference to the
Committee was as under:
1. To coordinate the regulatory roles of RBI and SEBI in regard to trading of Currency
and Interest Rate Futures on the Exchanges.

2. To suggest the eligibility norms for existing and new Exchanges for Currency and
Interest Rate Futures trading.

3. To suggest eligibility criteria for the members of such exchanges.

4. To review product design, margin requirements and other risk mitigation measures on
an ongoing basis.
5. To suggest surveillance mechanism and dissemination of market information.
6. To consider microstructure issues, in the overall interest of financial stability.


52
COMPARISION OF FORWARD AND FUTURES CURRENCY CONTRACT:-
BASIS FORWARD FUTURES
Size Structured as per requirement of
the parties
Standardized
Delivery date Tailored on individual needs Standardized
Method of transaction Established by the bank or
broker through electronic media
Open auction among buyers and seller on the floor of
recognized exchange.
Participants Banks, brokers, forex dealers,
multinational companies,
institutional investors,
arbitrageurs, traders, etc.
Banks, brokers, multinational companies, institutional
investors, small traders, speculators, arbitrageurs, etc.
Margins None as such, but
compensating bank balanced
may be required
Margin deposit required
Maturity Tailored to needs: from one
week to 10 years
Standardized
Settlement Actual delivery or offset with
cash settlement. No separate
clearing house
Daily settlement to the market and variation margin
requirements
Market place Over the telephone worldwide
and computer networks
At recognized exchange floor with worldwide
communications
Accessibility Limited to large customers
banks, institutions, etc.
Open to any one who is in need of hedging facilities or
has risk capital to speculate
Delivery More than 90 percent settled by
actual delivery
Actual delivery has very less even below one percent
Secured Risk is high being less secured Highly secured through margin deposit.

A currency future, also known as FX future, is a futures contract to exchange one currency
for another at a specified date in the future at a price (exchange rate) that is fixed on the
purchase date. On NSE the price of a future contract is in terms of INR per unit of other


53
currency e.g. US Dollars. Currency future contracts allow investors to hedge against foreign
exchange risk. Currency Derivatives are available on four currency pairs viz. US Dollars
(USD), Euro (EUR), Great Britain Pound (GBP) and Japanese Yen (JPY). Currency options
are currently available on US Dollars.
Clearing & Settlement - Currency Derivatives National Securities Clearing
Corporation Limited (NSCCL) is the clearing and settlement agency for all deals executed on
the Currency Derivatives segment. NSCCL acts as legal counter-party to all deals on NSE's
Currency Derivatives segment and guarantees settlement. A Clearing Member (CM) of
NSCCL has the responsibility of clearing and settlement of all deals executed by Trading
Members (TM) on NSE, who clear and settle such deals through them.

Futures vs. Forwards:-
Currency Futures Forwards
Type of Contracts Standardized Customized
Price transparency High, Real time rate Low, Over the phone
Accessibility Online / Offline modes Offline/ OTC
Underlying exposure Not Required Required
Margin
Requirement
3.00% Non standardized may vary from 8-12
%
MTM Settlement Daily Settled NA
Settlement Net settled in INR
(Cash)
Physical Settlement




54
Chapter 6:













55

Concept of interest rate parity:-

Let us assume that risk free interest rate for one year deposit in India is 7% and
in USA it is 3%. You as smart trader/ investor will raise money from USA and deploy it in
India and try to capture the arbitrage of 4%. You could continue to do so and make this
transaction as a non ending money making machine. Life is not that simple! And such
arbitrages do not exist for very long.

We will carry out the above transaction through an example to explain the concept of
interest rate parity and derivation of future prices which ensure that arbitrage does not exist

Assumptions:
1. Spot exchange rate of USDINR is 50 (S)
2. One year future rate for USDINR is F
3. Risk free interest rate for one year in USA is 3% (RUSD)
4. Risk free interest rate for one year in India is 7% (R INR)
5. Money can be transferred easily from one country into another without anyrestriction of
amount, without any taxes etc

You decide to borrow one USD from USA for one year, bring it to India, convert it in
INR and deposit for one year in India. After one year, you return the money back to USA.On
start of this transaction, you borrow 1 USD in US at the rate of 3% and agree to return 1.03
USD after one year (including interest of 3 cents). This 1 USD is converted into INR at the
prevailing spot rate of 50. You deposit the resulting INR 50 for one year at interest rate of
7%. At the end of one year, you receive INR 3.5 (7% of 50) as interest on your deposit and
also get back your principal of INR 50 i.e., you receive a total of INR 53.5. You need to use
these proceeds to repay the loan taken in USA.
Two important things to think before we proceed:
The loan taken in USA was in USD and currently you have INR. Therefore you
need to convert INR into USD
What exchange rate do you use to convert INR into USD?



56
At the beginning of the transaction, you would lock the conversion rate of INR into
US Dusing one year future price of USDINR. To ensure that the transaction does not result
into any risk free profit, the money which you receive in India after one year should be equal
to the loan amount that you have to pay in USA. We will convert the above argument into a
formula:
S(1+R INR)= F(1+R USD)
Or, F/ S = (1+R INR) / (1+RUSD)
Another way to illustrate the concept is to think that the INR 53.5 received after one year in
India should be equal to USD 1.03 when converted using one year future exchange rate.
Therefore,
F/ 50 = (1+.07) / (1+.03)
F= 51.9417
Approximately, F is equal to the interest rate difference between two currencies i.e.,
F = S + (R INR- R USD)*S

This concept of difference between future exchange rate and spot exchange rate being
approximately equal to the difference in domestic and foreign interest rate is called the
Interest rate parity. Alternative way to explain, interest rate parity says that the spot price
and futures price of a currency pair incorporates any interest rate differentials between the
two currencies assuming there are no transaction costs or taxes. A more accurate formula for
calculating, the arbitrage-free forward price is as follows.
F = S (1 + R QC Period) / (1 + R BC Period)
Where
F = forward price
S = spot price
R BC = interest rate on base currency
R QC = interest rate on quoting currency
Period = forward period in years
For a quick estimate of forward premium, following formula mentioned above for USDINR
currency pair could be used. The formula is generalized for other currency pairand is given
below:



57
F = S + (S (R QC R BC) Period)

In above example, if USD interest rate were to go up and INR interest rate were to remain at
7%, the one year future price of USDINR would decline as the interest rate difference
between the two currencies has narrowed and vice versa. Traders use expectation on change
in interest rate to initiate long/ short positions in currency futures. Everything else remaining
the same, if USD interest rate is expected to go up (say from 2.5% to 3.0%) and INR interest
rate are expected to remain constant say at 7%; a trader would initiate a short position in
USDINR futures market.

Illustration:
Suppose 6 month interest rate in India is 5% (or 10% per annum) and in USA are 1% (2%
per annum). The current USDINR spot rate is 50. What is the likely 6 month USDINR
futures price? As explained above, as per interest rate parity, future rate is equal to the
interest rate differential between two currency pairs. Therefore approximately 6 month future
rate would be:
Spot + 6 month interest difference = 50 + 4% of 50
= 50 + 2 = 52
The exact rate could be calculated using the formula mentioned above and the answer comes
to 51.98.
51.98 = 50 x (1+0.1/12 x 6) / (1+0.02/12 x 6)

Concept of premium and discount
Therefore one year future price of USDINR pair is 51.94 when spot price is 50. It means that
INR is at discount to USD and USD is at premium to INR. Intuitively to understand why INR
is called at discount to USD, think that to buy same 1 USD you had to pay INR 50 and you
have to pay 51.94 after one year i.e., you have to pay more INR to buy same 1 USD. And
therefore future value of INR is at discount to USD. Therefore in any currency pair, future
value of a currency with high interest rate is at a discount (in relation to spot price) to the
currency with low interest rate.





58
PRODUCT DEFINITIONS OF CURRENCY FUTURE ON NSE/BSE:
Underlying
Initially, currency futures contracts on US Dollar Indian Rupee (US$-INR) would be
permitted.
Trading Hours
The trading on currency futures would be available from 9 a.m. to 5 p.m.
Size of the contract
The minimum contract size of the currency futures contract at the time of introduction would
be US$ 1000. The contract size would be periodically aligned to ensure that the size of the
contract remains close to the minimum size.
Quotation
The currency futures contract would be quoted in rupee terms. However, the outstanding
positions would be in dollar terms.
Tenor of the contract
The currency futures contract shall have a maximum maturity of 12 months.
Available contracts
All monthly maturities from 1 to 12 months would be made available.
Settlement mechanism
The currency futures contract shall be settled in cash in Indian Rupee.
Settlement price
The settlement price would be the Reserve Bank Reference Rate on the date of expiry. The
methodology of computation and dissemination of the Reference Rate may be publicly
disclosed by RBI.




59
Final settlement day
The currency futures contract would expire on the last working day (excluding Saturdays) of
the month. The last working day would be taken to be the same as that for Interbank
Settlements in Mumbai. The rules for Interbank Settlements, including those for known
holidays and subsequently declared holiday would be those as laid down by FEDAI.
The contract specification in a tabular form is as under:
Underlying Rate of exchange between one USD and
INR
Trading Hours
(Monday to Friday)
09:00 a.m. to 05:00 p.m.
Contract Size USD 1000
Tick Size 0.25 paisa or INR 0.0025
Trading Period Maximum expiration period of 12 months
Contract Months 12 near calendar months
Final Settlement date/Value
date
Last working day of the month (subject toholiday
calendars)
Last Trading Day
Two working days prior to Final Settlement Date
Settlement Cash settled
Final Settlement Price The reference rate fixed by RBI two
working days prior to the final settlement
date will be used for final settlement








60
6.3 CURRENCY FUTURES PAYOFFS:-
A payoff is the likely profit/loss that would accrue to a market participant with change
in the price of the underlying asset. This is generally depicted in the form of payoff diagrams
which show the price of the underlying asset on the X-axis and the profits/losses on the Y-
axis. Futures contracts have linear payoffs. In simple words, it means that the losses as well
as profits for the buyer and the seller of a futures contract are unlimited. Options do not have
linear payoffs. Their pay offs are non-linear. These linear payoffs are fascinating as they can
be combined with options and the underlying to generate various complex payoffs. However,
currently only payoffs of futures are discussed as exchange traded foreign currency options
are not permitted in India.
Payoff for buyer of futures: Long futures
The payoff for a person who buys a futures contract is similar to the payoff for a person who
holds an asset. He has a potentially unlimited upside as well as a potentially unlimited
downside. Take the case of a speculator who buys a two-month currency futures contract
when the USD stands at say Rs.43.19. The underlying asset in this case is the currency, USD.
When the value of dollar moves up, i.e. when Rupee depreciates, the long futures position
starts making profits, and when the dollar depreciates, i.e. when rupee appreciates, it starts
making losses. Figure 4.1 shows the payoff diagram for the buyer of a futures contract.
Payoff for buyer of future:
The figure shows the profits/losses for a long futures position. The investor bought
futures when the USD was at Rs.43.19. If the price goes up, his futures position
starts making profit. If the price falls, his futures position starts showing losses.








61





Payoff for seller of futures: Short futures
The payoff for a person who sells a futures contract is similar to the payoff for a person who
shorts an asset. He has a potentially unlimited upside as well as a potentially unlimited
downside. Take the case of a speculator who sells a two month currency futures contract
when the USD stands at say Rs.43.19. The underlying asset in this case is the currency, USD.
When the value of dollar moves down, i.e. when rupee appreciates, the short futures position
starts 25 making profits, and when the dollar appreciates, i.e. when rupee depreciates, it starts
making losses. The Figure below shows the payoff diagram for the seller of a futures
contract.

P
R
O
F
I
T
L
O
S
S
USD
D
0
43.19


62


PRICING FUTURES COST OF CARRY MODEL:-
Pricing of futures contract is very simple. Using the cost-of-carry logic,
we calculate the fair value of a futures contract. Every time the observed price deviates from
the fair value, arbitragers would enter into trades to capture the arbitrage profit. This in turn
would push the futures price back to its fair value.
The cost of carry model used for pricing futures is given below:
F=Se^(r-rf)T
where:
r=Cost of financing (using continuously compounded interest rate)
rf= one year interest rate in foreign
T=Time till expiration in years
E=2.71828
The relationship between F and S then could be given as
F Se^(r rf )T
P
R
O
F
I
T
L
O
S
S
USD
D
0
43.19


63
This relationship is known as interest rate parity relationship and is used in
international finance. To explain this, let us assume that one year interest rates in US and
India are say 7% and 10% respectively and the spot rate of USD in India is Rs. 44. From the
equation above the one year forward exchange rate should be
F = 44 * e^(0.10-0.07 )*1=45.34
This relationship is known as interest rate parity relationship and is used in
international finance. To explain this, let us assume that one year interest rates in US and
India are say 7% and 10% respectively and the spot rate of USD in India is Rs. 44. From the
equation above the one year forward exchange rate should be
F = 44 * e^(0.10-0.07 )*1=45.34
It may be noted from the above equation, if foreign interest rate is greater than the
domestic rate i.e. rf > r, then F shall be less than S. The value of F shall decrease further as
time T increase. If the foreign interest is lower than the domestic rate, i.e. rf < r, then value of
F shall be greater than S. The value of F shall increase further as time T increases.
Clearing Members
A Clearing Member (CM) of NSCCL has the responsibility of clearing and settlement
of all deals executed by Trading Members (TM) on NSE, who clear and settle such deals
through them. Primarily, the CM performs the following functions:
Clearing ' Computing obligations of all his TM's i.e. determining positions to settle.
Settlement - Performing actual settlement. Only funds settlement is allowed at present.
Risk Management ' Setting position limits based on upfront deposits / margins for each TM.

Types of Clearing Members
Trading Member Clearing Member (TM-CM) A Clearing Member who is also a TM. Such
CMs may clear and settle their own proprietary trades, their clients' trades as well as trades of
other TM's & Custodial Participants
Professional Clearing Member (PCM) A CM who is not a TM. Typically banks or custodians
could become a PCM and clear and settle for TM's as well as of the Custodial Participants.



64
Clearing Member Eligibility Norms
Net worth of at-least Rs.10 crores.
Deposit of Rs. 50 lakhs to NSCCL which forms part of the security deposit of the
CM.
Daily Settlement Price for mark to market settlement of futures contracts
Daily settlement price for futures contracts is the closing price of such contracts on
the trading day. The closing price for a futures contract shall be calculated on the basis of the
last half an hour weighted average price of such contract or such other price as may be
decided by the relevant authority from time to time.Theoretical daily settlement price for
unexpired futures contracts which are not traded during the last half an hour on a day
Theoretical daily settlement price for unexpired futures contracts, which are not traded during
the last half an hour on a day, shall be the price computed as per the formula:
F
0
=S
0
e
(r-r)
f
T :-


where:
F0= Theoretical futures price

S0 = Value of the underlying

r = Cost of financing (using continuously compounded interest rate)

rf = Foreign risk free interest rate

T = Time till expiration

e = 2.71828

Rate of interest (r) may be the relevant MIFOR rate or such other rate as may be specified by
the Clearing Corporation from time to time.
Foreign risk free interest rate is the relevant LIBOR rate or such other rate as may be
specified by the Clearing Corporation from time to time.




65
Final Settlement Price for mark to market settlement of futures contracts:
Final settlement price for a futures contract for the various currencies shall be as mentioned
below, or as may be specified by the relevant authority from time to time.
USDINR EURINR GBPINR JPYINR
Final
settlement
price
RBI
reference
rate
RBI
reference
rate
Exchange rate published by
RBI in its Press Release
captioned RBI reference
Rate for US$ and Euro
Exchange rate published by
RBI in its Press Release
captioned RBI reference
Rate for US$ and Euro

6.5 HEDGING WITH CURENCY FUTURES
Exchange rates are quite volatile and unpredictable, it is possible that anticipated
profit in foreign investment may be eliminated, rather even may incur loss. Thus, in order to
hedge this foreign currency risk, the traders oftenly use the currency futures. For example, a
long hedge (I.e.., buying currency futures contracts) will protect against a rise in a foreign
currency value whereas a short hedge (i.e., selling currency futures contracts) will protect
against a decline in a foreign currencys value.
It is noted that corporate profits are exposed to exchange rate risk in many
situation. For example, if a trader is exporting or importing any particular product from other
countries then he is exposed to foreign exchange risk. Similarly, if the firm is borrowing or
lending or investing for short or long period from foreign countries, in all these situations, the
firms profit will be affected by change in foreign exchange rates. In all these situations, the
firm can take long or short position in futures currency market as per requirement.
The general rule for determining whether a long or short futures position will hedge a
potential foreign exchange loss is:
Loss from appreciating in Indian rupee= Short hedge
Loss form depreciating in Indian rupee= Long hedge




66
The choice of underlying currency
The first important decision in this respect is deciding the currency in which futures contracts
are to be initiated. For example, an Indian manufacturer wants to purchase some raw
materials from Germany then he would like future in German mark since his exposure in
straight forward in mark against home currency (Indian rupee). Assume that there is no such
future (between rupee and mark) available in the market then the trader would choose among
other currencies for the hedging in futures. Which contract should he choose? Probably he
has only one option rupee with dollar. This is called cross hedge.
Choice of the maturity of the contract
The second important decision in hedging through currency futures is selecting the
currency which matures nearest to the need of that currency. For example, suppose Indian
importer import raw material of 100000 USD on 1
st
November 2008. And he will have to pay
100000 USD on 1
st
February 2009. And he predicts that the value of USD will increase
against Indian rupees nearest to due date of that payment. Importer predicts that the value of
USD will increase more than 51.0000. So what he will do to protect against depreciating in
Indian rupee? Suppose spots value of 1 USD is 49.8500. Future Value of the 1USD on NSE
as below: Price watch
Order Book
Contract
Best
Buy Qty
Best
Buy Price
Best
Sell Price
Best
Sell Qty
LTP Volume
Open
Interest
USDINR 261109 464 49.8550 49.8575 712 49.8550 58506 43785
USDINR 291209 189 49.6925 49.7000 612 49.7300 176453 111830
USDINR 280110 1 49.8850 49.9250 2 49.9450 5598 16809
USDINR 250210 100 50.1000 50.2275 1 50.1925 3771 6367
USDINR 270310 100 49.9225 50.5000 5 49.9125 311 892
USDINR 280410 1 50.0000 51.0000 5 50.5000 - 278


67


Volume As On 26-NOV-2008 17:00:00
Hours IST
No. of Contracts
244645

Archives
As On 26-Nov-2011 12:00:00 Hours IST
Underlying
RBI reference
rate
USDINR 52.8500




Rules, Byelaws & Regulations


Membership


Circulars


List of Holidays









USDINR 270510 - - 51.0000 5 47.1000 - 506
USDINR 260610 25 49.0000 - - 50.0000 - 116
USDINR 290710 1 48.0875 - - 49.1500 - 44
USDINR 270810 2 48.1625 50.5000 1 50.3000 6 2215
USDINR 280910 1 48.2375 - - 51.2000 - 79
USDINR 281011 1 48.3100 53.1900 2 50.9900 - 2
USDINR 261111 1 48.3825 - - 50.9275 - -


68
Solution:
He should buy ten contract of USDINR 28012009 at the rate of 49.8850. Value of the
contract is (49.8850*1000*100) =4988500. (Value of currency future per USD*contract
size*No of contract). For that he has to pay 5% margin on 5988500. Means he will have to
pay Rs.299425 at present. And suppose on settlement day the spot price of USD is 51.0000.
On settlement date payoff of importer will be (51.0000-59.8850) =1.115 per USD. And
(1.115*100000) =111500.Rs.
Choice of the number of contracts (hedging ratio)
Another important decision in this respect is to decide hedging ratio HR. The value of
the futures position should be taken to match as closely as possible the value of the cash
market position. As we know that in the futures markets due to their standardization, exact
match will generally not be possible but hedge ratio should be as close to unity as possible.
We may define the hedge ratio HR as follows:
HR= VF / Vc;
Where, VF is the value of the futures position and Vc is the value of the cash position.
Suppose value of contract dated 28
th
January 2009 is 49.8850.
And spot value is 49.8500.
HR=49.8850/49.8500=1.001.









69
USES OF CURRENCY FUTURES:-
Hedgi ng:
Presume Entity A is expecting a remittance for USD 1000 on 27 August 08. Wants to
lock in the foreign exchange rate today so that the value of inflow in Indian rupee
terms is safeguarded. The entity can do so by selling one contract of USDINR
futures since one contract is for USD 1000. Presume that the current spot rate is
Rs.43 and

USDINR 27 Aug 08 contract is trading at Rs.44.2500. Entity A shall do

the following: Sell one August contract today. The value of the contract is
Rs.44,250. Let us assume the RBI reference rate on August 27, 2008 is Rs.44.0000.
The entity shall sell on August 27, 2008, USD 1000 in the spot market and get Rs.
44,000. The futures contract will settle at Rs.44.0000 (final settlement price = RBI
reference rate). The return from the futures transaction would be Rs. 250, i.e. (Rs.
44,250 Rs. 44,000). As may be observed, the effective rate for the remittance
received by the entity A is Rs.44. 2500 (Rs.44,000 + Rs.250)/1000, while spot rate
on that date was Rs.44.0000. The entity was able to hedge its exposure.
Speculation: Bullish, buy futures
Take the case of a speculator who has a view on the direction of the market. He would
like to trade based on this view. He expects that the USD-INR rate presently at
Rs.42, is to go up in the next two-three months. How can he trade based on this
belief? In case he can buy dollars and hold it, by investing the necessary capital, he
can profit if say the Rupee depreciates to Rs.42.50. Assuming he buys USD 10000, it
would require an investment of Rs.4,20,000. If the exchange rate moves as he
expected in the next three months, then he shall make a profit of around Rs.10000.
This works out to an annual return of around 4.76%. It may please be noted that the
cost of funds invested is not considered in computing this return.
A speculator can take exactly the same position on the exchange rate by using
futures contracts. Let us see how this works. If the INR- USD is Rs.42 and the three
month futures trade at Rs.42.40. The minimum contract size is USD 1000. Therefore
the speculator may buy 10 contracts. The exposure shall be the same as above USD
10000. Presumably, the margin may be around Rs.21, 000. Three months later if the


70
Rupee depreciates to Rs. 42.50 against USD, (on the day of expiration of the contract),
the futures price shall converge to the spot price (Rs. 42.50) and he makes a profit of
Rs.1000 on an investment of Rs.21, 000. This works out to an annual return of 19 percent.
Because of the leverage they provide, futures form an attractive option for speculators.
Speculation: Bearish, sell futures:-
Futures can be used by a speculator who
believes that an underlying is over-valued and is likely to see a fall in price. How can
he trade based on his opinion? In the absence of a deferral product, there wasn
'
t
much he could do to profit from his opinion. Today all he needs to do is sell the
futures.
Let us understand how this works. Typically futures move correspondingly with the
underlying, as long as there is sufficient liquidity in the market. If the underlying
price rises, so will the futures price. If the underlying price falls, so will the futures
price. Now take the case of the trader who expects to see a fall in the price of USD-
INR. He sells one two-month contract of futures on USD say at Rs. 42.20 (each
contact for USD 1000). He pays a small margin on the same. Two months later,
when the futures contract expires, USD-INR rate let us say is Rs.42. On the day of
expiration, the spot and the futures price converges. He has made a clean profit of 20
paise per dollar. For the one contract that he sold, this works out to be Rs.2000.

Arbitrage:
Arbitrage is the strategy of taking advantage of difference in price of the same or
similar product between two or more markets. That is, arbitrage is striking a
combination of matching deals that capitalize upon the imbalance, the profit being
the difference between the market prices. If the same or similar product is traded in
say two different markets, any entity which has access to both the markets will be
able to identify price differentials, if any. If in one of the markets the product is
trading at higher price, then the entity shall buy the product in the cheaper market
and sell in the costlier market and thus benefit from the price differential without
any additional risk.


71
One of the methods of arbitrage with regard to USD-INR could be a trading strategy
between forwards and futures market. As we discussed earlier, the futures price and
forward prices are arrived at using the principle of cost of carry. Such of those
entities who can trade both forwards and futures shall be able to identify any mis-
pricing between forwards and futures. If one of them is priced higher, the same shall
be sold while simultaneously buying the other which is priced lower. If the tenor of
both the contracts is same, since both forwards and futures shall be settled at the
same RBI reference rate, the transaction shall result in a risk less profit.

Situation:-
An importer, who is exposed to an appreciating USD/falling INR can hedge his spot
market exposure by buying USDINR futures/forwards/call options.
Hedge:-
A transaction in which an end user (Exporter/ Importer) seeks to protect a position or
anticipated position in the spot market by using an opposite position in derivatives is a Hedge
Transaction.
Participant Risk Underlying Position Hedging Position
Importer Currency of Import will
strengthen
Buyer of Currency of
Import
Long in Currency of
Import
Exporter Currency of Export will
weaken
Seller of Currency of
Export
Short in Currency of
Export



72
Hedging Strategies Importer:-
Illustration:
An importer, who is exposed to an appreciating USD/falling INR can hedge his spot
market exposure by buying USDINR futures/forwards/call options
Scenario 1: Supposedly, the importer doesnt have his position hedged.
Scenario 2: The importer has his hedging done through Futures
Scenario 3 : The importer uses call option or combination of options to hedge
Value of Imports: USD 15 million per month.
Importer has executed an order worth $15mn and outflow of foreign currency to be
made in August11.
Spot USDINR is 46.07
Risk: INDIAN Rupee may depreciate & import payment of USD 15 million to be
made at a conversion rate higher than assumed rate 46.07 .

Scenario 1: Unhedged Positions:-
CASE 1: if INR depreciates Supposedly, in August USDINR fluctuates to $46.40.
The importer will now have to convert INR and make the payment at $46.40 Now, the
importer incurs a net loss of 0.33 paisa, which converted to actual value of the
receivables becomes, Rs. 4950000 ($15mn*46.07 - $15mn*46.40)
CASE 2: if INR appreciates Lets assume, in August, USDINR reaches to $45.70. The
importer would have gained Rs. 5550000, but with an equal risk of being un hedged
in the market.
Scenario 2: Hedged Positions:-
Importer Buys 15000 lots ($15mn) of currency futures for the September Futures at
$46.22
Futures Rate: $46.22 (Assuming premium with Spot 15 paisa)
Upon Remittance the importer squares up the September contract at the exchange and
simultaneously convert Rupee to $ on spot from Bank .




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CASE 1: if INR depreciates Supposedly upon expiry, the USDINR prices move to
$46.52 (Spot - $46.42) The importer makes a profit of 30 paisa in exchange but he will
convert INR to USD at bank at $46.42 instead of $46.07, i.e., losses in spot market will
be offset with the gains in futures.
CASE 2: if INR appreciates Now, again lets assume upon expiry, the USDINR prices fall
to $45.90 (Spot - $45.80) The importer loses 32 paisa in currency futures but he will
convert INR to USD at bank at $45.80 instead of $46.07, i.e., losses in futures market will
be offset with the gains in currency futures.
Conclusion: Profit/Loss at exchange transaction would offset Bank transaction. The forward
contracts done through banks would be of the same nature as future contracts. However, the
comparison between both is illustrated in the later slides.
Scenario 3: Using Options:-
Purchased Call Option :
Options are like insurance contracts, they protect you from the downside at the same time
allowing you to reap the benefits of any upside.
USDINR option introduced greater flexibility in Risk management of corporate and cost
control.
The spot price of USDINR on 26th August is 46.07 per USD. An Importer has receivable on
USDINR.
He buys a call option with a strike price of 46.00 at a premium of 0.50 expiring on 27th
September.





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On Expiration
If the USDINR price is above 46.00, the call is in the money and Importer will
exercise the option.
On the contrary, if the USDINR pair falls below 46.00, the call is out of money and
Importer will not exercise the option and the maximum loss will be equal to the
premium paid i.e 50 paise per USD which he can always price while initiating the
purchase contract with supplier and include the same in his cost of Imports.
If the USDINR is at 46.00, call is at the money and he will not gain or lose any
amount.


Thus he has fixed the value of his import obligations











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Chapter 6



&




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FINDINGS:-
Cost of carry model and Interest rate parity model are useful tools to find out standard
future price and also useful for comparing standard with actual future price. And its
also a very help full in Arbitraging.

New concept of Exchange traded currency future trading is regulated by higher
authority and regulatory. The whole function of Exchange traded currency future is
regulated by SEBI/RBI, and they established rules and regulation so there is very safe
trading is emerged and counter party risk is minimized in currency Future trading.
And also time reduced in Clearing and Settlement process up to T+1 days basis.

Larger exporter and importer has continued to deal in the OTC counter even exchange
traded currency future is available in markets because.

There is a limit of USD 100 million on open interest applicable to trading member
who are banks. And the USD 25 million limit for other trading members so larger
exporter and importer might continue to deal in the OTC market where there is no
limit on hedges.

In India RBI and SEBI has restricted other currency derivatives except Currency
future, at this time if any person wants to use other instrument of currency derivatives
in this case he has to use OTC.









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SUGGESTIONS:-
Currency Future need to change some restriction it imposed such as cut off limit
of 5 million USD, Ban on NRIs and FIIs and Mutual Funds from Participating.

Now in exchange traded currency future segment only one pair USD-INR is
available to trade so there is also one more demand by the exporters and
importers to introduce another pair in currency trading. Like POUND-INR,
CAD-INR etc.

In OTC there is no limit for trader to buy or short Currency futures so there
demand arises that in Exchange traded currency future should have increase limit
for Trading Members and also at client level, in result OTC users will divert to
Exchange traded currency Futures.

In India the regulatory of Financial and Securities market (SEBI) has Ban on other
Currency Derivatives except Currency Futures, so this restriction seem
unreasonable to exporters and importers. And according to Indian financial
growth now its become necessary to introducing other currency derivatives in
Exchange traded currency derivative segment.











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CONCLUSIONS:-
By far the most significant event in finance during the past decade has been
the extraordinary development and expansion of financial derivativesThese instruments
enhances the ability to differentiate risk and allocate it to those investors most able and
willing to take it- a process that has undoubtedly improved national productivity growth and
standards of livings.
The currency future gives the safe and standardized contract to its investors and individuals
who are aware about the forex market or predict the movement of exchange rate so they will
get the right platform for the trading in currency future. Because of exchange traded future
contract and its standardized nature gives counter party risk minimized.

Initially only NSE had the permission but now BSE and MCX has also started currency
future. It is shows that how currency future covers ground in the compare of other available
derivatives instruments. Not only big businessmen and exporter and importers use this but
individual who are interested and having knowledge about forex market they can also invest
in currency future.

Exchange between USD-INR markets in India is very big and these exchange traded contract
will give more awareness in market and attract the investors.










79























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BIBLIOGRAPHY:-
NCFM: Currency future Module;
BCFM: Currency Future Module;
(Center for social and economic research) Poland;
Recent Development in International Currency Derivative Market by :( Lucjan T. Orlowski)
Report of the RBI-SEBI standing technical committee on exchange traded currency futures
2008;
Report of the Internal Working Group on Currency Futures (Reserve Bank of India, April
2008;
Financial Derivatives (theory, concepts and problems) By: S.L. Gupta.

Websites:
www.sebi.gov.in
www.rbi.org.in
www.frost.com
www.wikipedia.com
www.economywatch.com
www.bseindia.com
www.nseindia.com
www.nism.ac.in
http://www.smctradeonline.com/nse-currency-futures.aspx