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1.1 Introduction :

Globalisation and integration of financial markets, coupled with progressive increase of cross border flow of capital have transformed the dynamics of Indian financial markets. This has increased the need for dynamic currency risk

management. In today‟s globalised and integrated business environment, many entities irrespective of its business are impacted by currency risk either directly or

indirectly. The steady rise in India‟s foreign trade along with liberalization in foreign exchange regime has led to large inflow of foreign currency into the system

in the form of FDI and FII‟s investments. INR has seen huge fluctuations of around 10% in its price against USD in a span of less than one year.

In order to provide a liquid, transparent and vibrant market for foreign exchange

rate risk management, Securities & Exchange Board of India (SEBI) and Reserve Bank of India (RBI) have allowed trading in currency futures for the first time in

India based on the USD-INR exchange rate. This provided Indian corporate another tool for hedging their exchange risk effectively and flexibility at

transparent rates on an electronic trading platform. The primary purpose of exchange traded currency future derivatives is to provide a mechanism for price risk management and consequently provide price curve of expected future prices to

enable the industry to protect its foreign currency exposure. The need for such instrument increases with increase of foreign exchange volatility.

After its inception, currency future is coming up with good signs. It is still in its

nascent stage, still providing a better option for investment in comparison to other

future and options including gold. Gold are perceived as inflation hedges. India is

one of the largest importer of Gold. If India wants to use Gold, they have to buy it.

And they have to pay for it with the currency of the country that produces it. In this

India have to sell rupee and then buy dollar (as example) to pay for the Gold. From

this dollar gets double boost. A huge amount of dollar are bought in the market for

this particular transaction.

Although U.S is facing economic crisis, still dollar is looking strong against rupee

(graph 1). In expectation of improvement in future, investors are inclining toward

currency futures. It has been observed that inter-nationally, many investors use

futures rather than the cash market to manage the duration of their portfolio or

asset allocation because of low upfront payments and quick transactions.

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As per the latest Reserve Bank of India (RBI) data, non-resident Indians (NRIs) sent $28 billion in remittances in 2007-08. Strengthening of Indian rupee against

other currencies runs the risk of reducing the real value of the money sent back home by NRIs and people of Indian origin abroad --whether they are from the

West Asia, far east countries, the US,UK or Canada. Here the currency futures really help investors. As they can enter into future contract of currency future

derivatives. They can contract on future rate of currency. Since futures derivative are linked to the underlying cash market, its availability improves trading volume

in the cash market. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract.

Since the commencement of trading of currency futures in all the three exchanges,

the value of the trade has gone up steadily from Rs. 17,429 crores in October 2008

to Rs. 45,803 crores in December 2008.This trend is continuously increasing with

increasing number of contracts (graph 2).

Since futures derivative are linked to the underlying cash market, its availability improves trading volume in the cash market. Gold are perceived as inflation

hedges. If India wants to use Gold, they have to buy it. And they have to pay for it with the currency of the country that produces it. In this India have to sell rupee

and then buy dollar (as example) to pay for the Gold. From this dollar gets double boost. A huge amount of dollar are bought in the market for this particular

transaction. Here the currency futures really help investors. They can enter into future contract of currency. They can contract on future rate of currency.

The National Stock Exchange (NSE) will become the first exchange in the country

to introduce currency derivatives on 29th August 2008. Currency futures trading

currently is being offered by MCX-SX, NSE and BSE. Since the commencement

of trading of currency futures in all the three exchanges, the value of the trade has

gone up steadily from Rs. 17,429 crores in October 2008 to Rs. 45,803 crores in

December 2008. Without financial futures, investors would have only one trading

location to alter portfolio when they get new information that is expected to

influence the value of assets- the cash market. Future provide another market that

investors can use to alter their risk exposure to an asset when new information is

acquired.

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United Stock Exchange has received in-principal approval from the market regulator for commencing contracts in currency derivatives. The United Stock

Exchange of India (USE), promoted by state-run MMTC and brokerage firm Jaypee Capital, will start trading in currency derivatives from July this year. “USE

will launch currency futures in July 2009.

1.2 Rationale Behind Launching ETCF :

The introduction of exchange-traded currency futures (ETCF) on the National

Stock Exchange (NSE) from August 29 is a reflection of two important points.

First, it is evidence of the seriousness of efforts demonstrated by players across the board to sustain investors' interest in the markets.

The currency futures segment is meant to provide non-institutional market

participants a means to hedge their currency exposures in a transparent and price

efficient manner, the size of future contract is not unduly large. In currency future,

the price discovery are such that the individual and SME‟s are able to trade on

same price as are available to large customers. While in OTC market, if price

discovery is done for a large size lot, the individual and SME‟s may not be able to

capture the fineness of that rate for their small size lots. This is the one of demerit

of the OTC markets. Currency future is a very good alternative to the present over-

the-counter hedging mechanism, which requires a lot of documentation and

sanctions.

Second, an investor can take advantage of currency futures as an asset class.

Thirdly, by virtue of scale of participation and its cost structures, the transaction cost in futures is usually much lesser than that of OTC alternative.

Fourthly, compared to OTC, futures offer more price transparency, fully eliminating the counterparty risks and reach out to a larger section of population.

After its inception, currency future is coming up with good signs. It is still in its

nascent stage, still providing a better option for investment in comparison to other

future and options including gold. Although U.S is facing economic crisis, still

dollar is looking strong against rupee. In expectation of improvement in future,

investors are inclining toward currency futures. It has been observed that inter-

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nationally, many investors use futures rather than the cash market to manage the

duration of their portfolio or asset allocation because of low upfront payments and

quick transactions.

1.3 Objective of the Project:

The basic idea behind undertaking Currency Derivatives project is to gain knowledge about currency future market. To study the basic concept of Currency

future.

To understand the investors response for currency future with other currency

derivatives.

To study the hedging, speculation and arbitrage in Currency Future.

To understand the practical considerations and ways of considering currency

future price.

1.4 Methodology :

The research is basically a descriptive research. In this project Descriptive research methodologies is used. The research methodology will be used for gathering

details of different aspects of currency future derivative in India.

Primary Data will be collected from clients through structured questionnaire. The questionnaire will comprise of open ended and open ended questions. Such question will be sub-divided into three sub-types which are Free Response,

Probing and Projective.

Secondary data will be collected from articles in journals and magazines. The database of SEBI, RBI, NSE and BSE will be taken. As this topic is very new,

article from other website links is required. Report submitted by RBI/SEBI committee is used.

1.5 Limitation of the Study :

The analysis will be purely based on the primary and secondary data. The primary

data comprise only of feedback collected from retail investors. It will not include

institutional investors. The currency future is a new concept, the study is based on

information from different articles.

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2.1 ORIGIN OF FOREX MARKET

The foreign exchange market is where currency trading takes place. It is where

banks and other official institution facilitate the buying and selling of foreign

currencies. The foreign exchange market that we see today started evolving during

the 1970s when world over countries gradually switched to floating exchange rate

from fixed exchange rate. The purpose of foreign exchange market is to facilitate

trade and investment. It is the largest and most liquid financial market in the world.

The origin of the forex market development in India could be traced back to 1978

when banks were permitted to undertake intra-day trades. However, the market

witnessed major activity only in the 1990‟s with the floating of the currency in

March 1993, following the recommendations of the Report of the High Level

Committee on Balance of Payments. Exchange traded foreign exchange future

contracts were introduced in 1972 at the Chicago Mercantile Exchange and are

actively traded relative to most other future contracts. The global turnover is

around USD 4000 billion per day. It is 24hrs market. The main currencies traded in

forex market are USD, EUR, JPY.

The foreign exchange market is unique because of:

Its trading volumes

The extreme liquidity of the market

Its geographical dispersion

Its long trading hours

Use of leverage

In terms of convertibility, there are mainly three kind of currencies. The first is

fully convertible in that it can be freely converted into other currencies, the second

kind is only partially convertible for non-residents, while the third kind is not

convertible at all. The last holds true for currencies of a large number of

developing countries. All the developed countries already have fully convertible

capital accounts. Most emerging countries do not permit foreign exchange

derivative products on their exchange in view of prevalent control on the capital

accounts. However, a few select emerging countries like India, Korea, South

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Africa, have successfully experimented with the currency future exchanges, despite

having control on the capital account.

2.2 OVERVIEW OF THE FOREIGN EXCHANGE MARKET IN INDIA :

The foreign exchange market has acquired a distinct vibrancy as evident from the

range of products, participation, liquidity and turnover. According to the Bank for

International Settlements (2007), India‟s share in global transactions has increased

sharply in the past three years from about 0.3% to the current 0.7%. Currently,

India is a USD 34 billion OTC market, where all the major currencies like USD,

EURO, YEN, Pound, Swiss Franc etc. are traded. It has been a long felt need to

have a transparent currency derivatives platform in the country. With increasing

globalisation and robust performance of the economy, businesses in India have

been rapidly integrating with the world, especially in the past few years, forcing

them to face the additional risk of exchange rate fluctuations besides other risks.

The Indian foreign exchange market has grown significantly in the several years.

The daily average turnover has gone up from about USD 5 billion per day in 1998

to more than USD 50 billion per day in 2008.The spot foreign exchange market

remains the most important segment but the derivative segment has also grown. In

the derivative market foreign exchange swaps account for the largest share of the

total turnover of derivative in India followed by forward and options.

Cash settled exchange traded currency futures have made foreign currency a

separate asset class that can be traded without any underlying need or exposure and

on a leveraged basis on the recognized stock exchanges with the credit risks being

assumed by the central counterparty.

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. Although liberalization helped the Indian forex market in various ways, it led to extensive

fluctuations of exchange rate. This issue has attracted a great deal of concern from policymakers and investors. While some flexibility in foreign exchange markets

and exchange rate determination is desirable, excessive volatility can have an

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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.Later on, trading in

exchange traded currency futures commenced on August 29, 2008 on the National

Stock Exchange.

The need for widening hedging options arose as the OTC markets were largely

opaque and accessible only to a few players. However, currency derivatives differ

from OTC as they help improve the efficiency of price discovery, attracting

heterogeneous participants. So, the success of a futures platform is determined by

the liquidity it can achieve that will make the process of price discovery more

efficient.

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

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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.

2.3 Foreign exchange rate :

It is defined as the conversion rate of one currencies into another. This rate

depends on the local demand for foreign currencies and their local supply,

country‟s trade balance, strength of its economy, and other such factors. Exchange

rates are constantly changing, which means that the value of one currency in terms

of the other is constantly in flux. Changes in the rates are expressed as

strengthening or weakening of one currency over 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 term currency, the

base currency has strengthened/appreciated and the term currency has weakened.

2.4 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.

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3.1 DERIVATIVES Derivatives are very important financial instruments for risk management as they allow risks to be separated and more precisely controlled. Derivatives are used to

shift elements of risk and therefore can act as a form of insurance. There are three basic ways in which trading can take place:

1. Over The Counter (OTC);

2. On an exchange floor using open outcry; and

3. Using an electronic, automated matching system

Derivative is a product whose value is derived from the value of one or more basic

variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, foreign exchange, commodity or any

other asset. In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R)A) defines "derivative" to include-

1. A security derived from a debt instrument, share, loan whether secured or

unsecured, risk instrument or contract for differences or any other form of security.

2. A contract which derives its value from the prices, or index of prices, of underlying securities.

Derivatives are securities under the SC(R)A and hence the trading of derivatives is governed by the regulatory framework under the SC(R)A. The term derivative has

also been defined in section 45U(a) of the RBI act as follows:

“An instrument, to be settled at a future date, whose value is derived from change in interest rate, foreign exchange rate, credit rating or credit index, price of

securities (also called “underlying”), or a combination of more than one of them and includes interest rate swaps, forward rate agreements, foreign currency swaps,

foreign currency-rupee swaps, foreign currency options, foreign currency-rupee options or such other instruments as may be specified by the Bank from time to

time”.

There are two basic types of assets for which futures contracts exist. These are Commodity futures contracts and Financial futures contracts. Although both

contracts are similar in principle, the methods of quoting prices, delivery and

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settlement terms vary according to the contract being traded. Commodity futures comprise grains, oil seeds, energy, metals, coffee, sugar, cocoa, etc. Financial

futures comprise Interest rates, Bond prices, Currency exchange rates, stock indices. Financial Derivatives were introduced in India, mainly as a risk

management tool for both institutional and retail investors. Derivative products initially emerged as hedging devices against fluctuations in commodity prices, and

commodity-linked derivatives.

3.2 DERIVATIVE PRODUCTS

Derivative contracts have several variants. The most common variants are forwards, futures, options and swaps.

Forwards: A forward contract is a customized contract between two entities,

where settlement takes place on a specific date in the future at today's pre-agreed price. 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.

Futures: 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. Futures contracts are special types of forward contracts in the sense that they are standardized exchange traded

contracts. 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.

Options: Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the

obligation to sell a given quantity of the underlying asset at a given price on or before a given date.

Warrants: Options generally have lives of upto 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 over-the-counter.

LEAPS: The acronym LEAPS means Long-Term Equity Anticipation Securities.

These are options having a maturity of upto three years.

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Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index

options are a form of basket options.

Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as

portfolios of forward contracts. The two commonly used swaps are: · Interest rate swaps: These entail swapping only the interest related cash flows

between the parties in the same currency. · Currency swaps: These entail 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.

3.3 FACTORS DRIVING THE GROWTH OF DERIVATIVES : The derivatives market has seen a phenomenal growth. A large variety of

derivative contracts have been launched at exchanges across the world. Some of the factors driving the growth of financial derivatives are:

1. Increased volatility in asset prices in financial markets,

2. Increased integration of national financial markets with the international

markets,

3. Marked improvement in communication facilities and sharp decline in their costs,

4. Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies, and

5. Innovations in the derivatives markets, which optimally combine the risks and

returns over a large number of financial assets leading to higher returns, reduced risk as well as transactions costs as compared to individual financial assets.

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4.1 INTRODUCTION TO CURRENCY FUTURES :

Currency derivatives can be described as contracts between the sellers and buyers,

whose values are to be derived from the underlying assets, the currency amounts.

These are basically risk management tools in forex and money markets . They are

used for hedging risks and act as insurance against unforeseen and unpredictable

currency and interest rate movements. It is not completely risk free. Market r isks

can't be avoided, but have to be managed. The currency derivative serve the

purpose of financial risk management.

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 is an exchange rate, the contract is termed a

“currency futures contract. The origin of futures can be traced back to 1851 when the Chicago Board of Trade (CBOT) introduced standardized forward contracts The Chicago Mercantile Exchange (CME) first conceived the idea of a currency

futures exchange and it launched the same in 1972. The Chicago Mercantile Exchange, or CME, provides the most popular currency futures.

The undertaker in a futures market can have two positions in the contract :

i. Long position when the buyer of a future contract agrees to purchase the

underlying asset. ii. Short position when the seller agrees to sell the asset.

The holder of a contract could exit from his commitment prior to the settlement date by either selling a long position or buying back a short position (offset or

reverse trade). Currency futures can be cash settled or settled by delivering the respective obligation of seller and buyer. All settlements however, unlike in the case of OTC markets, go through the exchange. The future date is called the

delivery date or final settlement date. The pre-set price is termed as future price, while the price of the underlying asset on the delivery date is termed as the

settlement price. The future price normally converges towards the spot price on the settlement date.

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4.2 The standardized items in a futures contract are:

The standardized items of a future contract can be discussed as :

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

RBI has currently permitted futures only on the USD-INR rates. The contract

specification of the futures shall be as under: Underlying

Initially, currency futures contracts on US Dollar – Indian Rupee (USD-INR)

would be permitted.

Trading Hours

The trading on currency futures would be available from 9 a.m. to 5 p.m. from Monday to Friday. Size of the contract

The minimum contract size of the currency futures contract at the time of introduction would be USD 1000. 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.

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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 of India Reference Rate on the

last trading day.

Final settlement day

The final settlement would be the last working day (subject to holiday calendars)

of the month. In keeping with the modalities of the OTC markets, the value date / final settlement date for the each contract will be the last working day of each

month and the reference rate fixed by RBI two days prior to the final settlement date will be used for final settlement (graph 3). The last trading day of the contract will therefore be 2 days prior to the final settlement date. On the last trading day,

since the settlement price gets fixed around 12:00 noon, the near month contract shall cease trading at that time (exceptions: sun outage days, etc.) and the new far

month contract shall be introduced.

The contract specification in a tabular form is as under:

Underlying Rate of exchange between one USD and INR

Trading Hours (Monday to Friday)

9:00 a.m to 5:00 p.m

Contract Size USD 1000

Tick Size 0.25 paise or 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 to

holiday 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.

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4.3 Margining Facility:

The reason behind introducing margin facility in currency future trading is to stop

cornering of market. One type of irregularity occurs when investors group tries to

corner the market. The investors group can take huge long position and also tries to

exercise some control over the supply of underlying security. As the maturity of

future contract is approached, the investor does not close out its positions. So that

the number of outstanding future contracts may exceeds the amount of security

available for delivery. The holder of short position realize that they will find it

difficult to deliver and become desperate to close out their positions. The result is a

large rise in both futures and spot prices.

The regulators usually deal with this type of abuse of market by increasing margin

positions, imposing stricter positions limits, prohibiting trades that increase

speculator‟s open positions, and forcing market participants to close out their

positions.

4.4 Participants:

No person other than a person resident in India‟s as defined in section 2(v) of the

Foreign Exchange Management, 1999(Act 42 of 1999) shall participate in the

currency future market. Only a resident of India can participate in the trading and

no other agency, including banks, can participate in the futures market without

getting the approval of its concerned regulators. Foreign institutional investors and

NRIs (Non Resident Indians) are presently excluded from the market.

The membership of the currency future market of a recognized stock exchange

shall separate from the membership of the equity derivative segment or the cash

segment. Membership for both trading and clearing, in the currency futures market

shall be subject t the guidelines issued by the SEBI.

Bank authorized by the Reserve Bank of India under section 10 of the Foreign

Exchange Management Act, 1999 as „AD Category–I bank‟ are permitted to

become trading and clearing member of the currency future market of the

recognized stock exchange, on their account and on the behalf of their clients,

subject to fulfilling the required formalities. A bank can become a trading or a

clearing member of such an exchange provided it has capital and reserves worth

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Rs.500 crore,10 percent capital adequacy ratio, 3 percent or less net non-

performing assets and has a three-year profit record.

There are three types of participants on the currency futures market: floor trader,

floor broker (also called pit broker), broker- trader. Floor trader operate for their

own account. They are speculators whose time horizon is short term. Floor broker

representing the broker‟s firm, operate on behalf of their clients and, therefore, are

remunerated through commission. The third category, called broker trader,

operates either on the behalf of clients or for their own accounts.

4.5 Flow of Transaction on Future Market:

Purchase Order Sales Order

Transaction on the floor

4.6 Factors reflecting Currency Futures :

Conversion Rate,

High inflation level,

Higher import bill,

Government budget deficit

Dollarization (This refers to the broad use of a foreign currency in the place

of the domestic currency for transaction and other purposes) of an economy;

SELLER

Buyer

CLEARING

HOUSE

BROKER BROKER

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Risks of increased volatility in the exchange rate, which could then spill over

to other segments of the financial market and in the process have an

Impact on interest rates,

Pace of economic activity and financial stability.

4.7 EXCHANGE-TRADED VS. OTC DERIVATIVES MARKET : The OTC derivatives markets have witnessed rather sharp growth over the last few

years, which accompanied the modernization of commercial and investment banking and globalisation of financial activities. The recent developments in

information technology have contributed to a great extent to these developments. While both exchange-traded and OTC derivative contracts offer many benefits, the

former have rigid structures compared to the latter. Some of the features of OTC derivatives markets embody risks to financial market stability.

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 are 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 NSCCL, 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.

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OTC Market Currency futures

Price Transparency Low High

Underlying exposure Required Not required

Accessibility Credit dependent High

Liquidity Subject to credit limits High

Agreements Customized Standard

Credit Exposure Yes Mitigate through the clearing corporation

Margins(Collateral) Usually not required Required

Daily MTM No Yes

4.8 Advantages of Currency Future :

The advantage of exchange traded forex futures trading India:

EASY ACCESSIBILITY: Small investors would get an easy access to currency

futures trading on the popular exchanges.

EASY AFFORDABILITY: Margins are very low and the contract size is very

small. As per the specification of NSE USD-INR currency future contract, the lot

size is 1000$. Margin is 1.75%. It is easy and affordable for any retail investor to

take a call on Indian Rupee by taking position in currency futures.

LOW TRANSACTION COSTS: When you trade in currency futures in India,

you have to pay a small amount of brokerage fees and statutory duties and taxes. In

overseas forex trading you have to pay commissions to the banks or foreign

exchange agents in the form of spread. Spread is the difference in the buy/sell price

over the reference rate, which can be very high.

TRANSPERANCY: It is possible for you to verify trade details if you have a

doubt that the broker has tried to cheat you.

EFFICIENT PRICE DISCOVERY: Internationally it has been established that

currency future is a better and efficient mechanism for price discovery. With its

state of the art automated electronic trading system where the orders are executed

on the basis of price-time priority, it is well poised to offer efficient price

discovery.

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COUNTER-PARTY DEFAULT RISKS: All the trades done on the recognized

exchanges are guaranteed by the clearing corporations and hence it eliminates the

risks associated with counter party default. NSCCL (National Securities Clearing

Corporation Limited) carries out all the novation, clearing and settlement process

of currency futures trading.

STANDARDIZED CONTRACTS: Exchange Traded currency futures are

standarizsed in respect of lot size (1000$) and maturity (12 monthly contracts).

Retail investors with their limited resources would find it tremendously beneficial

to take positions in standardised USD INR futures contracts.

4.9 Distinction between Futures and Forward Contract :

Futures contracts Forwards contracts

1. Are traded on an exchange 1. Are not traded on an exchange

2. Use a Clearing House which provides protection for both parties

2. Are private and are negotiated between the parties with no exchange guarantees

3. Require a margin to be paid 3. Involve no margin payments

4. Are used for hedging and speculating

4. Are used for hedging and physical delivery

5. Are standardised and published 5. Are dependent on the negotiated

contract conditions

6. Are transparent - futures contracts are reported by the exchange.

6. Are not transparent as they are all private deals

4.10 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.

20

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, 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.

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

21

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.

MAINTENANCE MARGIN :

Member‟s 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.

22

5.1 PRICING CURRENCY FUTURES :

The price of Futures is closely linked with Spot rate. The difference between the

two is dependent on the number of days to maturity and interest rates of two

currencies. The difference between future rate and spot rate is called „basis‟ and

given by the equation:

Basis = Futures rate – Spot rate

The basis tends towards zero as the maturity date approaches. On the date of

maturity, the future is a perfect substitute of Spot rate and that is why Futures rate

and spot rate on the date of maturity are identical.

The Cost carry model applied to calculate price of futures. The general formula for

pricing futures is :

F = SerT

Where; r = cost of financing

T = time till expiration e = 2.71828

In the general formula discussed above, “S” would stand for the current spot price

of one unit dollar in Rupee terms and “F” would stand for the future price in Rupees of one unit of USD.

A foreign currency has the property that the holder of the currency can earn interest at the risk free interest rate prevailing in the foreign country. For example,

the holder can invest the currency in USD denominated bonds. The risk free interest rate that could be earned in a foreign country for the said period T, is

defined as rf. As in the general formula given above, the domestic risk free rate when money is invested for the time period T shall be referred as r. The

relationship between F and S then could be given as :

F = Se(r-r

f)T

This relationship is known as interest rate parity relationship.

23

It is important to be noted from the above relationship, 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.

As per the interest parity relationship, we can understand the Future and Spot rate

are linked by the equation:

Future rate = Spot rate 1+ Interest rate of home currency * D/360

1 + Interest rate of foreign currency * D/360

Where “D” is the number of days to maturity.

Basis = Future rate – Spot rate = Spot rate Future rate _ 1

Spot rate

For currencies which are fully convertible, the rate of exchange for any date other

than spot, is a function of spot and the relative interest rates in each currency. The

assumption is that, any funds held will be invested in a time deposit of that

currency. Hence, the forward rate is the rate which neutralizes the effect of

differences in the interest rates in both currencies.

The forward rate is a function of the spot rate and the interest rate differential

between the two currencies, adjusted for time. In the case of fully convertible currencies, having no restrictions on borrowing or lending of either currency the

forward rate can be calculated as follows;

Forward Rate = Spot +/- Points

Points = Spot 1 + terms i * days/basis _ 1 1 + base i * days/basis

where i = rate of interest

24

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.

There is an alternate approach, one that involve splitting the currency effect into two component: expected or known effect captured by forward premium or

discount; and unexpected or surprise effect as defined below.

Currency Surpriset =

(foreign currency spot ratet )-(foreign currency forward ratet-1) Foreign currency spot ratet-1

In other words, currency surprise can be interpreted as “the unexpected movement

of the foreign currency relative to its forward rate or market predicted rate”, the

assumption is that forward premium or discount will be embedded in the returns

from a fully hedged portfolio.

The market values the dollar rate based on two benchmarks: the current spot rate and the current forward rate. However, there is no reason to assume that the futures

rate will be higher than the spot and equivalent to the forward rates. The future rate is theoretically defined as the spot price plus cost of carry. If the cost of carry is

positive, then the futures will be higher than the spot price. However, today, the spot rate is not quite market-determined as the RBI has a role to play here. The

RBI ensures that the spot rate does not depreciate or appreciate too drastically, and uses forex reserves to do so. To do this, the RBI buys or sells dollars in the market.

5.2 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.

25

5.2.1 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. It

can be understood from graph below;

Profit

43.19 0

Loss

5.2.2 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 making profits,

and when the dollar appreciates, i.e. when rupee depreciates, it starts making losses. It can be understood from graph below;

26

Profit

43.19

0

Loss

27

6.1 PLAYERS IN THE CURRENCY FUTURE MARKETS :

The following three broad categories of participants –

Hedgers, Speculators,

Arbitrageurs

Hedgers face risk associated with the price of an asset and they use futures or options markets to reduce or eliminate this risk. Speculators wish to bet on future

movements in the price of an asset. Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. If, for example, they see

the futures price of an asset getting out of line with the cash price, they will take offsetting positions in the two markets to lock in a profit.

The participants in this segment shall prima -facie include all the entities who directly or indirectly have exposure to the foreign exchange movements. Any

importer or exporter of goods and services has exposure to foreign currency risk. These entities shall find this product useful for hedging their risks. The entities

shall include corporates importing machinery / raw materials or paying for services to an offshore entity, and corporate exporting their products and services abroad.

Therefore all entities having trade or capital related flows denominated in foreign currency will have an interest in using this product.

The share holders and creditors of the companies also may be indirectly exposed to

the currency risk and hence may find the product useful. Any entity using such goods and services whose price is exposed to foreign exchange movements may

also find this useful. For example, entities who procure, say oil or metals like say zinc, copper, etc. locally, are not importers. International price movement expose these users to foreign currency risks. Hence entities who are directly importers or

exporters or entities having an indirect or derived exposure are potential users of exchange traded futures.

6.2 HEDGING :

Currency futures are widely used as hedging tools by financial institutions, banks, exporters, importers etc. 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 currency risk arising from exchange rate fluctuations that is faced by exporters and importers needs to be properly managed. For example, an exporting

28

firm is expecting to receive dollar inflows. If the rupee appreciates against the dollar, then there will be a negative impact on the profitability of these companies.

If a company has un-hedged exposures in foreign currency on account of borrowings, and the rupee depreciates against the borrowed currency, there could

be a loss requiring disclosure. Though this is not a direct business loss, it adds to the liability and as such impacts the balance sheet. It is possible that subsequently

the rupee might appreciate or regain the lost ground; but, what is relevant is the rate as on the day of the closure of the books. The deficit on the date is considered

a notional loss as the liability has not crystallised and there is no outflow of rupees.

Says Geojit Financial Services‟ managing director, CJ George, “Exchange traded currency futures are likely to attract retail interest, so far as inflation-related

speculation (rupee movement) could be hedged here. For instance, a mid-level gold importer, currently unable to hedge dollar exposures, can come on to these markets

and take a directional call on the rupee.” Exporters who receive continuous cash inflows can hedge their positions through selling currency futures at the most

suited exchange rate.

Before the introduction of currency futures market, exporters had to take hedge positions in OTC markets where delivery of the underlying is a must. Contract cancellation is possible but it would be very expensive. In the futures market,

positions are settled in cash but the client-wise exposure is limited to 6 million dollars or 5% of the total open interest, whichever is higher. The position limits are

not high enough for exporting houses to take big positions. However, the interest of small exporters has been protected after the introduction of the currency futures

market.

A key difference between investing in domestic and foreign asset is that the latter

exposes the investor to a currency risk. The reasoning was that if the exchange rate

remains constant from time of purchase of the foreign asset to its sale, then the

currency risk has had zero impact. On the other hand, if the domestic has

weakened (strengthened) against the foreign currency, the exposure would result in

a gain (loss).

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

29

currency futures contracts) will protect against a decline in a foreign currency‟s 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 firm‟s 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. In a long hedge, one takes a

long futures position to offset an existing short position in the cash market. In a short hedge, one takes a short futures position to offset an existing long position in

the cash market. 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 Principle of covering on future market is rather simple. A long position is covered

by a short position on Future market and vice versa. In order to have a perfect

cover, it is necessary that the value of a position in Future changes by the same

amount as the Spot position, but in opposite direction. On future market, enterprise

which want to cover themselves against rate risk, compensate for the losses that

they are likely to incur on Spot market. For this they need to take reverse position

on Future market as against their position on Spot market. The contracts may be

kept up to the maturity date or they may be settled before that date, depending

upon the choice of the operator or hedger.

The price difference between Spot and future is called Basis, and the risk arising

out of the difference is defined as Basis Risk. The situation in which the difference

between spot and future price reduces (either negative or positive) is defined as

“Narrowing of the Basis”. Two situations generally happen;

First; When future prices are higher than spot price, then

Narrowing of Basis Widening of Basis

Benefits Short Hedgers Benefits Long Hedgers

30

Second; When future prices are lower (discount) to spot price, then

Narrowing of Basis Widening of Basis

Benefits Long Hedgers Benefit Short Hedgers

If a small importer wants to hedge through currency futures, he can do so by

buying futures. After purchasing the currency futures if the rupee closes at a depreciated price, then the importer gains in currency futures, and later, he has to

convert the rupee into dollar at a higher price. Imagine that an importer with an obligation to pay US$10,000 after three months, bought currency futures which is

maturing after three months at Rs.44. A few weeks later, currency depreciates to Rs.46. Here, the importer gains Rs.2/- per dollar (Rs.2 *10000). Later, he converts

his import obligation at Rs.46. The importer‟s net obligation is therefore only Rs.44.

NRIs who regularly send dollars to their families can also advise their family

members to create hedge positions in the currency futures market. When the exchange rates are comfortable, the family members can take short positions on

various maturities. Later, if the rupee appreciates, then the family member can make profits. On the other hand, if the rupee depreciates, the family member incurs

a loss, but he can later convert the currency at a higher exchange rate thereby getting a fixed amount throughout the year.

Choice of underlying currency;

The first important decision in this respect is deciding the currency in which futures contracts are to be initiated.

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.

Choice of the number of contracts (hedging ratio) Another important decision in this respect is to decide hedging ratio. The value of

the futures position should be taken to match as closely as possible the value of the cash market position. In the futures markets due to their standardization, exact

31

match will generally not be possible but hedge ratio should be as close to unity as possible, which can be defined 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 28th May 2009 is 49.8850. And spot value is 49.8500. HR=49.8850/49.8500=1.001.

Currency exposure could happen to anybody and hedging against future risks could work to one's advantage. The latest decision of the government would enable multiple hedging opportunities for individuals. A person could hedge on a currency

for future medical treatment of a kin abroad or reduce one's risk while receiving the periodical remittances from abroad or even for the individual who paid in

foreign currency for his kin's education abroad.

6.3 SPECULATION :

Generally two strategies is followed by the investors which are as follows:

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 earn 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.

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. All he needs to do is sell the futures.

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. Suppose a trader who

32

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.

6.4 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. 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 mispricing 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.

33

7.1 QUESTIONNAIRE :

The questionnaire (page 36) is prepared to analyse the investors response. It is

basically divide into two parts. The first part of the questions is for the investors

who know about the currency future derivatives. The questionnaire in first part is

having open ended as well as close ended questions. The second part consists of

open ended questions, mainly for the investors who do not aware about the

currency future.

The questionnaire collect the investors profile like their age group, gender, marital

status and profession.

7.2 Investors Response from the Questionnaire :

On taking survey of ten investors following findings come into picture;

In survey every investor knows about the Derivatives. These investors are

below 35 years of age. These investors are mainly the employees.

Out of examined investors who know about the derivatives, they trade in

derivative instruments. The most famous derivatives among investors are in

stocks and index. The investment in stock derivatives are preferred by 66 per

cent while investment in index instrument is found to be around 34 per cent

(Graph 4).

Out of investors who know about derivatives whether just aware or trade in

it, almost 70 per cent of them know about the Currency future derivatives

and used it for hedging, speculation and arbitrage. The following graph will

show the proportions in percentage. The 14 per cent are found using it as

hedging and for 29 per cent of people using it as speculation. The most

important fact which come out which is, about 57 per cent of examined

people use it for both hedging and speculation depending upon the market

situation (Graph 4).

While the volume of contract trading has grown impressively, the range and diversity of contracts and instruments developed and traded have not increased

commensurately. It requires to make aware the investors about Currency future. It is important to aware investors of following prospects;

34

Profit Earning Capacity Risk associated with currency future

Growth potential Benefit of service provided by the trading company.

Also it is the institutional segment of the capital market has not yet begun to use

derivatives for risk hedging or for position taking in the way that such investors should. That is for two reasons.

First, the development of derivatives has so far been excessively skewed toward

derivatives used in the equity rather than debt or forex markets.

Second, India‟s financial institutions are dominantly idle, retarded state-owned financial intermediaries (SFIs) – i.e. the public sector banks (PSBs), mutual funds

(UTI as well as those run by the public banks), insurance companies (LIC and GIC), pension funds and non-bank financial intermediaries (e.g. state level financial institutions of various types) of various types.

Though private financial intermediaries now exist in almost every segment of the

financial market, and though their influence is growing, they still represent less than 80% of overall financial assets.

It is found that due to lack of knowledge of derivative especially currency future, it

is not gaining its pace. Another reason is preoccupied concepts regarding the mode

of investment. Two prong strategy can be taken: firstly focus on clients/investors

already engaged in derivative trading other than currency futures. Secondly, focus

on clients/investors who never tried their hand in derivative segment. This requires

elaborate awareness program to attract retail investors. Along with these , it require

to reconsider the regulation prevailing in the market.

Currency Future need to change some restriction it imposed such as cut off limit of

5 million USD, Ban on NRI‟s and FII‟s and Mutual Funds from participating. FIIs

with a larger stake, reach and access to global exchanges have the potential to sway

the market in particular directions more suitable to them than to be of any

relevance to the real economy. We can target traders, HNIs (high net worth

individuals) and those who receive remittances from abroad and want to mitigate

their currency risk,”. In view of the promising performance of currency futures

35

segment as also greater prospects for its growth in the future, analysts normally

expect that the participation of FIIs in currency futures trading will lead to further

rise in volumes and improvement in market depth. However, if RBI allows foreign

players to trade locally, there may be a good reason for all flows to migrate to the

Indian market. The market for currency futures could even pull players, currently

active on the OTC market, where deals happen over-the-counter on a bilateral

basis. Much depends on the price discovery in this market. Foreign Institutional

Investors(FII) can be permitted to trade in currency futures once the market gets

stabilized and matured.

Once the new market segment gains traction, the RBI alongwith SEBI can look at

introducing contracts in other currencies too, which would further help in making the market move away from the bilateral over-the-counter mode. 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 POUNDINR, CAD-INR etc. There are other major currencies against which the rupee is transacted would have to be brought into the

realm of futures. For example, almost one-fifth of India‟s total foreign trade in 2006-07 was done with the EU bloc. Hence, the current scenario, when the dollar‟s

supremacy is being challenged by currencies such as the euro, calls for taking it into consideration as well. The road map to launch contracts on other currencies

need continuous innovation and improvement in the design of financial products, its customer service as well as all India delivery.

In response to the emerging global development, the RBI has taken a series of measures to augment forex and domestic liquidity. The Securities and Exchange

Board of India (SEBI) is studying a proposal submitted by exchanges to extend trading hours of the currency futures segment in line with commodities as both are

linked closely with each other. If SEBI approves the demand, trading hours of currency futures will be extended to 11.30 pm from the existing 9 am to 5.30 pm.

Internationally trading in futures continues for nearly 23 hours a day. It is important that some space be given for the domestic players to understand the

market and grasp it with more confidence before we allow the floor for FIIs. The financial sector needs to be opened up to greater competition so as to be able to

provide world class financial services at competitive rates. They should work towards removal of entry barriers to domestic corporate player and foreign

financial firms in all segments of the financial services industry. All legal tangle in currency futures can be avoided for growth of exchange traded currency futures.

36

Questionnaire

I, Rudra Kumar, a first year MBA student of ICFAI Business School (IBS),am

conducting a research project titled “Use of Currency Future Derivatives” as part

of my curriculum. I am doing a study to understand the response of investors

regarding Currency Future Derivative and mechanism of hedging, speculation and

arbitrage in it. Any information provided by you will be treated in the „most

confidential‟ manner and will not be used for any other purpose.

1. Do you know about derivatives. Yes No

2. How do you come to know about derivatives.

Just Aware Do trade Both

3. If you trade in derivatives, then in which instrument,

Stocks Index Currency Commodity

4. Are you aware that you can trade in currency future derivative.

Yes No

If “yes”, answer the question from 5 to 17,

5. In which all exchanges you can trade in Currency Future Derivatives.

MCX BSE NSE NCDEX

6. The currency future derivative was launched on

1April 2000 29August 2008 8 August 2008

7. The underlying asset in currency future derivative contract.

Exchange Rate Index Stock Commodity

8. Which one is base currency for currency future derivative segment.

US Dollar Euro Yen Rupee

37

9. Which is the tick size (breakeven point) in the currency future contract.

0.25 0.50 1.00 0.75

10. Which currency pair is currently traded in currency future derivative segment.

USD-INR USD-EURO Yen-INR EURO-INR

11. The size of Currency future contract,

1000$ 5000$ 100$ 2000$

12. How many contracts for currency future derivative are open at particular time.

1month 2month 3month 12month All these

13. For what purpose you use currency future derivatives for

Hedging Speculation Arbitrage

14. In Over the Counter, daily settlement happens in currency derivative contracts.

Yes No

15. National Securities Clearing Corporation Limited(NSCCL) undertakes clearing

and settlement of all trades executed on the Currency Derivative segment of

NSE. True False

16. As an investor, what do you think of benefit in Currency future derivative as

compared to other financial derivatives.

…………………………………………………………………………………

………………………………………………………………………………....

…………………………………………………………………………………

17. Your suggestions; …………………………………………………………….

………………………………………………………………………………...

………………………………………………………………………………...

38

If “No”, then answer following questions..

18. Would you like to know and trade if properly guided and informed.

Yes No

19. What are the aspects you want to know to trade in Currency Future Derivative.

a.)

b.)

c.)

20. Your suggestions for Currency Future Derivative.

………………………………………………………………………………….

………………………………………………………………………………….

………………………………………………………………………………….

Name:

Age: Below 25 26-35 36-45 Above 45

Gender: Male Female

Marital Status: Married Single

Occupation : Businessman Professional Employed

Student Others

Date: Signature

39

GRAPHS

Graph 1 : USD INR Rate from 29th

August 2008 to 10th

April 2009.

Graph 2 : Number of contracts from 29th

August 2008 to 26th

March 2009.

38

40

42

44

46

48

50

52

54

Series1

0

100000

200000

300000

400000

500000

600000

700000

800000

900000

Series1

40

Graph 3: RBI Reference Rate Vs. USD INR (Series 1: RBI Rate, Series 2 :USD

INR) from 29th

August 2008 to 26th

March 2009.

Graph 4: Investment in stock derivative and index derivatives.

38

40

42

44

46

48

50

52

1 2 3 4 5 6 7 8

Series1

Series2

66%

34%

Chart Title

1 2

41

Graph 5: Preference for using currency future as hedging, speculation and both.

14%

29%57%

Chart Title

1 2 3

42

References

Books:

(a) Options, Futures & Other Derivatives (fifth edition) by John C. Hull. Publisher:

Prentice Hall of India Private Limited.

(b)Bulls, Bears & The Mouse, an Introduction to Online Market Trading. By Dr.

Kamlesh N Agarwala, Deeksha Agarwala.

Publisher: Macmillan.

(c)Derivative Core Module (NSE‟s Certification In Financial Markets)

(d)FEDAI-NSE Currency Futures (Basic) Module

Websites:

http://www.derivativesindia.com

http://www.xe.com

http://www.nse-india.com

http://www.bseindia.com

http://www.geojit.com

http://www.sebi.gov.in

http://www.bloomberg.com