INTRODUCTION OF CURRENCY DERIVATIVES

Meaning:In accounting terms, treated as Currency Derivatives are financial instruments composed of two or more underlying currency instruments, which are denominated in at least two currencies, and the fair value of which is not influenced by the interest rate of a risk-bearing financial instrument of another accounting entity. A Currency Forward is a contract in which the parties agree to exchange cash flows in two different currencies at an agreed upon date in the future. A forward currency derivative represents an agreement (a commitment) to exchange two currencies in the future, with the maturity extending beyond the spot value date. A Cross-Currency Swap is essentially an interest rate swap in which each side is denominated in a different currency. And a Currency Option is a contract that gives the buyer the right, but not the obligation, to exchange one currency for another at a predetermined exchange rate on or until the maturity date. Futures Contracts In 1972, the Chicago Mercantile Exchange opened its International Monetary Market division. The IMM provides an outlet for currency speculators and for those looking to reduce their currency risks. Trade takes place in currency futures, which are contracts for specific quantities of given currencies; the exchange rates is fixed at the time the contract is entered into, and the delivery date is set by the board of directors of the IMM. These contracts, which represented the first steps in the development of financial futures, are patterned after those for gain and commodity futures contracts, which have been traded on Chicagos exchanges for over 100 years.

Currency futures contracts are currently available for the British pound Canadian dollar, deutschemark, Swiss franc, French franc, Japanese yen, Australian dollar, European currency etc. contracts size are standardized according to amount of foreign currency. The organization of futures of trading with a clearing house reduces the default risks of trading. The exchange members, in effect, guarantee both sides of a contract. Profits and losses of futures contracts are paid over every day at the end of trading, a practice called marking to market. For example, on Tuesday morning and investor takes a long position in a Swiss franc future contract that matures on Thursday afternoon. The agreed upon price is $ 0.75 for SFr 125000. At the close of trading on Tuesday, the futures price has risen to $0.755. Due to daily settlement, three things occur. First, the investor receives her cash profit of $625(125000*0.005). Second, the existing futures contracts with a price of $0.75 are canceled. Third, the investors receive a new futures contract with the prevailing price of $0.755. Thus the value of the futures contract is set to zero at the end of each trading day. At Wednesday closed the price has declined to $0.752. The investors must pay the $375 loss (125000*0.003) to the others side of the contract and trade in her old contract for a new one with a price of $0.752. At Thursday close, the price drops to $0.74, and the contract matures. The investors pay her $1500 loss to the other side and takes delivery of the Swiss francs, paying the prevailing price of $0.74. Exhibit 3.3 details the daily settlement process. Daily settlements reduce the default risk of futures contract relatives to forward contract. Everyday futures investors must pay over any losses or receive any gains from the days price movements. An insolvent investors with an unprofitable position would be forced into default after only one days trading, rather than being allowed to build of

huge losses that lead to one large default at the time the contract matures (as could occur with a forward contract). Futures contract also can be closed out easily with an offsetting trade. For example, if a companys long position in DM futures has proved to be profitable, it need not literally take delivery of the DM at the time the contract matures. Rather the company can sell futures contracts on a like amount of DM just prior to the maturity of the long position. The two position cancel on the books of the futures exchange and the company receives its profit in cash. Basic Difference Between Forward And Futures Contracts 1. Trading Forward contract are traded by telephone or telex. Future contracts are traded in a competitive arena. The forward market is self regulatory. The IMM is regulated by the commodity future trading commission More than 90 % of all forward contracts are settled by actual delivery. By contrast, less than 1% of the IMM future contracts are settled by delivery. Forward contracts are individually tailored and tend to be much larger than the standardized contact on the future market. Futures contracts are standardized in terms of currency amount. Bank offer forward contract for delivery on any date. IMM futures contract are available for delivery on only a few specified dates a year. 5. Delivery date

2. Regulation

3. Frequency of delivery

4. Size of contract

6. Settlement: Forward contract settlement occurs on the date agreed upon between the bank and its customer. Futures contract settlement are made daily via the Exchanges Clearing House; gains on position values may be withdrawn and losses are collected daily. This practice is known as marking to market. 7. Quotes Forward prices generally are quoted in European terms (units of local currency per U. S. dollar). Futures contracts are quoted in American terms (dollars per one foreign currency unit). 8. Transaction Costs Costs of forward contracts based on bid-ask spread. Futures contracts entail brokerage fees for buy and sell orders. Margins are not required in the forward market. Margins are required of all participations in the futures market. The credit risk is born by each party to a forward contract. Credit limits must therefore be set fore each customer. The exchanges Clearing House becomes the opposite side to each futures contract, thereby reducing credit risk substantially.

9. Margins

10. Credit Risk

Currency Options Whatever advantages the forward or the future contracts might hold for their

purchaser, they have common disadvantages: While they protect the holder again the risk of adverse movement in exchange rate they eliminate the possibility of gaining a windfall profit from favorable movements. This was apparently one of the considerations that led some commercial banks to offer currency option to their customers. Exchange-traded currency options were first offered in 1983 by the Philadelphia Stock Exchange (PHLX). In principal, an option is a financial instrument that gives the holder the right but not the obligation- to sell (put) or buy (call) another financial instrument at a set price and expiration date. The seller of the put option or call option must fulfill the contract if the buyer so desire it. Because the option not to buy or sell has value, the buyer must pay the seller of the option some premium for this privilege. As applied to foreign currencies, call options give the customer the right to purchase, and put options give the right to sell, the contracted currencies at the expiration date; a European option can only be exercised at maturity. An option that would be profitable to exercise at the current exchange rate is said to be in-the-money. Conversely, an out-of-the money option is one that would not be profitable to exercise at the current exchange rate. The price at which the option is exercised is called the exercise price or strike price. An option whose exercise price is the same as the spot exchange rate is termed at-the-money.

Using Currency Options To see how currency options might be used, consider a U.S. importer that has a

DM 62500 payment to make to a Germen exporter in 60 days. The import could purchase a European call option to have the deutche marks delivered to it at a specified exchange rate (the strike price) on the due date. Suppose the option premium is $0.02 per DM, and the exercise price is $0.64. The importer has paid $1250 for the right to by DM 62500 at a price of $0.64 per mark at the end of 60 days. If at the time the importers payment falls due, the value of the deutsche mark has risen to, say, $0.70, the option would be in-the-money. In this case, the importer exercises its call option, and purchases deutsche marks for $0.64. The importer would earn a profit of $3750 (62500*0.06), which would more then cover the $1250 cost of option. If the rate has declined below the contracted rate two, say, $0.60, the option would be out- of the money. Consequently, the importer would let the option expire and purchase the Deutsche marks in the spot market. Despite losing the $1250 option premium, the importer would still be $1250 better off than if it had locked in a rate of $0.64 with a forward or futures contract. In contrast, a put option at same term would be in-the-money at the spot price of $0.60 and out-of-the-money at $0.70. If the spot price falls to, say, $0.58, the holder of put option will deliver DM 62500 worth $36250 and received $40000 (0.64*62500). At the extreme, if the spot rate falls to zero, the buyers profit on the contract will reach $38750 (0.64*62500- 1250). At spot prices above $0.64, the holder would not exercise the option and so would lose the $1250 premium.

Arbitrage between the Futures and Forward Markets. Arbitrageurs play an important role on the IMM. They translate IMM futures rates into interbank-forwad rates and, by releasing profit opportunities, keep IMM futures rate in line with bank forward rates. Example: Suppose that the inter bank forward bid for June 18 on pounds sterling is $1.2927 at the same time that the price of IMM sterling futures for delivery on June 18 is $1.2915. The dealer buy the June sterling futures contract for $80718.75 (62500 * $1.2915) and sell equivalent amount sterling forward, worth $80793.75 (62500 * $1.2927) for June delivery. Upon settlement, the dealer would earn of profit of $75.

USE OF CURRENCY DERIVATIVES BY INDIAS INSTITUTIONAL INVESTORS

Different types of derivatives available for use by these institutional investors in India: Equity, Foreign Currency, and Commodity Derivatives. The intensity of derivatives usage by any institutional investor is a function of its ability and willingness to use derivatives for one or more of the following purposes: 1. Risk Containment: Using derivatives for hedging and risk containment purposes. 2. Risk Trading/Market Making: Running derivatives trading book for profits and arbitrage. The different institutional investors could be meaningfully classified into: Banks, All India Financial Institutions (FIs), Mutual Funds (MFs), Foreign Institutional Investors (FIIs) and Life and General Insurers. 1. Banks Based on the differences in governance structure, business practices and organizational ethos, it is meaningful to classify the Indian banking sector into the following: 1. Public Sector Banks (PSBs); 2. Private Sector Banks (Old Generation); 3. Private Sector Banks (New Generation); and 4. Foreign Banks (with banking and authorized dealer license). Foreign Currency Derivatives Of Banks Banks that are Authorized Dealers (ADs) under the exchange control law are permitted by RBI to undertake the following foreign currency (FCY) derivative transactions:

For bank customers for hedging their FCY risks. FCY: INR Forward Contracts, and Swaps Cross-Currency Forward Contracts and Swaps. Cross-Currency Options. There is now an active Over-The-Counter (OTC) foreign currency derivatives market in India. However, the activity of most PSB majors in this market is limited to writing FCY derivatives contracts with their corporate customers on fully covered back-to-back basis. And, most PSBs do not run an active foreign currency derivative trading book, on account of the impediments enumerated earlier that need to be overcome at their end. 2. All India financial institutions (FIs) With the merger of ICICI into ICICI Bank, the universe of all-India FIs comprises IDBI, IFCI, IIBI, SIDBI, EXIM, NABARD and IDFC. In the context of use of financial derivatives, the universe of FIs could perhaps be extended to include a few other financially significant players such as HDFC and NHB. Foreign Currency Derivatives Of FIs Most FIs with foreign currency borrowings have been users of FCY:INR swaps, cross currency swaps, CC-IRS, and FRAs for their liabilities management. With the prior approval of RBI, FIs can also offer foreign currency derivatives as a product to their corporate borrowers on a fully covered back-to-back basis. Yet, most FIs have not yet readied themselves to explore this business opportunity. 3. Mutual funds Foreign currency derivatives In September 1999, 9 Indian mutual funds were allowed to invest in ADRs/GDRs of Indian companies in the overseas market within the overall limit of US$ 500 million with a sub-ceiling for individual mutual funds of 10 percent of net

assets managed by them (at previous year-end), subject to maximum of US$ 50 million per mutual fund. Several mutual funds had obtained the requisite approvals from SEBI and RBI for making such investments. However, given that most ADRs/GDRs of Indian companies traded in the overseas market at a premium to their prices on domestic equity markets, this facility has remained largely unutilized. Therefore, the question of using FCY: INR forward cover or swap did not much arise. However, recently, from 30 March 2002, 10 domestic mutual funds have been permitted to invest in foreign sovereign and corporate debt securities (AAA rated by S&P or Moody or Fitch IBCA) in countries with fully convertible currencies within the overall market limit of US$ 500 million, with a sub-ceiling for individual mutual funds of four percent of net assets managed by them as on 28 February 2002, subject to a maximum of US$ 50 million per mutual fund. Several mutual funds have now obtained the requisite SEBI and RBI approvals for making these investments. Once investment in foreign debt securities pick-up, mutual funds ought to emerge as active users of FCY: INR swaps to hedge the foreign currency risk in these investments. 4. Life and general insurance Foreign currency derivatives Given the long-term nature of life insurance contracts, insurance regulations in many parts of the world apply currency-matching principle for assets and liabilities under life insurance contracts. Indian insurance law too prohibits investment of funds from insurance business written in India, into overseas or foreign securities. Hence, Indian life and general insurers have no presence in the foreign currency derivatives market in India.

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Concluding Remarks

Derivative markets in equities, fixed income, and foreign currency are at their nascent stage of evolution in India, but have significant growth potential. For this potential to be realized, as discussed in the previous sections, one or more of the following issues or impediments would have to be overcome and resolved: 1. The regulatory framework applicable to the respective derivative markets and participants would need to evolve further. 2. The technological and business process framework of several key participants in these markets needs to readied to manage the risks relating their activity in the derivatives market. 3. The human resources/talent of several key participants in these markets needs to be vastly upgraded and readied to manage the exposures and risks relating their activity in the derivatives market. 4. The tax treatment applicable to the participants vis-a-vis respective derivative contracts would need to be clarified to provide certainty about it to the market participants.

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FOREIGN CURRENCY HEDGING

A Foreign Currency Hedge Is Placed : When a trader enters the foreign currency market with the specific intent of protecting existing or anticipated physical market exposure from an adverse move in foreign currency rates An investor or trader who is long a particular foreign currency can hedge to protect against downside risk exposure (a downward price move). An investor who is short a particular foreign currency can hedge to protect against upside risk exposure Both speculators and foreign currency hedgers can benefit by knowing how to properly utilize a foreign currency hedge Who Hedges Foreign Currency Risk Exposure: Banks: Banks who deal internationally have inherent risk exposure to foreign currencies, often in multiple ways including trading vehicles. Placing a currency hedge can help to manage foreign exchange rate risk. MNCs: Both large and small firms who conduct international business also have risk exposure to foreign currencies. Selling in foreign currencies and accepting foreign exchange rate risk are often a function of day-to-day business and can help firms stay competitive.

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Retail Investors: Retail foreign currency traders use foreign currency hedging to protect open positions against adverse moves in foreign currency rates. Placing a currency hedge can help to manage foreign exchange rate risk.

Hedging techniques include: Futures hedge, Forward hedge, Money market hedge, and Currency option hedge.

Futures hedge, A futures hedge involves the use of currency futures. To hedge future payables, the firm may purchase a currency futures contract for the currency that it will need. To hedge future receivables, the firm may sell a currency futures contract for the currency that it will be receiving. Forward hedge, A forward hedge differs from a futures hedge in that forward contracts are used instead of futures contract to lock in the future exchange rate at which the firm will buy or sell a currency. Recall that forward contracts are common for large transactions, while the standardized futures contracts involve smaller amounts. Money Market Hedge A money market hedge involves taking one or more money market position to cover a transaction exposure.

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Often, two positions are required. Payables: 1.Borrow in the home currency, and 2. Invest in the foreign currency. Receivables: 1.Borrow in the foreign currency, and 2.invest in the home currency.

Note that taking just one money market position may be sufficient. A firm that has excess cash need not borrow in the home currency when hedging payables. Similarly, a firm that is in need of cash need not invest in the home currency money market when hedging receivables.

For the two examples shown, the known results of money market hedging can be compared with the known results of forward or futures hedging to determine which the type of hedging that is preferable.

Currency Option Hedge A currency option hedge involves the use of currency call or put options to hedge transaction exposure. Since options need not be exercised, firms will be insulated from adverse exchange rate movements, and may still benefit from favorable movements. However, the firm must assess whether the premium paid is worthwhile.

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Kinds Of Currency Derivatives

Futures Hedge Contract Forward Hedge Contract Money Market Hedge Currency Option

Hedging Payables Hedging Receivables Purchase currency futures Sell currency futures contract(s). Negotiate forward to buy foreign currency. Borrow local currency. Convert to and then invest in foreign currency. Purchase currency call option(s). contract(s). Negotiate forward contract to sell foreign currency. Borrow foreign currency. Convert to and then invest in local currency. Purchase currency put option(s).

A comparison of hedging techniques should focus on minimizing payables, or maximizing receivables. The hedging policy of an MNC may be to hedge most of its exposure, none of its exposure, or to selectively hedge its exposure.

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Limitations of Hedging Some international transactions involve an uncertain amount of foreign currency, such that overhedging may result. One way of avoiding overhedging is to hedge only the minimum known amount in the future transaction(s). In the long run, the continual hedging of repeated transactions may have limited effectiveness. For example, the forward rate often moves in tandem with the spot rate. Thus, an importer who uses one-period forward contracts continually will have to pay increasingly higher prices during a strong-foreign-currency cycle.

Hedging Long-Term Transaction Exposure Long-term forward contracts, or long forwards, with maturities of ten years or more, can be set up for very creditworthy customers. Currency swaps can take many forms. In one form, two parties, with the aid of brokers, agree to exchange specified amounts of currencies on specified dates in the future. A parallel loan, or back-to-back loan, involves an exchange of currencies between two parties, with a promise to re-exchange the currencies at a specified exchange rate and future date.

Alternative Hedging Techniques Sometimes, a perfect hedge is not available (or is too expensive) to eliminate transaction exposure. To reduce exposure under such a condition, the firm can consider: leading and lagging, cross-hedging, or

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Currency diversification.

The act of leading and lagging refers to an adjustment in the timing of payment request or disbursement to reflect expectations about future currency movements.

Expediting a payment is referred to as leading, while deferring a payment is termed lagging. When a currency cannot be hedged, a currency that is highly correlated with the currency of concern may be hedged instead. The stronger the positive correlation between the two currencies, the more effective this cross-hedging strategy will be. With currency diversification, the firm diversifies its business among numerous countries whose currencies are not highly positively correlated.

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ONE OF THE GROWING CURRENCY DERIVATIVES EXCHANGE OF THE WORLD IS DGCX.

DGCX has introduce Currency Futures DGCX is the first currency futures exchange in the Middle East region. This will lead to establishment of standardized currency trading in the region. Strengthening Dubais position amongst the leading financial centers of the world. The Dubai Gold and Commodities Exchange (DGCX) today announced a landmark development where the exchange confirmed that Emirates Securities and Commodities Authority (ESCA) have approved its application for launching currency futures trading. Initially DGCX will trade futures contracts in 3 currencies Euro-Dollar, Yen-Dollar and Sterling-Dollar with contracts maturing in March, June, September and December each year. These will be deliverable contracts. This will establish DGCX as the first exchange for trading currencies in the Middle East. National Bank of Dubai and HSBC has agreed to act as Delivery Banks for the purpose of settlement of DGCX currencies futures contracts. This development positions DGCX among the handful of exchanges globally that offer trading on commodities and currencies under one umbrella. Statistics :-

Average daily international foreign exchange trading volume was $1.9 trillion in April 2004, according to the Bank of International Settlements (BIS) study. Also as per Futures Industry Association figures, total volumes in exchange traded foreign currency derivatives raised by over 57% from 55.34 million in 2004 to 165.51 million contracts in 2005. Currency derivatives products are very useful for all those who engage in international commodity trade for hedging the risk rising out of currency movements. In fact most corporate having transnational operations use currency derivatives to hedge

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against adverse movements in exchange rates. Currency derivatives also form a large part of treasury operations for banks, hedge funds and investment houses. Dubai is fast emerging as a financial hub in the Middle East, with many of the Fortune 500 companies having a presence here. The region has a huge potential for currencies trading. It is very important to have a healthy commodities and currency derivatives markets for any region to achieve a global recognition as an attractive financial hub. Currency futures contracts will be traded on fully electronic trading platform, giving currency traders the ability to immediately respond to events in global markets. This function is expected to generate interest among corporate treasuries, importers and exporters, professional and inter-bank proprietary traders, and retail participants in the region, who were traditionally confined to banks and other large financial institutions for their foreign exchange market requirements. Currency Futures product will be an opportunity for private investors and an important risk management tool for foreign currency market participants in the region.

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The Global Derivatives Industry: Outstanding Contracts, $ billion

1986 Exchange Traded Interest rate futures Interest rate options Currency futures Currency options Stock Index futures Stock Index options Some of the OTC Industry Interest rate swaps Currency swaps Caps, collars, floors, swaptions 583 370 146 10 39 15 3 500 400 100 1083 1990 2292 1454 600 16 56 70 96 3450 2312 578 561 5742 1993 7839 4960 2362 30 81 119 286 7777 6177 900 700 16616 1994 8838 5757 2623 33 55 128 242 11200 8815 915 1470 20038

Total

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The Global Derivatives Industry: Chronology of Instruments

1874 1972 1973 1975 1981 1982 1983 1985 1987 1989 1990 1991 1993 1994 Commodity Futures Foreign currency futures Equity options T-bond futures Currency swaps Interest rate swaps; T-note futures; Eurodollar futures; Equity index futures; Options on T-bond futures; Exchangelisted currency options Options on equity index; Options on T-note futures; Options on currency futures; Options on equity index futures; Interest rates caps and floors Eurodollar options; Swaptions OTC compound options; OTC average options Futures on interest rate swaps; Quanto options Equity index swaps Differential swaps Captions; Exchange-listed FLEX options Credit default options

GEORGE SOROS THE LEADER IN CURRENCY DERIVATIVES

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First and foremost, George Soros is a currency speculator -- that was where he made most of his big bets and big money. He is also a macro trader, which means he observes macroeconomic trends taking place in the global markets and takes positions based on his analysis and insights of their implications. This is opposed to investors like Warren Buffett who typically assess industry trends and perform detailed company analysis. Macroeconomic trends (eg. state of the economy, interest rates, fluctuations in currency markets, commodities, stocks) are often inter-related and Soros' ability to comprehend the abstruse links between them is legendary; he even has a term for it: reflexivity, which is basically a description for the feedback process that a change in one factor affects the input factors that caused the change in the first place. His bets also often take on a multi-asset approach, similar to the combined arms approach in modern warfare I guess. For example, for the 1991 British pound attack, he shorted British bonds together with the pound, and longed German marks (to protect the falling pound, the Bank of England would raise interest rates which would cause bond prices to drop; in this European crisis, German marks would be the safe haven and appreciate accordingly, ie. a convergence in value between British pound and German mark). There are several defining qualities of George Soros' trading style, in addition to his macro-analysis approach in generating trading ideas. The first is his use of heavy margins, especially in currencies and derivatives. Such leverage can produce huge rewards when the market position moves favorably but can wipe out the trader if not: it necessitates a short-term trading approach (for if one bases his decisions on the longterm, he might not be able to see it through as short-term fluctuations clear off his margins), and also one that requires trading with the (price and market) trend. Soros constantly analyses his position real-time as the market always re-adjusts, a consequence of "reflexivity". The second quality is a consequence of the first: Soros is able to switch his position at a moment's notice as he observes the macroeconomic, corporate or price developments unfolding before him. This is not easy for we typically

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condition our beliefs according to our incumbent investments, when in fact it should be the opposite. As Soros himself says, ""Its not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong." Typical mental framework of a successful speculator and George Soros is the best there is.

CONCLUSION

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Myths behind derivatives

IN LESS than three decades of their coming into vogue, derivatives markets have become the most important. Today, derivatives have become part of the day-to-day life for ordinary people in most parts of the world. Financial derivatives came into the spotlight along with the rise in uncertainty of post1970, when the US announced an end to the Bretton Woods System of fixed exchange rates leading to introduction of currency derivatives followed by other innovations, including stock index futures. There are still apprehensions about derivatives. Numerous studies have led to a broad consensus, both in the private and public sectors, that derivatives provide substantial benefits to the users. Derivatives are a low-cost, effective method for users to hedge and manage their exposures to interest rates, commodity prices, or currency rates risk. Trading in standard derivatives such as forwards, futures and options is already prevalent in India and has a long history. The Reserve Bank of India allows forwardtrading in rupee-dollar forward contracts, which has become liquid market. The RBI also allows cross currency options trading. Current Scenario

The Indian rupee has been experiencing significant movement in the recent past. It is affecting the interest of both importers and exporters. With the economy and trade growing and Indian economy being increasingly linked to the world economy, such volatilities are exposing the participants to currency risks.

In such a scenario, it is necessary to have an independent currency derivatives exchange so as to enable all importers and exporters to manage effectively currency risks even

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while doing business. In this context, it is imperative to examine the nitty-gritty of setting up a Currency Derivatives Exchange under the existing regulatory frame-work. Currently the Indian rupee is not fully convertible on capital account and there are restrictions on remittances of foreign currency funds in and out of India. The RBI, through FEMA, regulates the entire flow of foreign currency. Therefore, it is important to examine the modalities of setting up a currency derivatives exchange: 1. Without changing any of the existing regulatory framework; 2. Without making the rupee fully convertible; and, 3. Without necessarily liberalizing the process of remittance of funds. In order to achieve these objectives, the contracts should be traded only in India and there should be no foreign participation or remittance of funds outside the country through this contract as the rupee is not fully convertible. Otherwise, it becomes a de facto conversion. These contracts can be cash-settled as per the RBI reference rate on the maturity date or if these are delivery based, then outstanding positions on maturity are to be settled by delivery of dollars. Receipts and delivery of dollars must happen only in India, electronically through bank transfers, and banks should comply with all the RBI norms relating to the delivery of dollars by their clients. In the present structure there are three markets governed by three different regulatory bodies. The SEBI regulates the securities and stock markets under Securities Contracts Regulation Act, 1956. It regulates both spot and futures markets. Futures trading in commodities are regulated under Forwards Contracts Regulation Act, 1952 by FMC. And the RBI regulates the entire forex market. Foreign currency markets are very sensitive. Any complication in this market might lead to a very serious consequence and affect severely exports, imports, balance of

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trade, balance of payments and our competitiveness in global trade. Any wild fluctuations in the forex market are more severe than any price fluctuations in stock or commodity markets. Therefore, the forex market needs to be regulated by an authority that has the best possible experience and expertise in handling foreign currency markets. At present the RBI is such an authority. It is also important that this market is insulated completely from any adverse developments in other markets. There should not be any regulatory overlapping, lest there be confusion. Legally speaking, the currency derivatives market will fall neither within the purview of Sebi nor of FMC. The preamble of the Securities Contracts Regulation Act (SCRA) specified it as, an Act to prevent undesirable transactions in securities by regulating the business of dealing therein, by providing for certain other matters connected therewith.

Also, Section 2 (h) of Securities Contracts Regulation Act defines securities as shares, scrips, bonds, debentures, derivatives, units or any other instrument issued by any collective investment scheme. This definition does not cover currency; therefore, regulating currency market is beyond the scope of SCRA, as it would be against the basic preamble of the Act In any case, currency is a sovereign instrument it is money and not an instrument issued by a company or an organisation. It is a kind of bearer bond payable on demand and its inclusion in SCRA will have to dovetail with amendments to FEMA as well. The simple solution suggested below will facilitate the functioning of the currency futures in the existing legal framework.

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The currency derivatives market will not fall under jurisdiction of FMC either, because FMC constituted under the provisions of FCRA has got power to regulate forward trading in goods only. The term goods has been defined under the provisions of FCRA, which specifies that goods include every kind of movable property excluding actionable claims, securities and money. Since money is categorically excluded from the definition of goods it does not fall under the scope of FCRA. Even though currently there is no currency futures exchange, forex market essentially functions independently through interaction of demand and supply forces that are reflected in inter-bank transactions. However, the RBI intervenes in the markets, if and when required to do so, in the overall interest of the country to control the exchange rate.

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Bibliography
Book: Multinational Financial Management By Alan C. Shapiro Links: http://www.google.com/intl/en_us/mobile/sms/ http://www.derivativesstrategy.com/magazine/archive/2000/0400fea2.asp http://www.hedgeweek.com/articles/detail.jsp?content_id=47614&livehome=true http://www.wachovia.com/ws/econ/view/0,,3630,00.pdf http://www.gftforex.com/documents/manuals/db360_user_guide.pdf? ts=81620070624 http://www.american-currency.com/american_currency.htm http://www.worldlinkfutures.com/ http://www.investopedia.com/stockadvice/ http://www.prudentbear.com/articles/show/547

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