Trading in Currency Futures

Why to Trade in Currency Futures

Why to Trade in Currency Futures:

A separate Asset Class
Correlation with different Asset Classes

Commodities International/COMEX Gold Price

USD/INR depreciation leads to rise in MCX gold prices

International Crude Price

Equities

Market Potential of USD 34 Billion a day

(Average Daily Volume in the OTC Market)
Conservatively: USD 30 Billion= 30 X 100 X 40 = INR 1, 20, 000 Crs Lets Assume 1 USD = INR 40.00

50% of the above will be Rs 50 60, 000 Crs a day

Foreign Exchange Markets in India

Regulated by Reserve Bank of India Participants include; banks, corporate entities, FIIs, NRIs and individuals All participants trade within limits or parameters prescribed by the Reserve Bank of India Tenor Amount Direction Past Performance The average daily volume stands at USD 34 billion All foreign currency spot and forward transactions need to be routed through Scheduled Commercial Banks, which have been granted Authorized Dealer licenses by the RBI

Currency Futures - Framework

Category Underlying Contract Size Contract Months Final Settlement Date Min Price fluctuation Settlement Description Rate of exchange between 1 USD and INR (USDINR) USD 1000 12 near calendar months Last business day of the month 0.25 paise or INR 0.0025 (46.9000 46.9025) Cash settled in INR on relevant RBI reference rate Last trading day: two business days prior to last business day of the month (spot convention) Expiring contract will trade till 12:00 noon on the last trading day

Market timings 09:00 to 17:00

Order driven market

Currency Futures - Framework

All resident Indian entities and individuals permitted to trade No underlying required to be provided, this enables hedging of derived exposures Position limits will determine amount that can be traded Trading member USD 25 million or 15% of Open Interest whichever is higher Client position limits USD 5 million or 6% of Open Interest whichever is higher Margins to be posted with the trading / clearing member pre - trade Daily mark to market on the following day

OTC vs Currency futures

OTC Market Accessibility Price Transparency Liquidity Credit dependent Low Subject to credit limits Exchange Traded Futures High High High

Agreements
Credit Exposure Margins (collateral) Daily MTM

Customized
Yes Usually not required No

Standard
Mitigated through the clearing corporation Required Yes

OTC vs Currency futures

OTC Market Execution Underlying exposure Settlement Position limits Bank Required Physical Delivery Dependent on Underlying Exchange Traded Futures Trading Member Not required Net Settled in INR Higher of USD 5 mio or 6% of Open Interest

As a client on NSE CDS

Underlying not required to trade on the exchange Immediate trade reversal can be done Margins released when trade is unwound or expires MTM settlement happens the next day and you need not wait for original contract maturity date for cash flow Trading screen accessible to client - price transparency

CDS - Participation
More than 500 Members are Participating 12 Banks are trading members and more are in the pipeline Daily gross traded volume: around Rs. 2000 crs.

Proprietary Corporate Banks Retail

: : : :

40% 10% 10% 40%

Near month most active Thin Bid-ask spreads

Understanding the Rate Fluctuation

INR/USD goes from Rs.40 to Rs.45 Thus more INR will be required to buy the same amount of USD This is appreciation of USD But depreciation of INR Holders of buy position in USD will benefit

If INR/USD goes from Rs.40 to Rs.35 This is depreciation of USD But appreciation of INR Holders of Sell position in USD will benefit

What factors affect Exchange Rate & hence trading decisions ?

Macro economic views Monetary Policy RBI intervention USD sentiment Performance of key commodities affecting trade

Flow information
Performance of other Asian currencies Performance of equity markets

Policy announcements affecting flows trade or capital

REER Real Effective Exchange Rate Data announcements

Indian Foreign Exchange Markets:

INR trades in a managed floating exchange rate regime INR is fully convertible on Indias current account, but not on the capital account Foreign institutional investors can fully repatriate their investments Resident Indian individuals have been permitted to invest offshore All foreign currency spot and forward transactions need to be routed through schedule commercial banks (Authorized Dealers) Access is restricted to banks and entities having a commercial exposure Volumes and tenor is restricted to underlying exposure Only banks have open position limits

A new and better alternative for trading:

USD-INR cash-settled futures market at NSE Access to all Indians Currently restrictions on NRI / FII No requirement for underlying position Small contract size Low margins Settlements guaranteed & no counter party risks Online real-time screen based trading Convergence of national / international investors Transparent order book

What drives trading of currencies & who are the participants

Directional Views Positioning for INR appreciation or depreciation Hedging existing exposure Importers & Exporters hedging future payables or receivables Borrowers hedging FCY loans interest or principle payments NRIs looking to hedge their investment in India Resident Indians looking to hedge investments offshore FIIs hedging their investments in India Trade and Capital Flows Remittances for trade or services and capital transactions Arbitrage Entities who can access onshore and non deliverable forward markets

Taking a View on the Spot Market

Volatility of USD/INR exchange rate

Taking a View on Spot INR

USD/INR 28th Jan 09 Contract
Current Spot Rate (29th Dec 08) View Position in Futures Position at maturity (28th Jan 09) Profit / Loss Investment in Margin

: 49.20
: 49.10 : INR to depreciate : Buy USD/INR future Contract at 49.20 : 49.60 : Profit Rs. 400 on 01 Contract : Approx. 5% of the Contract size

A currency future contract is similar to a futures contract on any Scrip or Index

Factors Affecting Trading decisions

Hedge Currency Risk

Using Futures to Hedge Currency Risk

An exporter wants to protect himself from the likely appreciation in Rupee. He has dispatched the consignments on 5th September and he is expecting the payment of $25,000 by December end. Current spot rate of USD-INR is 44.80. On 5th September sell 25 numbers of USD-INR future contracts (each of $1000) of December month at the prevailing rate of 44.95 On 28th December cover sell position by purchasing 25 contracts of December month at the then prevailing rate of say 44.45. Simultaneously sell $25,000 (receipt from overseas party) in the spot market at the rate of 44.45 Profit from future contracts = 25,000 x (44.95 44.45) = Rs. 12,500 In spot Market: Loss due to currency appreciation from 44.80 in September to 44.45 in December = 25,000 x (44.8 44.45) = Rs.8, 750

Payoff of Hedge vis--vis the transaction

His Notional Net Profit as a result of Hedging transactions would be: Rs. 12,500 - Rs.8, 750 = Rs.3, 750

o NOTE: Had he not taken position in the currency futures, he

would have made a loss of Rs.8, 750. On the contrary, he has not only covered his loss but also earned little profit from the futures transaction.

Remove Forex Risk while trading in the Commodity Market

Remove Forex Risk while trading Commodities

COMEX gold prices have direct relationship with MCX gold prices
MCX prices decreases along with decrease in COMEX prices But USD/INR depreciation leads to rise in MCX gold prices This fluctuation affects the profit margins of corporate/clients By hedging USD/INR through futures, offsets the deviation caused in COMEX and MCX prices

Pay off from the Hedge

Scenario I - USD/INR = 44.30 (Constant)
Sell COMEX Gold @ $830 Buy COMEX Gold @ $820 Profit = $10 Sell MCX Gold @ 11,860 Buy MCX Gold @ 11,760 Profit = Rs.100/-

Scenario II - USD/INR = 44.60 (Depreciates from 44.30)

Sell COMEX Gold @ $830 Buy COMEX Gold @ $820 Profit = $10 Sell MCX Gold @ 11,860 Buy MCX Gold @ 11,810 Profit = Rs.50/-

Arbitrage (Futures Market & OTC Market)

Arbitrage Opportunity
Sell in futures @ 44.4625 levels (1 month) Buy in forward @ 44.3250 + 3 paisa premium = 44.3550 (1 month)
Net Gain = 44.4625-44.3550 = 0.1075 i .e. Approx 11 Paisa arbitrage Arbitrage will be realized at the expiry of the contract.

Currency Futures Trading at Sharekhan

CDS WEB site

Currency Futures Trading at Sharekhan:

Market Timing Contract Size Maturity Period Quote Margin

: 9.00 A.M. to 5.00 P.M. : 1000 USD per lot : 12 monthly contracts with expire
on the last working day (excluding Saturdays) of the month

: INR per USD : Initial Margin + SPAN

(Maintenance Margin), Total would be approx. 5% - 6% Tick : 0.0025 INR Profit/Loss (per Contract) : 01 tick = Rs 2.50 01 Paise = Rs. 10.00

If Price is 47.50
Brokerage % Absolute Brokerage 0.01% 0.00475 0.02% 0.0095 0.00114 0.03% 0.01425 0.00171 0.04% 0.019 0.00228 0.05% 0.02375 0.00285

Service Tax On Brok. w.e.f. 16.05.08 Edu. CESS on Service Tax Higher Edu.CESS on Service Tax Transaction Charge on T.O. SEBI Turnover fees on Value Stamp Duty on T.O. Total Tick (0.25 paise or INR 0.0025)

12.00%

0.00057

2.00% 0.0000114 0.0000228 0.0000342 0.0000456 0.000057 1.00% 0.0000057 0.0000114 0.0000171 0.0000228 0.0000285 0.0002% 0.002%
0.000095 0.000095 0.000095 0.000095 0.000095 0.00095 0.00095 0.00095 0.00095 0.00095 0.0063821 0.0117192 0.0170563 0.0223934 0.0277305 3 5 7 9 11

Important Websites :

Nseindia.com Sharekhan.com Reuters.in (in.reuters.com) Rbi.org.in Fedai.org.in

Last Trade Date

25-SEP-2008 27-OCT-2008 26-NOV-2008

RBI Reference Rate

46.2500 50.0900 49.8500

Last Traded Price

46.2500 50.1050 49.8550

Diff.
0.0000 0.0150 0.0050