Currency Derivatives

RBI has currently permitted futures only on the USD-INR rates. ENAM Securities Direct Pvt. Ltd. offers trading facilities to investors on the Currency derivatives segment of the NSE. The contract Specification of the futures shall be as under: Underlying Trading Hours (Monday to Friday) Contract Size Tick Size Trading Period Contract Months Final Settlement date / Value date Last Trading Day Settlement Final Settlement Price Rate of exchange between one USD and INR 09:00 a.m. to 05:00 p.m. USD 1000 0.25 paise or INR 0.0025 Maximum expiration period of 12 months 12 near calendar months Last working day of the month (subject to holiday calendars) Two working days prior to Final Settlement Date Cash settled The reference rate fixed by RBI two working days prior to the final settlement date will be used for final settlement

The Currency Derivatives trading system of NSE, called NEAT-CDS (National Exchange for Automated Trading Currency Derivatives Segment) trading System, provides a fully automated screen-based trading for currency futures on a nationwide basis as well as an online monitoring and surveillance Mechanism. It supports an order driven market and provides complete Transparency of trading operations. The online trading system is similar to that of trading of equity derivatives in the Futures & Options (F&O) segment of NSE. Client Broker Relationship in Derivatives Segment A client of a trading member is required to enter into an agreement with the trading member before commencing trading. A client is eligible to get all the details of his or her orders and trades from the trading member. A trading member must ensure compliance particularly with relation to the following while dealing with clients: 1. 2. 3. 4. 5. 6. 7. Filling of 'Know Your Client' form Execution of Client Broker agreement Bring risk factors to the knowledge of client by getting acknowledgement of client on risk disclosure document Timely execution of orders as per the instruction of clients in respective client codes. Collection of adequate margins from the client. Maintaining separate client bank account for the segregation of client money. Timely issue of contract notes as per the prescribed format to the client.

8. 9. 10. 11. 12. 13.

Ensuring timely pay-in and pay-out of funds to and from the clients Resolving complaint of clients if any at the earliest. Avoiding receipt and payment of cash and deal only through account payee Cheques. Sending the periodical statement of accounts to clients. Not charging excess brokerage Maintaining unique client code as per the regulations

The system allows the trading members to enter orders with various conditions attached to them as per their requirements. These conditions are broadly divided into the following categories:

Time conditions Price conditions Other conditions

Charges The maximum brokerage chargeable by a trading member in relation to trades effected in the contracts admitted to dealing on the Currency Derivatives segment of NSE is fixed at 2.5% of the contract value. The transaction charges payable to the exchange by the trading member for the trades executed by him on the Currency Derivatives segment would be as prescribed by the Exchange from time to time. The trading members would also contribute to Investor Protection Fund of Currency Derivatives segment at the rate as may be prescribed by the Exchange from time to time. Clearing and Settlement National Securities Clearing Corporation Limited (NSCCL) undertakes clearing and settlement of all trades executed on the Currency Derivatives Segment of the NSE. It also acts as legal counterparty to all trades on the Currency Derivatives segment and guarantees their financial settlement. Settlement of currency futures contracts Currency futures contracts have two types of settlements, the MTM settlement which happens on a continuous basis at the end of each day, and the final settlement which happens on the last trading day of the futures contract. Mark to Market settlement (MTM Settlement): All futures contracts for each member are marked-to-market (MTM) to the daily settlement price of the relevant futures contract at the end of each day. The profits/losses are computed as the difference between:

The trade price and the day's settlement price for contracts executed during the day but not squared up. The previous day's settlement price and the current day's settlement price for brought forward contracts. The buy price and the sell price for contracts executed during the day and squared up.

Final settlement for futures On the last trading day of the futures contracts, after the close of trading hours, NSCCL marks all positions of a CM to the final settlement price and the resulting profit/loss is settled in cash. Final settlement loss/profit amount is debited/ credited to the relevant CM's clearing bank account on T+2 working day following last trading day of the contract (Contract expiry Day). Settlement prices for futures Daily settlement price on a trading day is the closing price of the respective futures contracts on such day. The closing price for a futures contract is currently calculated as the last half an hour weighted average price of the contract in the Currency Derivatives Segment of NSE. The final settlement price is the RBI reference rate on the last trading day of the futures contract. All open positions shall be marked to market on the final settlement price. Such marked to market profit / loss shall be paid to / received from clearing members.

Risk Management NSCCL has developed a comprehensive risk containment mechanism for the Currency Derivatives segment. The salient features of risk containment mechanism on the Currency Derivatives segment are:

The financial soundness of the members is the key to risk management. Therefore, the requirements for membership in terms of capital adequacy (net worth, security deposits) are quite stringent. NSCCL charges an upfront initial margin for all the open positions of a CM. It specifies the initial margin requirements for each futures contract on a daily basis. It also follows a value-at-risk (VaR) based margining through SPAN. The CM in turn collects the initial margin from the TMs and their respective clients. The open positions of the members are marked to market based on contract settlement price for each contract. The difference is settled in cash on a T+1 basis. NSCCL's on-line position monitoring system monitors the member open positions and margins on a real-time basis vis--vis the deposits provided by the CM/ limits set for the TM by the CM. The on-line position monitoring system generates alerts whenever the margins of a member reaches X% of the capital deposited by the CM or limits set for the TM by the CM. NSCCL monitors the CMs for initial margin and extreme loss margin violations, while TMs are monitored for initial margin violation. CMs are provided a trading terminal for the purpose of monitoring the open positions of all the TMs clearing and settling through him. A CM may set limits for a TM clearing and settling through him. NSCCL assists the CM to monitor the intra-day limits set up by a CM and whenever a TM exceeds the limit, it stops that particular TM from further trading. A member is alerted of his position to enable him to adjust his position or bring in additional capital. Margin violations result in withdrawal of trading facility for all TMs of a CM in case of a violation by the CM. A separate settlement guarantee fund for this segment has been created out of the capital of members.

The most critical component of risk containment mechanism for the Currency Derivatives segment is the margining system and on-line position monitoring. The actual position monitoring and margining is carried out on-line through Parallel Risk Management System (PRISM). PRISM uses SPAN (Standard Portfolio Analysis of Risk) system for the purpose of computation of on-line margins, based on the parameters defined by SEBI. Margining System

NSCCL has developed a comprehensive risk containment mechanism for the Currency Derivatives segment. The most critical component of a risk containment mechanism is the online position monitoring and margining system. The actual margining is done on-line, on an intra-day basis using PRISM (Parallel Risk Management System) which is the real-time position monitoring and risk management system. The risk of each trading and clearing member is monitored on a real-time basis and alerts/disablement messages are generated if the member crosses the set limits. NSCCL uses the SPAN (Standard Portfolio Analysis of Risk) system; a portfolio based margining system, for the purpose of calculating initial margins.

In order to determine the largest loss that a portfolio might reasonably be expected to suffer from one day to the next day based on 99% VaR methodology, the price scan range has been currently fixed at 3.5 standard deviation The initial margin so computed would be subject to a minimum of 1.75% on the first day of currency futures trading and a minimum of 1 % thereafter.

Types of margins

Initial margin: Margin in the Currency Derivatives segment is computed by NSCCL upto client level for open positions of CMs/TMs. These are required to be paid up-front on gross basis at individual client level for client positions and on net basis for proprietary positions. NSCCL collects initial margin for all the open positions of a CM based on the margins computed by NSCCLSPAN . A CM is required to ensure collection of adequate initial margin from his TMs up-front. The TM is required to collect adequate initial margins upfront from his clients. Extreme loss margin of 1% on the value of the gross open positions shall be adjusted from the liquid assets of the clearing member on an on line, real time basis. Client margins: NSCCL intimates all members of the margin liability of each of their client. Additionally members are also required to report details of margins collected from clients to NSCCL, which holds in trust client margin monies to the extent reported by the member as having been collected form their respective clients.

Position limits

Client Level: The gross open positions of the client across all contracts should not exceed 6% of the total open interest or 5 million USD whichever is higher. The Exchange will disseminate alerts whenever the gross open position of the client exceeds 3% of the total open interest at the end of the previous days trade. Trading Member level: The gross open positions of the trading member across all contracts should not exceed 15% of the total open interest or 25 million USD whichever is higher. However, the gross open position of a Trading Member, which is a bank, across all contracts, shall not exceed 15% of the total open interest or 100 million USD, whichever is higher. Clearing Member Level: No separate position limit is prescribed at the level of clearing member. However, the clearing member shall ensure that his own trading position and the positions of each trading member clearing through him is within the limits specified above. Reporting of client margin: Clearing Members (CMs) and Trading Members (TMs) are required to collect initial margin, extreme loss margin, calendar spread margin and mark to market settlements from all their Trading Members/ Constituents. CMs are required to compulsorily report, on a daily basis, details in respect of such margin amount due and collected, from the TMs/ Constituents clearing and settling through them, with respect to the trades executed/ open positions of the TMs/ Constituents, which the CMs have paid to NSCCL, for the purpose of meeting margin requirements.

Similarly, TMs are required to report on a daily basis details in respect of such margin amount due and collected from the constituents clearing and settling through them, with respect to the trades executed/ open positions of the constituents.

The Exchange shall impose stringent penalty on members who do not collect margins from their clients. The Exchange shall also conduct regular inspections to ensure margin collection from clients. For further details on this product please contact Dhaval Choksi on +91-22-66803600 or e-mail dhaval.choksi@enam.com

Derivative (finance)
From Wikipedia, the free encyclopedia

Jump to: navigation, search A derivative instrument is a contract between two parties that specifies conditions (especially the dates, resulting values of the underlying variables, and notional amounts) under which payments are to be made between the parties.[1][2] Under US law and the laws of most other developed countries, derivatives have special legal exemptions that make them a particularly attractive legal form to extend credit.[3] However, the strong creditor protections afforded to derivatives counterparties, in combination with their complexity and lack of transparency, can cause capital markets to underprice credit risk. This can contribute to credit booms, and increase systemic risks.[3] Indeed, the use of derivatives to mask credit risk from third parties while protecting derivative counterparties contributed to the financial crisis of 2008 in the United States.[3][4] Financial reforms within the US since the financial crisis have served only to reinforce special protections for derivatives, including greater access to government guarantees, while minimizing disclosure to broader financial markets.[5] One of the oldest derivatives is rice futures, which have been traded on the Dojima Rice Exchange since the eighteenth century.[6] Derivatives are broadly categorized by the relationship between the underlying asset and the derivative (such as forward, option, swap); the type of underlying asset (such as equity derivatives, foreign exchange derivatives, interest rate derivatives, commodity derivatives, or credit derivatives); the market in which they trade (such as exchange-traded or over-the-counter); and their pay-off profile. Derivatives can be used for speculation ("bets") or to hedge ("insurance"). For example, a speculator may sell deep in-the-money naked calls on a stock, expecting the stock price to plummet, but exposing himself to potentially unlimited losses. Very commonly, companies buy currency forwards in order to limit losses due to fluctuations in the exchange rate of two currencies.

Third parties can use publicly available derivative prices as educated predictions of uncertain future outcomes, for example, the likelihood that a corporation will default on its debts.[7]

Contents
[hide]

1 Usage o 1.1 Hedging o 1.2 Speculation and arbitrage 2 Types o 2.1 OTC and exchange-traded o 2.2 Common derivative contract types o 2.3 Examples 3 Economic function of the derivative market 4 Valuation o 4.1 Market and arbitrage-free prices o 4.2 Determining the market price o 4.3 Determining the arbitrage-free price 5 Criticism o 5.1 Erroneous Analysis of Benefits o 5.2 Hidden Tail Risk o 5.3 Risk o 5.4 Counter party risk o 5.5 Large notional value o 5.6 Leverage of an economy's debt 6 Benefits 7 Government regulation 8 Glossary 9 See also 10 References 11 Further reading 12 External links

[edit] Usage
Derivatives are used by investors for the following:

provide leverage (or gearing), such that a small movement in the underlying value can cause a large difference in the value of the derivative;[8] speculate and make a profit if the value of the underlying asset moves the way they expect (e.g., moves in a given direction, stays in or out of a specified range, reaches a certain level);

hedge or mitigate risk in the underlying, by entering into a derivative contract whose value moves in the opposite direction to their underlying position and cancels part or all of it out;[9] obtain exposure to the underlying where it is not possible to trade in the underlying (e.g., weather derivatives);[10] create option ability where the value of the derivative is linked to a specific condition or event (e.g. the underlying reaching a specific price level).

[edit] Hedging
Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another. For example, a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future. Both parties have reduced a future risk: for the wheat farmer, the uncertainty of the price, and for the miller, the availability of wheat. However, there is still the risk that no wheat will be available because of events unspecified by the contract, such as the weather, or that one party will renege on the contract. Although a third party, called a clearing house, insures a futures contract, not all derivatives are insured against counter-party risk. From another perspective, the farmer and the miller both reduce a risk and acquire a risk when they sign the futures contract: the farmer reduces the risk that the price of wheat will fall below the price specified in the contract and acquires the risk that the price of wheat will rise above the price specified in the contract (thereby losing additional income that he could have earned). The miller, on the other hand, acquires the risk that the price of wheat will fall below the price specified in the contract (thereby paying more in the future than he otherwise would have) and reduces the risk that the price of wheat will rise above the price specified in the contract. In this sense, one party is the insurer (risk taker) for one type of risk, and the counter-party is the insurer (risk taker) for another type of risk. Hedging also occurs when an individual or institution buys an asset (such as a commodity, a bond that has coupon payments, a stock that pays dividends, and so on) and sells it using a futures contract. The individual or institution has access to the asset for a specified amount of time, and can then sell it in the future at a specified price according to the futures contract. Of course, this allows the individual or institution the benefit of holding the asset, while reducing the risk that the future selling price will deviate unexpectedly from the market's current assessment of the future value of the asset.

Derivatives traders at the Chicago Board of Trade Derivatives can serve legitimate business purposes. For example, a corporation borrows a large sum of money at a specific interest rate.[11] The rate of interest on the loan resets every six months. The corporation is concerned that the rate of interest may be much higher in six months. The corporation could buy a forward rate agreement (FRA), which is a contract to pay a fixed rate of interest six months after purchases on a notional amount of money.[12] If the interest rate after six months is above the contract rate, the seller will pay the difference to the corporation, or FRA buyer. If the rate is lower, the corporation will pay the difference to the seller. The purchase of the FRA serves to reduce the uncertainty concerning the rate increase and stabilize earnings.

[edit] Speculation and arbitrage

Derivatives can be used to acquire risk, rather than to hedge against risk. Thus, some individuals and institutions will enter into a derivative contract to speculate on the value of the underlying asset, betting that the party seeking insurance will be wrong about the future value of the underlying asset. Speculators look to buy an asset in the future at a low price according to a derivative contract when the future market price is high, or to sell an asset in the future at a high price according to a derivative contract when the future market price is low. Individuals and institutions may also look for arbitrage opportunities, as when the current buying price of an asset falls below the price specified in a futures contract to sell the asset. Speculative trading in derivatives gained a great deal of notoriety in 1995 when Nick Leeson, a trader at Barings Bank, made poor and unauthorized investments in futures contracts. Through a combination of poor judgment, lack of oversight by the bank's management and regulators, and unfortunate events like the Kobe earthquake, Leeson incurred a US$1.3 billion loss that bankrupted the centuries-old institution.[13]

[edit] Types
[edit] OTC and exchange-traded

In broad terms, there are two groups of derivative contracts, which are distinguished by the way they are traded in the market:

Over-the-counter (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as swaps, forward rate agreements, exotic options - and other exotic derivatives - are almost always traded in this way. The OTC derivative market is the largest market for derivatives, and is largely unregulated with respect to disclosure of information between the parties, since the OTC market is made up of banks and other highly sophisticated parties, such as hedge funds. Reporting of OTC amounts are difficult because trades can occur in private, without activity being visible on any exchange. According to the Bank for International Settlements, the total outstanding notional amount is US$708 trillion (as of June 2011).[14] Of this total notional amount, 67% are interest rate contracts, 8% are credit default swaps (CDS), 9% are foreign exchange contracts, 2% are commodity contracts, 1% are equity contracts, and 12% are other. Because OTC derivatives are not traded on an exchange, there is no central counter-party. Therefore, they are subject to counter-party risk, like an ordinary contract, since each counter-party relies on the other to perform. Exchange-traded derivative contracts (ETD) are those derivatives instruments that are traded via specialized derivatives exchanges or other exchanges. A derivatives exchange is a market where individuals trade standardized contracts that have been defined by the exchange.[15] A derivatives exchange acts as an intermediary to all related transactions, and takes initial margin from both sides of the trade to act as a guarantee. The world's largest[16] derivatives exchanges (by number of transactions) are the Korea Exchange (which lists KOSPI Index Futures & Options), Eurex (which lists a wide range of European products such as interest rate & index products), and CME Group (made up of the 2007 merger of the Chicago Mercantile Exchange and the Chicago Board of Trade and the 2008 acquisition of the New York Mercantile Exchange). According to BIS, the combined turnover in the world's derivatives exchanges totaled USD 344 trillion during Q4 2005. Some types of derivative instruments also may trade on traditional exchanges. For instance, hybrid instruments such as convertible bonds and/or convertible preferred may be listed on stock or bond exchanges. Also, warrants (or "rights") may be listed on equity exchanges. Performance Rights, Cash xPRTs and various other instruments that essentially consist of a complex set of options bundled into a simple package are routinely listed on equity exchanges. Like other derivatives, these publicly traded derivatives provide investors access to risk/reward and volatility characteristics that, while related to an underlying commodity, nonetheless are distinctive.

[edit] Common derivative contract types

Some of the common variants of derivative contracts are as follows:

1. Forwards: A tailored contract between two parties, where payment takes place at a specific time in the future at today's pre-determined price. 2. Futures: are contracts to buy or sell an asset on or before a future date at a price specified today. A futures contract differs from a forward contract in that the futures contract is a standardized contract written by a clearing house that operates an exchange where the contract can be bought and sold; the forward contract is a non-standardized contract written by the parties themselves. 3. Options are contracts that give the owner the right, but not the obligation, to buy (in the case of a call option) or sell (in the case of a put option) an asset. The price at which the sale takes place is known as the strike price, and is specified at the time the parties enter into the option. The option contract also specifies a maturity date. In the case of a European option, the owner has the right to require the sale to take place on (but not before) the maturity date; in the case of an American option, the owner can require the sale to take place at any time up to the maturity date. If the owner of the contract exercises this right, the counter-party has the obligation to carry out the transaction. Options are of two types: call option and put option. The buyer of a Call option has a right to buy a certain quantity of the underlying asset, at a specified price on or before a given date in the future, he however has no obligation whatsoever to carry out this right. Similarly, the buyer of a Put option has the right to sell a certain quantity of an underlying asset, at a specified price on or before a given date in the future, he however has no obligation whatsoever to carry out this right. 4. Binary options are contracts that provide the owner with an all-or-nothing profit profile. 5. Warrants: Apart from the commonly used short-dated options which have a maximum maturity period of 1 year, there exists certain long-dated options as well, known as Warrant (finance). These are generally traded over-the-counter. 6. Swaps are contracts to exchange cash (flows) on or before a specified future date based on the underlying value of currencies exchange rates, bonds/interest rates, commodities exchange, stocks or other assets. Another term which is commonly associated to Swap is Swaption which is basically an option on the forward Swap. Similar to a Call and Put option, a Swaption is of two kinds: a receiver Swaption and a payer Swaption. While on one hand, in case of a receiver Swaption there is an option wherein you can receive fixed and pay floating, a payer swaption on the other hand is an option to pay fixed and receive floating. Swaps can basically be categorized into two types:

Interest Rate Swap: These basically necessitate swapping only interest associated cash flows in the same currency, between two parties. Currency swap: In this kind of swapping, the cash flow between the two parties includes both principal and interest. Also, the money which is being swapped is in different currency for both parties.[17]

[edit] Examples

The overall derivatives market has five major classes of underlying asset:

interest rate derivatives (the largest) foreign exchange derivatives credit derivatives equity derivatives commodity derivatives

Some common examples of these derivatives are the following: CONTRACT TYPES ExchangeExchangeUNDERLYING traded traded OTC swap OTC forward OTC option futures options Option on DJIA Index Stock option DJIA Index Back-to-back future Warrant Equity future Equity swap Repurchase Single-stock Turbo Single-share agreement future warrant option Option on Interest rate Eurodollar Eurodollar cap and floor Interest rate Forward rate Interest rate future future Swaption swap agreement Euribor future Option on Basis swap Euribor future Bond option Credit default Credit Option on swap Repurchase Credit Bond future default Bond future Total return agreement option swap Foreign Currency Option on Currency Currency Currency exchange future currency future swap forward option Iron ore WTI crude oil Weather Commodity Commodity forward Gold option futures derivatives swap contract Other examples of underlying exchangeables are:

Property (mortgage) derivatives Economic derivatives that pay off according to economic reports[18] as measured and reported by national statistical agencies Freight derivatives Inflation derivatives Weather derivatives Insurance derivatives[19] Emissions derivatives[20]

[edit] Economic function of the derivative market

Some of the salient economic functions of the derivative market include: 1. Prices in a structured derivative market not only replicate the discernment of the market participants about the future but also lead the prices of underlying to the professed future level. On the expiration of the derivative contract, the prices of derivatives congregate with the prices of the underlying. Therefore, derivatives are essential tools to determine both current and future prices. 2. The derivatives market relocates risk from the people who prefer risk aversion to the people who have an appetite for risk. 3. The intrinsic nature of derivatives market associates them to the underlying Spot market. Due to derivatives there is a considerable increase in trade volumes of the underlying Spot market. The dominant factor behind such an escalation is increased participation by additional players who would not have otherwise participated due to absence of any procedure to transfer risk. 4. As supervision, reconnaissance of the activities of various participants becomes tremendously difficult in assorted markets; the establishment of an organized form of market becomes all the more imperative. Therefore, in the presence of an organized derivatives market, speculation can be controlled, resulting in a more meticulous environment. 5. A significant accompanying benefit which is a consequence of derivatives trading is that it acts as a facilitator for new Entrepreneurs. The derivatives market has a history of alluring many optimistic, imaginative and well educated people with an entrepreneurial outlook, the benefits of which are colossal. In a nutshell, there is a substantial increase in savings and investment in the long run due to augmented activities by derivative Market participant.[21]

[edit] Valuation

Total world derivatives from 19982007[22] compared to total world wealth in the year 2000[23]

[edit] Market and arbitrage-free prices

Two common measures of value are:

Market price, i.e., the price at which traders are willing to buy or sell the contract; Arbitrage-free price, meaning that no risk-free profits can be made by trading in these contracts; see rational pricing.

[edit] Determining the market price

For exchange-traded derivatives, market price is usually transparent, making it difficult to automatically broadcast prices. In particular with OTC contracts, there is no central exchange to collate and disseminate prices.

[edit] Determining the arbitrage-free price

See List of finance topics# Derivatives pricing. The arbitrage-free price for a derivatives contract can be complex, and there are many different variables to consider. Arbitrage-free pricing is a central topic of financial mathematics. For futures/forwards the arbitrage free price is relatively straightforward, involving the price of the underlying together with the cost of carry (income received less interest costs), although there can be complexities. However, for options and more complex derivatives, pricing involves developing a complex pricing model: understanding the stochastic process of the price of the underlying asset is often crucial. A key equation for the theoretical valuation of options is the Black Scholes formula, which is based on the assumption that the cash flows from a European stock option can be replicated by a continuous buying and selling strategy using only the stock. A simplified version of this valuation technique is the binomial options model. OTC represents the biggest challenge in using models to price derivatives. Since these contracts are not publicly traded, no market price is available to validate the theoretical valuation. Most of the model's results are input-dependent (meaning the final price depends heavily on how we derive the pricing inputs).[24] Therefore it is common that OTC derivatives are priced by Independent Agents that both counterparties involved in the deal designate upfront (when signing the contract).

[edit] Criticism
Derivatives are often subject to the following criticisms:

[edit] Erroneous Analysis of Benefits

Economists and bankers claimed derivatives made markets safer. But instead, they made them [the markets] unstable.[25]

[edit] Hidden Tail Risk

According to Raghuram Rajan, a former chief economist of the International Monetary Fund (IMF), "... it may well be that the managers of these firms [investment funds] have figured out the correlations between the various instruments they hold and believe they are hedged. Yet as Chan and others (2005) point out, the lessons of summer 1998 following the default on Russian government debt is that correlations that are zero or negative in normal times can turn overnight to one a phenomenon they term phase lock-in. A hedged position can become unhedged at the worst times, inflicting substantial losses on those who mistakenly believe they are protected."[26]

[edit] Risk
See also: List of trading losses The use of derivatives can result in large losses because of the use of leverage, or borrowing. Derivatives allow investors to earn large returns from small movements in the underlying asset's price. However, investors could lose large amounts if the price of the underlying moves against them significantly. There have been several instances of massive losses in derivative markets, such as the following: American International Group (AIG) lost more than US$18 billion through a subsidiary over the preceding three quarters on Credit Default Swaps (CDS).[27] The US federal government then gave the company US$85 billion in an attempt to stabilize the economy before an imminent stock market crash. It was reported that the gifting of money,which came to be known as the "Back door bailout" of America's largest trading firms, was necessary because over the next few quarters the company was likely to lose more money. The loss of US$7.2 Billion by Socit Gnrale in January 2008 through mis-use of futures contracts. The loss of US$6.4 billion in the failed fund Amaranth Advisors, which was long natural gas in September 2006 when the price plummeted. The loss of US$4.6 billion in the failed fund Long-Term Capital Management in 1998. The loss of US$1.3 billion equivalent in oil derivatives in 1993 and 1994 by Metallgesellschaft AG.[28] The loss of US$1.2 billion equivalent in equity derivatives in 1995 by Barings Bank.[29] UBS AG, Switzerlands biggest bank, suffered a $2 billion loss through unauthorized trading discovered in September, 2011.[30]

This comes to a staggering $39.5 billion, the majority in the last decade after the Commodity Futures Modernization Act of 2000 was passed.

[edit] Counter party risk

Some derivatives (especially swaps) expose investors to counter party risk, or risk arising from the other party in a financial transaction. Different types of derivatives have different levels of counter party risk. For example, standardized stock options by law require the party at risk to have a certain amount deposited with the exchange, showing that they can pay for any losses; banks that help businesses swap variable for fixed rates on loans may do credit checks on both parties. However, in private agreements between two companies, for example, there may not be benchmarks for performing due diligence and risk analysis.

[edit] Large notional value

Derivatives typically have a large notional value. As such, there is the danger that their use could result in losses for which the investor would be unable to compensate. The possibility that this could lead to a chain reaction ensuing in an economic crisis was pointed out by famed investor Warren Buffett in Berkshire Hathaway's 2002 annual report. Buffett called them 'financial weapons of mass destruction.' The problem with derivatives is that they control an increasingly larger notional amount of assets and this may lead to distortions in the real capital and equities markets. Investors begin to look at the derivatives markets to make a decision to buy or sell securities and so what was originally meant to be a market to transfer risk now becomes a leading indicator.(See Berkshire Hathaway Annual Report for 2002)

[edit] Leverage of an economy's debt

Derivatives massively leverage the debt in an economy, making it ever more difficult for the underlying real economy to service its debt obligations, thereby curtailing real economic activity, which can cause a recession or even depression.[citation needed] In the view of Marriner S. Eccles, US Federal Reserve Chairman from November, 1934 to February, 1948, too high a level of debt was one of the primary causes of the Great Depression. (See Berkshire Hathaway Annual Report for 2002)

[edit] Benefits
The use of derivatives also has its benefits:

Derivatives facilitate the buying and selling of risk, and many financial professionals[who?] consider this to have a positive impact on the economic system. Although someone loses money while someone else gains money with a derivative, under normal circumstances, trading in derivatives should not adversely affect the economic system because it is not zero-sum in utility.[citation needed]

[edit] Government regulation

In the context of a 2010 examination of the ICE Trust, an industry self-regulatory body, Gary Gensler, the chairman of the Commodity Futures Trading Commission which regulates most derivatives, was quoted saying that the derivatives marketplace as it functions now "adds up to higher costs to all Americans." More oversight of the banks in this market is needed, he also said. Additionally, the report said, "[t]he Department of Justice is looking into derivatives, too. The departments antitrust unit is actively investigating 'the possibility of anticompetitive practices in the credit derivatives clearing, trading and information services industries,' according to a department spokeswoman."[31] Over-the-counter dealing will be less common as the 2010 Dodd-Frank Wall Street Reform Act comes into effect. The law mandated the clearing of certain swaps at registered exchanges and imposed various restrictions on derivatives. To implement Dodd-Frank, the CFTC developed new rules in at least 30 areas. The Commission determines which swaps are subject to mandatory clearing and whether a derivatives exchange is eligible to clear a certain type of swap contract.

[edit] Glossary

Bilateral netting: A legally enforceable arrangement between a bank and a counterparty that creates a single legal obligation covering all included individual contracts. This means that a banks obligation, in the event of the default or insolvency of one of the parties, would be the net sum of all positive and negative fair values of contracts included in the bilateral netting arrangement. Counterparty: The legal and financial term for the other party in a financial transaction. Credit derivative: A contract that transfers credit risk from a protection buyer to a credit protection seller. Credit derivative products can take many forms, such as credit default swaps, credit linked notes and total return swaps. Derivative: A financial contract whose value is derived from the performance of assets, interest rates, currency exchange rates, or indexes. Derivative transactions include a wide assortment of financial contracts including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards and various combinations thereof. Exchange-traded derivative contracts: Standardized derivative contracts (e.g., futures contracts and options) that are transacted on an organized futures exchange. Gross negative fair value: The sum of the fair values of contracts where the bank owes money to its counter-parties, without taking into account netting. This represents the maximum losses the banks counter-parties would incur if the bank defaults and there is no netting of contracts, and no bank collateral was held by the counter-parties. Gross positive fair value: The sum total of the fair values of contracts where the bank is owed money by its counter-parties, without taking into account netting. This represents the maximum losses a bank could incur if all its counter-parties

default and there is no netting of contracts, and the bank holds no counter-party collateral. High-risk mortgage securities: Securities where the price or expected average life is highly sensitive to interest rate changes, as determined by the U.S. Federal Financial Institutions Examination Council policy statement on high-risk mortgage securities. Notional amount: The nominal or face amount that is used to calculate payments made on swaps and other risk management products. This amount generally does not change hands and is thus referred to as notional. Over-the-counter (OTC) derivative contracts: Privately negotiated derivative contracts that are transacted off organized futures exchanges. Structured notes: Non-mortgage-backed debt securities, whose cash flow characteristics depend on one or more indices and / or have embedded forwards or options. Total risk-based capital: The sum of tier 1 plus tier 2 capital. Tier 1 capital consists of common shareholders equity, perpetual preferred shareholders equity with noncumulative dividends, retained earnings, and minority interests in the equity accounts of consolidated subsidiaries. Tier 2 capital consists of subordinated debt, intermediate-term preferred stock, cumulative and long-term preferred stock, and a portion of a banks allowance for loan and lease losses.

[edit] See also

Book: Finance
Wikipedia books are collections of articles that can be downloaded or ordered in print.

Derivative suit Dual currency deposit Forward contract FX Option

[edit] References
1.
^ Rubinstein, Mark (1999). Rubinstein on derivatives. Risk Books. ISBN 1899332-53-7. 2. ^ Hull, John C. (2006). Options, Futures and Other Derivatives, Sixth Edition. Prentice Hall. pp. 1. 3. ^ a b c Michael Simkovic, Secret Liens and the Financial Crisis of 2008, American Bankruptcy Law Journal, Vol. 83, p. 253, 2009 4. ^ Michael Simkovic, Bankruptcy Immunities, Transparency, and Capital Structure, Presentation at the World Bank, January 11, 2011 5. ^ Michael Simkovic, Paving the Way for the Next Financial Crisis, Banking & Financial Services Policy Report, Vol. 29, No. 3, 2010 6. ^ Kaori Suzuki and David Turner (December 10, 2005). "Sensitive politics over Japan's staple crop delays rice futures plan". The Financial Times.

http://www.ft.com/cms/s/0/d9f45d80-6922-11da-bd30-0000779e2340.html. Retrieved October 23, 2010. 7. ^ Michael Simkovic and Benjamin Kaminetzky, Leveraged Buyout Bankruptcies, the Problem of Hindsight Bias, and the Credit Default Swap Solution (August 29, 2010). Columbia Business Law Review, Vol. 2011, No. 1, p. 118, 2011 8. ^ Shirreff, David (2004). "Derivatives and leverage". Dealing With Financial Risk. USA: The Economist. p. 23. ISBN 1-57660-162-5. http://books.google.com/books? id=mwirEO_f1DkC. Retrieved 14 September 2011. 9. ^ Khullar, Sanjeev (2009). "Using Derivatives to Create Alpha". In John M. Longo. Hedge Fund Alpha: A Framework for Generating and Understanding Investment Performance. Singapore: World Scientific. p. 105. ISBN 978-981-283-465-2. http://books.google.com/books?id=uv73DVVSgAsC. Retrieved 14 September 2011. 10. ^ Don M. Chance; Robert Brooks (2010). "Advanced Derivatives and Strategies". Introduction to Derivatives and Risk Management (8th ed.). Mason, Ohio: Cengage Learning. pp. 483515. ISBN 978-0-324-60120-6. http://books.google.com/books?id=DT0nnLDMYTgC. Retrieved 14 September 2011. 11. ^ Chisolm, Derivatives Demystified (Wiley 2004) 12. ^ Chisolm, Derivatives Demystified (Wiley 2004) Notional sum means there is no actual principal. 13. ^ News.BBC.co.uk, "How Leeson broke the bank BBC Economy" 14. ^ BIS survey: The Bank for International Settlements (BIS) semi-annual OTC [derivatives market report, for end of June 2008, shows US$683.7 trillion total notional amounts outstanding of OTC derivatives with a gross market value of US$20 trillion. See also Prior Period Regular OTC Derivatives Market Statistics. 15. ^ Hull, J.C. (2009). Options, futures, and other derivatives . Upper Saddle River, NJ : Pearson/Prentice Hall, c2009 16. ^ Futures and Options Week: According to figures published in F&O Week 10 October 2005. See also FOW Website. 17. ^ "Financial Markets: A Beginner's Module". http://www.nseindia.com/education/content/module_ncfm.htm. 18. ^ "Biz.Yahoo.com". Biz.Yahoo.com. 2010-08-23. http://biz.yahoo.com/c/e.html. Retrieved 2010-08-29. 19. ^ Canter, Michael S.; Cole, Joseph B.; Sandor, Richard L. (1996). "Insurance Derivatives A New Asset Class for the Capital Markets and a New Hedging Tool for the Insurance Industry". Journal of Derivatives 4 (2): 89104. DOI:10.3905/jod.1996.407966. 20. ^ FOW.com, Emissions derivatives, 1 December 2005 21. ^ "Currency Derivatives: A Beginner's Module". http://www.nseindia.com/education/content/module_ncfm.htm. 22. ^ "Bis.org". Bis.org. 2010-05-07. http://www.bis.org/statistics/derstats.htm. Retrieved 2010-08-29. 23. ^ "Launch of the WIDER study on The World Distribution of Household Wealth: 5 December 2006". http://www.wider.unu.edu/events/past-events/2006events/en_GB/05-12-2006/. Retrieved 9 June 2009. 24. ^ Boumlouka, Makrem (2009),"Alternatives in OTC Pricing", Hedge Funds Review, 10-30-2009. http://www.hedgefundsreview.com/hedge-fundsreview/news/1560286/otc-pricing-deal-struck-fitch-solutions-pricing-partners

25.

^ Ferguson, Charles (Director) (May 16, 2010). Inside Job (Television Documentary (DVD)). Sony Pictures Classics. Event occurs at 22:58. http://www.imdb.com/title/tt1645089/. 26. ^ Raghuram G. Rajan (September 2006). "Has Financial Development Made the World Riskier?". EUROPEAN FINANCIAL MANAGEMENT (EUROPEAN FINANCIAL MANAGEMENT) 12 (4): 499533. DOI:10.1111/j.1468-036X.2006.00330.x. http://ssrn.com/abstract=923683. Retrieved January 17, 2012. 27. ^ Kelleher, James B. (2008-09-18). ""Buffett's Time Bomb Goes Off on Wall Street" by James B. Kelleher of Reuters". Reuters.com. http://www.reuters.com/article/newsOne/idUSN1837154020080918. Retrieved 2010-0829. 28. ^ Edwards, Franklin (1995), "Derivatives Can Be Hazardous To Your Health: The Case of Metallgesellschaft", Derivatives Quarterly (Spring 1995): 817, http://www0.gsb.columbia.edu/faculty/fedwards/papers/DerivativesCanBeHazardous.pdf 29. ^ Whaley, Robert (2006). Derivatives: markets, valuation, and risk management. John Wiley and Sons. p. 506. ISBN 0-471-78632-2. http://books.google.com/books? id=Hb7xXy-wqiYC&printsec=frontcover&cad=0#v=onepage&q&f=false. 30. ^ http://www.businessweek.com/news/2011-09-15/ubs-loss-shows-banks-fail-tolearn-from-kerviel-leeson.html 31. ^ Story, Louise, "A Secretive Banking Elite Rules Trading in Derivatives", The New York Times, December 11, 2010 (December 12, 2010 p. A1 NY ed.). Retrieved 2010-12-12.

[edit] Further reading

Hull, John C. (2011). Options, Futures and Other Derivatives (8th ed.). Harlow: Pearson Education. ISBN 9780132604604. Durbin, Michael (2011). All About Derivatives (2nd ed.). New York: McGraw-Hill. ISBN 978-0-07-174351-8. Mattoo, Mehraj (1997). Structured Derivatives: New Tools for Investment Management: A Handbook of Structuring, Pricing & Investor Applications. London: Financial Times. ISBN 0-273-61120-8.

[edit] External links

BBC News Derivatives simple guide The Gamma Trader Financial Options Guide European Union proposals on derivatives regulation 2008 onwards Derivatives in Africa Derivatives Litigation Interest rate Derivatives explained simply Exchange Traded Derivatives

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sector units and corporate institutions. 3 Bachelors: Sharman Joshi gets legal notice USE is India? newest stock exchange for Watch: The trailer of Ajith Kumar's 'Billa 2' s currency derivatives. The exchange offers a Topless pic of singer angers Indians in better platform to corporates and SMEs for Australia managing forex risk as spread rates in an See: The first ever photo of an atom's shadow exchange are better and it does not involve Google to kill iGoogle, Symbian search app Twitter helps find lost dog any counter party risk. Review: Renault Duster SUV in India All 21 Indian public sector banks have Federer sets Djokovic clash in Wimbledon promoted United Stock Exchange by investing in equity which include Allahabad semis Bank, Andhra Bank, Bank of Baroda, Bank Paes-Vesnina reach mixed-doubles pre-quarters Chhetri joins Sporting Clube de Portugal B side of India, Bank of Maharashtra, Canara Bank, Central Bank of India, Corporation Brazil slump to record low in FIFA rankings Bank, Dena Bank, IDBI Bank, Indian Bank, Indian Overseas Bank, Oriental Bank of Commerce, Punjab and Sind Bank, Punjab National Bank, State Bank of India, Syndicate Bank, UCO Bank, Union Bank of From DJ EU Officials Spain Aid Cap Of 100 India, United Bank of India, Vijaya Bank. Bn Euros 'should Be Enough' In addition to public sector banks, 5 private The latest earning numbers FIRST on CNBCsector banks have also an equity TV18 participation in USE; they include Axis Bank, Federal Bank, HDFC Bank, ICICI Videos Bank and J&K Bank. Apart from banks, Jaypee Capital, MMTC and Indian Potash have also invested in United Stock Exchange to build an institution that is on its way to becoming an Jul 5 2012, 09:40 enduring symbol of India? modern s Take bullish positions if Nifty breaks 5320financial markets. Bombay Stock Exchange is also a strategic 5330: Sukhani partner with USE as it holds a 15% stake - in Technicals and all its members are connected to the new USE platform. It has clocked volumes of Rs 45,485.97 crore on first day of trading -United Stock Exchange of India has gained Jul 5 2012, 09:40 a 52% market share in the segment -Leader in all 4 currency pairs individually ?Experts bullish on gold, silver, natural gas & USD-INR; EUR-INR, JPY-INR, GBP-INR aluminium -Surpassed highest first day volume in any - in Commodities Interviews currency futures exchange within 10 minutes of trading (73955 contracts @ 9:10 AM) -Volumes: Rs 45,485.97 crore (USD 9.97 billion)

-USD INR: 44,394 crore Jul 4 2012, 21:52 | Source: CNBC-TV18 -EUR INR: 242.55 crore US 'bring jobs home' act a concern for Indian I-GBP INR: 551.72 crore T: Experts -JPY INR: 218.12 crore -Became the number one stock exchange in the currency derivatives segment in terms of volume by 11:00AM (1434421 contracts 1.43 million) -Surpassed the highest volume in a single trading day by any exchange in Jul 4 2012, 21:50 | Source: CNBC-TV18 the currency derivatives segment at 13:31 Need UK-like policy on managerial pay disclosure: Minister (5.5 million contracts, USD 5billion, Rs Corporate Announcements 25523 crore was previous record) see all Top 5 Mutual Funds All Indian Fund Houses Top Performing. Worst Performing www.fundsupermart.co.in 1/2/3 BHK Flats For Sale Buy Or Sell Flats! 30000+ New Bank Approved Flats IndiaProperty.com/Mumbai Ads by Google Subscribe to PREVIOUS STORY Moneycontrol Newsletters Buy Alkyl Amines; target of Rs 111: Top of Form Firstcall Research NEXT STORY Air India pilots strike ends after two months Moneycontrol.com offers you a choice of various sectoral and other newsletters for Top of Form FREE! Bottom of Form Post Your Comments Have an opinion on this news? Post your comment here.

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action lift mood? Asian shares ease from rally before ECB decision Bull's Eye Buy Arvind, Voltas, Jaypee Infra, HCC Porsche, Volkswagen agree to speed up merger Shanthi Gears up 5% on possible stake sale news No bottom in sight for China coal prices Analyst Multiplayer games for your smartphone Ganeshaspeaks Market prediction for July 05 Gold stays put ahead of ECB, ignores firm dollar Sensex, Nifty open flat; Rupee falls 1% to 55/$ Another day of consolidation Mohit Gaba Nikkei flat ahead of ECB move, capped below resistance Tags: United Stock Exchange of India, USE, currency derivatives Follow moneycontrol.com Facebook Twitter Google Plus RSS Wap SMS SMS Alert iPad iPhone Blackberry OVI Android Window Explore Moneycontrol STOCKS A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z | Others MUTUAL FUNDS A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U |V|W|X|Y|Z News | Markets | IPO | Technicals | Mutual Fund | Commodities | Best Portfolio Manager | Bse Sensex | Bombay Stock Exchange | Share Market Live | Commodities Price | Silver Price/Rate in India | Gold Price/Rate in India | Crude Oil | USD to INR | National Stock Exchange | Bank Fixed Deposits | Company Fixed Deposits | Small Savings Schemes | Bonds | Unit Linked Insurance Plans (ULIPs) | Rss Feeds | Budget: 2008, 2009, 2010, 2011, 2012 | Intuit Money Manager | RBI Credit Policy | News Archive | BSE A Group Companies | BSE B Group Stocks | Financial Glossary | Message Board | Moneybhai | Latest Movie Songs | Business Yellow Pages | India's Premiere Technology Guide | History India | Latest News | IBNLive News | News in Hindi | Cricket News | Latest Videos | Jhalak Dikhhla Jaa | Business Technology News & Videos | Hawker Beechcraft | Air India | BSE Sensex | Generic drug | L and T | Rapid transit | CIL IPO | Wheat | PMI | Anand Mahindra Site Map | About Us | Contact Us | Advertise | Bookmark | Disclaimer | Privacy Statement | Terms of Use | Careers

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USE commences operations in currency derivatives

United Stock Exchange of India (USE) today commenced operations in the august presence of C B Bhave, Chairman of Securities and Exchange Board of India (SEBI) and Smt Shyamala Gopinath, Deputy Governor, Reserve Bank of India (RBI) at the BSE International Convention Hall in Mumbai. With the exchange going live at 9.00 am, trading began in all four currency pairs currently allowed by the Securities and Exchange Board of India i.e. USD-INR, EURO-INR, JPY-INR, GBP-INR. United Stock Exchange commenced operations at 9.00 am with 251 SEBI approved members as well as a robust support from all 21 Indian public sector banks, leading private sector banks, public sector units and corporate institutions. USE is India? newest stock exchange for currency s derivatives. The exchange offers a better platform to corporates and SMEs for managing forex risk as spread rates in an exchange are better and it does not involve any counter party risk.

Nifty
BSE

| NSE 05/07/12

Are Mutual Funds betting on Nifty?

All 21 Indian public sector banks have promoted United Stock Exchange by investing in equity which include Allahabad Bank, Andhra Bank, Bank of Baroda, Bank of India, Bank of Maharashtra, Canara Bank, Central Bank of India, Corporation Bank, Dena Bank, IDBI Bank, Indian Bank, Indian Overseas Bank, Oriental Bank of Commerce, Punjab and Sind Bank, Punjab National Bank, State Bank of India, Syndicate Bank, UCO Bank, Union Bank of India, United Bank of India, Vijaya Bank. In addition to public sector banks, 5 private sector banks have also an equity participation in USE; they include Axis Bank, Federal Bank, HDFC Bank, ICICI Bank and J&K Bank.

Apart from banks, Jaypee Capital, MMTC and Indian Potash have also invested in United Stock Exchange to build an institution that is on its way to becoming an enduring symbol of India? modern financial markets. s Bombay Stock Exchange is also a strategic partner with USE as it holds a 15% stake and all its members are connected to the new USE platform. It has clocked volumes of Rs 45,485.97 crore on first day of trading -United Stock Exchange of India has gained a 52% market share in the segment -Leader in all 4 currency pairs individually ? USD-INR; EUR-INR, JPY-INR, GBP-INR -Surpassed highest first day volume in any currency futures exchange within 10 minutes of trading (73955 contracts @ 9:10 AM) -Volumes: Rs 45,485.97 crore (USD 9.97 billion) -USD INR: 44,394 crore -EUR INR: 242.55 crore -GBP INR: 551.72 crore -JPY INR: 218.12 crore -Became the number one stock exchange in the currency derivatives segment in terms of volume by 11:00AM (1434421 contracts 1.43 million) -Surpassed the highest volume in a single trading day by any exchange in the currency derivatives segment at 13:31 (5.5 million contracts, USD 5billion, Rs 25523 crore was previous record)

Why Firms Use Currency Derivatives (Citations: 329)

CHRISTOPHER GECZY, BERNADETTE A. MINTON, CATHERINE SCHRAND
We examine the use of currency derivatives in order to differentiate among existing theories of hedging behavior. Firms with greater growth opportunities and tighter financial constraints are more likely to use currency derivatives. This result suggests that firms might use derivatives to reduce cash flow variation that might otherwise preclude firms from investing in valuable growth opportunities. Firms with extensive foreign exchange-rate exposure and economies of scale in hedging activities are also more likely to use currency derivatives. Finally, the source of foreign exchange-rate exposure is an important factor in the choice among types of currency derivatives. LARGE U.S. CORPORATIONS INCREASINGLY turn to derivatives to reduce their expo- sures to a variety of risks. The motives for this behavior are not well under- stood, and the empirical evidence on the characteristics of derivatives users is limited. However, theoretical research provides several explanations for opti- mal hedging that result from different types of capital market imperfections. To distinguish among these explanations, we examine the use of currency derivatives for a sample of firms that have ex ante exposure to foreign ex- change-rate risk. We also consider how the magnitude of this exposure affects the level of benefits that can be realized from reducing risk and the costs associated with risk reduction. Our sample represents 372 of the Fortune 500 nonfinancial firms in 1990. All of our sample firms have potential exposure to foreign

currency risk from foreign operations, foreign-denominated debt, or a high concentration of foreign competitors in their industries. Approximately 41 percent of these firms use currency swaps, forwards, futures, options, or combinations of these in- struments. We find that firms with greater growth opportunities and tighter financial constraints are more likely to use currency derivatives. This result is consistent with the notion that firms use derivatives to reduce the variation in

Published in 1997.

United Stock Exchange (USE) A Currency Derivatives Trading Platform

ADVERTISEMENTS

United Stock Exchange (USE), a new exchange promoted by 21 public sector banks, 5 private banks and 3 trading firms began its operations from yesterday (September 20th 2010). At present it offers a platform for trading currency derivatives to Corporates and Small and Medium Enterprises. The main aim of USE is to provide a sophisticated, new age trading platform for Indian markets and also aims to become one of the best exchanges which provide world class trading platforms. It would start operations in all types of financial instruments, going forward. Bombay Stock exchange, Asias oldest exchange, is a strategic partner with United Stock Exchange with 15% stake. USE hopes BSEs expertise in exchange technology, clearing & settlement, regulatory structure and governance would help become a leading exchange of future. USE offers currency derivatives in 4 currencies viz. INR (Indian Ruppe) vs USD INR vs EUR INR vs GBP (Great Britain Pound Sterling) INR vs JPY (Japanese Yen) The RBI fixed the below exchange rates for reference. Underlying RBI Ref rate USD 45.7300 EUR 59.8400 GBP 71.2405 JPY 53.4400 / 100 Yen The Corporates will use the platform for entering currency future contracts to hedge against the risk of uncertainty in foreign exchange rates. On the first day itself it captured a market share of 52%, giving hints of becoming a single major source for trading currency derivatives in the coming days.

Currency Derivatives and Futures Trading

Welcome to Currency Derivatives Trading

Indian investors can now add one more 'investment option' to their portfolio Currency Derivatives. Regulatory approval f recently made available (Aug 2008) and this allows exchanges in India to launch currency derivatives for trading, similar t derivatives

With the launch of currency derivatives in India through stock exchanges, there would be a dynamic shift in currency tr Indian entity would be able to take positions on the external value of the rupee without having an underlying foreign curre enhance overall efficiency of the currency market through transparency in pricing, increasing investor base and opportunities to invest and eliminating counter-party FAQs to understand the basics of this market: Q) Who can use / participate currency derivatives trading ?

A) As per current regulation, the following entities can participate in 1. Indian 2. Corporates registered in India (particularly those that involve dealing in foreign currency due to t 3. Domestic / Indian Financial Institutions As of now, the regulation does not allow Foreign Institutional Investors (FII) and Non-Resident Indian (NRI) to participate i Q) What is the contract size / specification? A) A contract will have the following basic 1. Size 2. Minimum price fluctuation / tick 3. Period / term of contract 4. Expiry date & time last business day of the month Q) What are market timing for trading in currency derivatives? A) Market time would be from IST 9 am to IST 5 pm. Q) How will the order placement mechanism work? A) Order will be market driven just like in an equity market (prioritized on time & rate basis). Q) How would the Risk Management System work in currency derivatives trading for a client? specifications, USDINR example has US Dollar size Rupee 0.0025 for 12 near

1,0 or c

A) A client would need to have adequate margin for any order / trade. Basic margin requirement calculation will take into a 1. 2. Standardized Portfolio Analysis of Risk (SPAN), Initial margin a. Minimum Initial margin of 1.75% on day of trade and thereafter 1% b. Calendar spread margin defined by exchange(s) at Rs 250/c. Any additional margin, if & as notified by the exchange Extreme Loss Margin a. 1% of value of gross open positions b. Any additional margin, if & as notified by the exchange Position Limits a. 6% of total open interest or US Dollar 5 million, whichever is higher Member-broker specified margin a.

3. 4. 5.

As per any requirement of the member-broker, client to need to have additional margin as specified by the

Q) How will daily billing be done?

A) Daily billing will be done, based on client trades and open position, the financial ledger of client account for mark-to-ma along with margin requirements (similar to equity derivatives). Client would have to make up for such requirements upfro each billing cycle) as per specification of the member-broker. The daily clearing and settlement process would take into position computation, daily settlement price for outstanding position contract(s) and MTM. Q) How will settlement of the contract take place?

A) An Open contract will be settled on the relevant expiry date (as per contract specification) in cash (in Indian rup reference rate. The final / expiry day clearing and settlement process would take into account final day settlement price contract(s). Q) How can a participant register for trading in currency derivatives in India?

Why Firms Use Currency Derivatives

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Geczy, Christopher Minton, Bernadette A Schrand, Catherine

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Abstract
The authors examine the use of currency derivatives in order to differentiate among existing theories of hedging behavior. Firms with greater growth opportunities and tighter financial constraints are more likely to use currency derivatives. This result suggests that firms might use derivatives to reduce cash flow variation that might otherwise preclude firms from investing in valuable growth opportunities. Firms with extensive foreign exchange-rate exposure and economies of scale in hedging activities are also more likely to use currency derivatives. Finally, the source of foreign exchange-rate exposures is an important factor in the choice among types of currency derivatives. Copyright 1997 by American Finance Association.

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Article provided by American Finance Association in its journal Journal of Finance. Volume (Year): 52 (1997) Issue (Month): 4 (September) Pages: 1323-54 Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF Handle: RePEc:bla:jfinan:v:52:y:1997:i:4:p:1323-54 Contact details of provider: Web page: http://www.afajof.org/ More information through EDIRC Order Information: Web: http://www.afajof.org/membership/join.asp For corrections or technical questions regarding this item, or to correct its listing, contact: JDL@wiley.com (Wiley-Blackwell Digital Licensing) or baum@bc.edu (Christopher F. Baum).

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