LALA LAJPATRAI COLLEGE OF

COMMERCE & ECONOMICS

SUBJECT
FINANCIAL MARKETS

TOPIC
CURRENCY DERIVATIVES

SYBBI

GROUP-5
 SUBMITTED BY

MEMBERS NO.

KUSHANT JAIN 910302

MOZZAM SAYED 910303
JATIN JAIN 910316
KIRAN JAIN 910317
SURBHI MALANI 910325
CHIRAG VORA 910345
PRACHI SAKARIA 910347
 CURRENCY
DERIVATIVES
 ACKNOWLEDGEMENT

We sincerely thank all our group members for

giving us time for the project. We also thank our
professor who helped us in this project.

The purpose of making this project is to gain

knowledge about the Currency Derivatives.

We kindly acknowledge our Professor who gave us

the best topic.
 Currency Derivatives
A derivative is a financial instrument that is derived from some
other asset, index, event, value or condition (known as the underlying
asset).

The Underlying Securities for Derivatives are :

Commodities: Castor seed, Grain, Pepper, Potatoes, etc.

Precious Metal: Gold, Silver

Short Term Debt Securities: Treasury Bills

Interest Rates

Common shares/stock

Stock Index Value: NSE Nifty

Currency: Exchange Rate
 INTRODUCTION TO CURRENCY
DERIVATIVES
Each country has its own currency through which both national
and international transactions are performed. All the international
business transactions involve an exchange of one currency for
another.
For example, if any Indian firm borrows funds from
international financial market in US dollars for short or long term then
at maturity the same would be refunded in particular agreed currency
along with accrued interest on borrowed money. It means that the
borrowed foreign currency brought in the country will be converted
into Indian currency, and when borrowed fund are paid to the lender
then the home currency will be converted into foreign lender’s
currency. Thus, the currency units of a country involve an exchange
of one currency for another.
The price of one currency in terms of other currency is known as
exchange rate.

EXCHANGE RATE
It is way of expressing one country’s currency in terms of other
country’s currency. Factors affecting exchange rates are as follows:
• Balance of Payment:
If there is BOP deficit, then your own country would require foreign
currency & thus depreciating the value of your own currency.
• Interest rates:
If the interest rates in your currency are high, that will attract foreign
currency & will help in appreciating your own currency.
• Speculation:
If the exchange rate falls, then the speculators may speculate that the
exchange rate will fall further & may sell the currency, bringing down
the exchange rate further.
The foreign exchange markets of a country provide the
mechanism of exchanging different currencies with one and another,
and thus, facilitating transfer of purchasing power from one country to
another.
With the multiple growths of international trade and finance all
over the world, trading in foreign currencies has grown tremendously
over the past several decades.
Since the exchange rates are continuously changing, so the firms
are exposed to the risk of exchange rate movements. As a result the
assets or liability or cash flows of a firm which are denominated in
foreign currencies undergo a change in value over a period of time
due to variation in exchange rates.
This variability in the value of assets or liabilities or cash flows
is referred to exchange rate risk. Since the fixed exchange rate system
has been fallen in the early 1970s, specifically in developed countries,
the currency risk has become substantial for many business firms. As
a result, these firms are increasingly turning to various risk hedging
products like foreign currency futures, foreign currency forwards,
foreign currency options, and foreign currency swaps.
 KINDS OF CURRENCY DERIVATIVES
Financial derivatives are those assets whose values are
determined by the value of some other assets, called as the
underlying.
One form of classification of derivative instruments is between
commodity derivatives and financial derivatives. The basic difference
between these is the nature of the underlying instrument or assets. In
commodity derivatives, the underlying instrument is commodity
which may be wheat, cotton, pepper, sugar, jute, turmeric, corn, crude
oil, natural gas, gold, silver and so on. In financial derivative, the
underlying instrument may be treasury bills, stocks, bonds, foreign
exchange, stock index, cost of living index etc.
It is to be noted that financial derivative is fairly standard and
there are no quality issues whereas in commodity derivative, the
quality may be the underlying matters.
In the simple form, the derivatives can be classified into
different categories which are shown below:

DERIVATIVES

Financials Commodities

Basics Complex
1. Forward 1.Swaps
2. Futures
3. Options
 Presently there are Complex varieties of derivatives already in
existence and the markets are innovating newer and newer ones
continuously. For example, various types of financial derivatives
based on their different properties like, plain, simple or
straightforward, composite, joint or hybrid, synthetic, leveraged,
mildly leveraged, OTC traded, standardized or organized exchange
traded, etc. are available in the market. Due to complexity in nature,
it is very difficult to classify the financial derivatives, so in the present
context, the basic financial derivatives which are popularly in the
market have been described.

Derivative contracts have several variants. The most common variants

are forwards, futures, options and swaps. We take a brief look at
various derivatives contracts that have come to be used.

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

Features:
a. Standardized & exchange traded, Contract size (USD 100),
Initial margin (amt of money to be deposited for taking a
position), Maintenance margin (minimum amt of money to be
kept in the account)
b. Long position in futures: Buy the base currency (USD) & sell
the terms currency as you are expecting the base currency to
rise in value.
c. Short position in futures: Buy terms currency & sell base
currency.(Hedging means to take an opposite position in futures
market to the position in physical market)

CURRENCY OPTIONS :
Currency option is a financial instrument that give the option
holder a right and not the obligation, to buy or sell a given amount of
foreign exchange at a fixed price per unit for a specified time period
(until the expiration date ).
In other words, a foreign currency option is a contract for future
delivery of a specified currency in exchange for another in which
buyer of the option has to right to buy (call) or sell (put) a particular
currency at an agreed price for or within specified period. The seller
of the option gets the premium from the buyer of the option for the
obligation undertaken in the contract.
Options generally have lives of up to one year; the majority of options
traded on options exchanges having a maximum maturity of nine
months. Longer dated options are called warrants and are generally
traded OTC.

CURRENCY SWAP :
Swap is private agreements between two parties to exchange
cash flows in the future according to a prearranged formula. They can
be regarded as portfolio of forward contracts.
The currency swap entails swapping both principal and interest
between the parties, with the cash flows in one direction being in a
different currency than those in the opposite direction.
There are a various types of currency swaps like as fixed-to-fixed
currency swap, floating to floating swap, fixed to floating currency
swap.
In a swap normally three basic steps are involve:
(1) Initial exchange of principal amount
(2) Ongoing exchange of interest
(3) Re - exchange of principal amount on maturity.
 FOREIGN EXCHANGE SPOT (CASH)
MARKET
The foreign exchange spot market trades in different currencies
for both spot and forward delivery. Generally they do not have
specific location, and mostly take place primarily by means of
telecommunications both within and between countries.

It consists of a network of foreign dealers which are often banks,

financial institutions, large concerns, etc. The large banks usually
make markets in different currencies.

In the spot exchange market, the business is transacted

throughout the world on a continual basis. So it is possible to
transaction in foreign exchange markets 24 hours a day. The standard
settlement period in this market is 48 hours, i.e., 2 days after the
execution of the transaction.

The spot foreign exchange market is similar to the OTC market

for securities. There is no centralized meeting place and no fixed
opening and closing time.

Since most of the business in this market is done by banks,

hence, transaction usually do not involve a physical transfer of
currency, rather simply book keeping transfer entry among banks.

Exchange rates are generally determined by demand and supply

force in this market. The purchase and sale of currencies stem partly
from the need to finance trade in goods and services. Another
important source of demand and supply arises from the participation
of the central banks which would emanate from a desire to influence
the direction, extent or speed of exchange rate movements.
 FOREIGN EXCHANGE QUOTATIONS
Foreign exchange quotations can be confusing because
currencies are quoted in terms of other currencies. It means exchange
rate is relative price.
For example, if one US dollar is worth of Rs. 45 in Indian
rupees then it implies that 45 Indian rupees will buy one dollar of
USA, or that one rupee is worth of 0.022 US dollar which is simply
reciprocal of the former dollar exchange rate
EXCHANGE RATE
Direct Indirect
The numbers of units of domestic The number of unit of
currency stated against one unit foreign currency per unit of
of foreign currency currency.

Most countries use the direct method. In global foreign

exchange market, two rates are quoted by the dealer: one rate for
buying (bid rate), and another for selling (ask or offered rate) for a
currency. This is a unique feature of this market. It should be noted
that where the bank sells dollars against rupees, one can say that
rupees against dollar. In order to separate buying and selling rate, a
small dash or oblique line is drawn after the dash.
For example, If US dollar is quoted in the market as Rs
46.3500/3550, it means that the forex dealer is ready to purchase the
dollar at Rs 46.3500 and ready to sell at Rs 46.3550. The difference
between the buying and selling rates is called spread.
It is important to note that selling rate is always higher than the
buying rate. Traders, usually large banks, deal in two way prices,
both buying and selling, are called market
Base Currency/ Terms Currency:
In foreign exchange markets, the base currency is the first
currency in a currency pair. The second currency is called as the
terms currency. Exchange rates are quoted in per unit of the base
currency. That is the expression Dollar-Rupee, tells you that the
Dollar is being quoted in terms of the Rupee. The Dollar is the base
currency and the Rupee is the terms currency.
Exchange rates are constantly changing, which means that the
value of one currency in terms of the other is constantly in flux.
Changes in rates are expressed as strengthening or weakening of one
currency vis-à-vis the second currency.
Changes are also expressed as appreciation or depreciation of
one currency in terms of the second currency. Whenever the base
currency buys more of the terms currency, the base currency has
strengthened / appreciated and the terms currency has weakened /
depreciated.
For example, If Dollar – Rupee moved from 43.00 to 43.25.
The Dollar has appreciated and the Rupee has depreciated. And if it
moved from 43.0000 to 42.7525 the Dollar has depreciated and Rupee
has appreciated.
 Global Currency Derivatives
Many of the most popular futures markets that are based upon
currencies include the following:
· EUR - The Euro to US Dollar currency future
· GBP - The British Pound to US Dollar currency future
· CHF - The Swiss Franc to US Dollar currency future
· AUD - The Australian Dollar to US Dollar currency future
· CAD - The Canadian Dollar to US Dollar currency future
· RP - The Euro to British Pound currency future
· RF - The Euro to Swiss Franc currency future
Other currencies in futures are South African Rand, Hungarian Forint,
Polish, Zloty, Czech Koruna, Brazilian Real, and Swedish Krona
 FUTURE TERMINOLOGY

SPOT PRICE :
The price at which an asset trades in the spot market. The
transaction in which securities and foreign exchange get traded for
immediate delivery. Since the exchange of securities and cash is
virtually immediate, the term, cash market, has also been used to refer
to spot dealing. In the case of USDINR, spot value is T + 2.

FUTURE PRICE :
The price at which the future contract traded in the future
market.

CONTRACT CYCLE :
The period over which a contract trades. The currency future
contracts in Indian market have one month, two month, and three
month up to twelve month expiry cycles. In NSE/BSE will have 12
contracts outstanding at any given point in time.

VALUE DATE / FINAL SETTELMENT DATE :

The last business day of the month will be termed the value date
/final settlement date of each contract. The last business day would
be taken to the same as that for inter bank settlements in Mumbai.
The rules for inter bank settlements, including those for ‘known
holidays’ and would be those as laid down by Foreign Exchange
Dealers Association of India (FEDAI).

EXPIRY DATE :
It is the date specified in the futures contract. This is the last
day on which the contract will be traded, at the end of which it will
cease to exist. The last trading day will be two business days prior to
the value date / final settlement date.

CONTRACT SIZE :
The amount of asset that has to be delivered under one contract.
Also called as lot size. In case of USDINR it is USD 1000.

BASIS :
In the context of financial futures, basis can be defined as the
futures price minus the spot price. There will be a different basis for
each delivery month for each contract. In a normal market, basis will
be positive. This reflects that futures prices normally exceed spot
prices.

COST OF CARRY :
The relationship between futures prices and spot prices can be
summarized in terms of what is known as the cost of carry. This
measures the storage cost plus the interest that is paid to finance or
‘carry’ the asset till delivery less the income earned on the asset. For
equity derivatives carry cost is the rate of interest.

INITIAL MARGIN :
When the position is opened, the member has to deposit the
margin with the clearing house as per the rate fixed by the exchange
which may vary asset to asset. Or in another words, the amount that
must be deposited in the margin account at the time a future contract
is first entered into is known as initial margin.

MARKING TO MARKET :
At the end of trading session, all the outstanding contracts are
reprised at the settlement price of that session. It means that all the
futures contracts are daily settled, and profit and loss is determined on
each transaction. This procedure, called marking to market, requires
that funds charge every day. The funds are added or subtracted from
a mandatory margin (initial margin) that traders are required to
maintain the balance in the account. Due to this adjustment, futures
contract is also called as daily reconnected forwards.

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

TRADER TRADER

(BUYER) (SELLER)

Purchase order Sales order

Transaction on the floor

MEMBER (Exchange) MEMBER

(BROKER) (BROKER)

Informs

CLEARING

HOUSE

It has been observed that in most futures markets, actual physical

delivery of the underlying assets is very rare and hardly has it ranged
from 1 percent to 5 percent. Most often buyers and sellers offset their
original position prior to delivery date by taking an opposite positions.

This is because most of futures contracts in different products are

predominantly speculative instruments. For example, X purchases
American Dollar futures and Y sells it. It leads to two contracts, first,
X party and clearing house and second Y party and clearing house.
Assume next day X sells same contract to Z, then X is out of the
picture and the clearing house is seller to Z and buyer from Y, and
hence, this process is goes on.
 Currency Futures in India
Product Specifications:

• Underlying: Initially, currency futures contracts on US Dollar –

Indian Rupee (US$-INR) would be permitted.

• Trading Hours: The trading on currency futures would be

available from 9 a.m. to 5 p.m.

• Size of the contract: The minimum contract size of the

currency futures contract at the time of introduction would be US$
1000. The contract size would be periodically aligned to ensure that
the size of the contract remains close to the minimum size.

• Quotation: The currency futures contract would be quoted in

rupee terms. However, the outstanding positions would be in dollar
terms.

• Tenor of the contract: The currency futures contract shall have

a maximum maturity of 12 months.

• Available contracts: All monthly maturities from 1 to 12

months would be made available.

• Settlement mechanism: The currency futures contract shall be

settled in cash in Indian Rupee.

• Settlement price: The settlement price would be the Reserve

Bank Reference Rate on the date of expiry. The methodology of
computation and dissemination of the Reference Rate may be publicly
disclosed by RBI.
• Final settlement day: The currency futures contract would
expire on the last working day (excluding Saturdays) of the month.
The last working day would be taken to be the same as that for
Interbank Settlements in Mumbai. The rules for Interbank
Settlements, including those for ‘known holidays’ and ‘subsequently
declared holiday’ would be those as laid down by FEDAI.

USES OF CURRENCY FUTURES:

HEDGING:
It means Protection. Like futures contracts, forward
contracts can be used for hedging. Suppose an Indian Company
knows that it is due to pay Rs.10, 00,000 in 90 days and the 90
days forward rate is 1.8381. It can choose at no cost to enter into
a long forward contract to buy rs.10, 00,000 in 90 days for Rs.
18,38,100. In this way, it hedges its foreign exchange risk by
locking in the exchange rate that will apply to the sterling it
requires.
Similarly, a Indian company that knows it is due to receive
Rs.10,00,000 in 90 days can at no cost enter into a short forward
contract to sell Rs.10,00,000 in 90 days for Rs.18,38,100. In this
way, it hedges its foreign exchange risk by locking in the price
that will apply to the sterling it receives.

SPECULATION:
Forward contracts can be used for speculation as well as
hedging. An investor who thinks that sterling will increase in
value relative to the Indian rupee, can speculate by taking a long
position in a forward contract on sterling. Similarly, an investor
who feels that sterling will fall in value can speculate by taking
a short position in a forward contract on sterling. Their aim is to
use futures markets to reduce a particular risk that they face.

For Example consider a company that knows it will gain

Rs. 10,000 for each Paisa increase in the price of a commodity
over the next three months and lose Rs. 10,000 for each paisa
decrease in its price during this period. The futures position
should lead to a loss of Rs.10, 000 for each paisa increase in the
price of the commodity over the three months and a gain of
Rs.10, 000 for each paisa decrease in its price during the period.

If the price of the commodity goes down, the gain on the

futures position offsets the loss on the rest of the company’s
business. If the price of the commodity goes up, the loss on the
futures position is offset by the gain on the rest of the company
business.
 Advantages of Currency Futures Market:

• Decent intraday volatility

There is an opportunity for the intraday traders to make short
term profits as the median intraday volatility for the last 6 months on
NSE has been about 43 paise. On the MCX, the median trading range
has been wider at about 52 paise. Traders can capitalize on the same
and make intraday profits.

• Lower Margins
The margins on the trades on NSE have been reduced. At the
start of the currency futures trading on NSE, the margins per contract
were about Rs.2900, which have been reduced by about 50%. This
works out to 3-3.5% of contract value compared to average10-15% on
index/stock futures.

• Low Brokerage charges

The brokerage charges vary between 3 to 10 bps depending on
volumes and squaring up period.

• Easy to trade
Since the contract is exchange traded, it is easy to trade and also
it smoothens the transaction process.

• Transparency
The futures market is transparent as compared to the OTC
market, as the exchange guarantees the settlement process.
 REGULATIONS

CDX (Currency Derivative Exchange), currency derivative

segment of BSE (Bombay Stock Exchange) commenced currency
futures trading from 1st October. BSE on its very first day of trading
in currency futures clocked a turnover of about 65,000 contracts,
which is approximately Rs. 300 Crores.

With ever-growing global financial crisis, exchange rates are

fluctuating widely. INR exchange rate has touched 47 against USD.
Currency futures trading in India has generated huge interest among
Indian retail investors and traders. There is a strong demand for
information gathering about the intricacies of currency futures from
small investors and enterprises.
 CONCLUSIONS
By far the most significant event in finance during the past
decade has been the extraordinary development and expansion of
financial derivatives…These instruments enhances the ability to
differentiate risk and allocate it to those investors most able and
willing to take it- a process that has undoubtedly improved national
productivity growth and standards of livings.
The currency future gives the safe and standardized contract to its
investors and individuals who are aware about the forex market or
predict the movement of exchange rate so they will get the right
platform for the trading in currency future. Because of exchange
traded future contract and its standardized nature gives counter party
risk minimized.
Initially only NSE had the permission but now BSE and MCX
has also started currency future. It is shows that how currency future
covers ground in the compare of other available derivatives
instruments. Not only big businessmen and exporter and importers
use this but individual who are interested and having knowledge
about forex market they can also invest in currency future.
Exchange between USD-INR markets in India is very big and
these exchange traded contract will give more awareness in market
and attract the investors.
 BIBLIOGRAPHY
Financial Services - S. Mohan

Websites:
www.sebi.gov.in
www.rbi.org.in
www.wikipedia.com