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UNDERSTANDING

CURRENCY FUTURES
Futures Contract

• Standardized derivative contract


• Traded on recognized exchanges
• Price and date of delivery-predetermined
• Margin requirements
• Eliminates counterparty risk
• Transparency in pricing
• Settlement through Clearing house
Currency Futures
•Standardized foreign exchange derivative contract
•Traded on a recognized exchange
•Underlying is the exchange rates
•Traded in limited number of currencies
•Price and date of delivery-predetermined
History of Currency futures
• First Currency futures- Chicago Mercantile Exchange
(CME) in 1972

• International Monetary Market (IMM) launched trading in


seven currency futures on May 16, 1972

• As per the latest BIS report, the OTC market accounts for
more than $3 trillion of currency trading every day; this
compares with the notional principal of $72 billion traded on
exchanges.
Currency futures in India
• Currency futures trading was started in Mumbai August 29,
2008.
• With over 300 trading members including 11 banks
registered in this segment, the first day saw a very lively
counter, with nearly 70,000 contracts being traded.
• The first trade on the NSE was by East India Securities Ltd.
• Amongst the banks, HDFC Bank carried out the first trade.
The largest trade was by Standard Chartered Bank
constituting 15,000 contracts. Banks contributed 40 percent of
the total gross volume.
• Traded in BSE, NSE and MCX exchanges
Features of Currency Futures
• Only USD-INR contracts are allowed to be traded.

• Standardized contract size - $1000.

• The contracts quoted and settled in Indian Rupees.

• The maturity of the contracts shall not exceed 12 months.

• Settled on specified future date called as settlement date.

• Only resident Indians are allowed to trade in currency futures.

• Future price= Spot Price + Cost of Carry.


Hedging with Currency Futures
• Importer buys the required currency futures contract, “locks
in” a price for the purchase of foreign currency

• Exporter sells the expected currency futures contract, thus


“locks in” a price for the sale of foreign currency
Imperfections in hedging with Currency
Futures
• Maturity mismatch
– Mismatch in maturity date of futures contract and date of
cash transaction
• Size mismatch
– Mismatch between size of futures contract and size of cash
transaction
• Hedging with currency futures may not result in perfect
hedge
• Final delivery of the foreign currency will take place only
through the banking system
Speculation with Currency Futures
• Spot rate: USD = Rs.50.20
• 1 month future rate: USD = Rs.50.40
• Expected spot rate on maturity: USD = Rs. 50.65
• Dealer buys 100 lots of currency futures contract (100,000
USD)
• Value of contract: Rs.50,40,000; Margin deposit: Rs.5,40,000
• If exchange rate move up to Rs.50.65 as anticipated, dealer
gains profit of Rs.15,000 (100,000* Re.0.15)
• Rate of return: (15000/5,40,000)(12)(100) = 33.33%
Factors Impeding Liquidity in system
• There is a limit of $100 million on the open interest applicable
to trading members who are banks and $25 million limit for
other trading members. So, larger exporters and importers might
continue to deal in the OTC market, where there is no limit on
the hedges.
• The management of margin and settlement of daily mark – to –
market differences could be cumbersome for some corporate
customers.
• Absence of FIIs could reduce liquidity
Getting Started
• Get in touch with your broker permitted to trade in currency
futures on NSE, MCX or BSE and become a member

• Deposit the margin as per the tariff with the exchange

• Buy/Sell the currency for the desired future period using the
trading platform given by the exchange or through broker
Membership Type
• Trading Member (TM): A member with rights to trade on its
own account as well as on account of its clients, but has no
right to clear and settle such trades itself.

• Trading-cum-Clearing Member (TCM): A member with a


right to trade on its own account as well as on account of its
clients. He can clear and settle the trades for self and for others
through the Clearing House.

• Professional Clearing Member (PCM): A PCM is entitled to


clear and settle trades executed by other members of the
exchange. Only corporate entities or institutions are eligible to
apply for PCM.
Deposits For Membership

All values in Rupees Existing Members

Membership Trading Members Trading cum clearing members

Stock Exchange MCX NSE BSE MCX NSE BSE

Minimum Net Worth 1 Cr 1 Cr 1 Cr 10 Cr 10 Cr 10 Cr

Minimum Liquid Asset 50 L

Security Deposit (Interest Free) 10 L 10 L 5L 50 L 5L

Cash to NSEIL 10 L

Cash to Clearing corporation 25 L 25 L 25 L

Non-cash to Clearing corporation 25 L 25 L 25 L


Deposits For Membership

( All Values in Rupee) New Applicants

Membership TM TCM PCM

Stock Exchange MCX NSE BSE MCX NSE BSE MCX NSE BSE

Minimum Net Worth 1 Cr 1 Cr 1 Cr 10 Cr 10 Cr 10 Cr 10 Cr 10 Cr 10 Cr

Minimum Liquid Asset 50L 50L 50 L 50 L 50 L 50 L

Security Deposit (Interest Free) 10 L 75 L 50 L 10 L

Cash to NSEIL 15 L 15 L 20 L

Cash to Clearing corporation 25 L 25 L 25 L 25 L 25 L 25 L


Non-Cash to Clearing
Corporaton 25 L 25 L 25 L 25 L 25 L 25 L

Processing Fee 10000 waiver 10000 waiver 10000 waiver


Position Limits
– Trading Member Level: The gross open positions across
all contracts cannot exceed 15% of the total open interest
or USD 25 million, whichever is higher
For banks: cannot exceed 15% of the total open interest or
USD 100 million , whichever is higher

– Client Level: The gross open positions across all contracts


cannot exceed 6% of the total open interest or USD 5
million, whichever is higher

– Clearing Member Level: No separate position limit is


prescribed at the level of the Clearing Member
Clearing House
• Each exchange has a clearing house

• Clearing house arranges for delivery of asset and payment of


money

• Clearing house becomes the counter party to the original


parties
Mode of settlement

Daily settlement: T + 1 day


 Calculated on the basis of the last half an hour weighted average
price.
 MTM profit and loss is payable/receivable by the traders.

Final settlement: T + 2 days


Contracts would be settled in cash on the final settlement date as per
the reference rate of RBI. Final settlement date would be the last
working day of the month (except Saturday and holiday).
Margins & Price Limits
• Minimum Initial Margin: 1.75% on day 1, 1% thereafter

• Extreme Loss Margin:1% of MTM value of Open position.

• Price limits:
Tenure up to 6 months: +/- 3% of base price
9 months:+/- 5% of base price
Costs involved in currency futures trade

• Margin
• Brokerage
• Exchange transaction charges
• Stamp duty
• STT
• Service tax
• Education tax on brokerage fees
Forward Contract

A forward contract is a private contract between a buyer and a


seller in which the buyer agrees to buy and the seller agrees to sell
a specific quantity of a certain security or commodity (known as
the underlying instrument) at the price specified in the contract.
Difference between Forward and Futures
Features Currency Future Currency
Forward

Agreement standardized contract with customized contract


fixed maturity date and fixed where the parties can
quantity as defined by the negotiate terms and
exchange conditions
Accessibility High Low
Channel of trade Exchange- traded contract Traded on OTC markets
that is available for trading through authorized
on recognized exchanges dealer network of RBI
such as NSE BSE and MCX such as scheduled banks
or licensed foreign
exchange dealers.
Default risk Low and Clearing house High and the parties bear
bears the risk the risk.
Features Currency Future Currency Forward
Documentation Minimal paperwork More paperwork
Awareness of the Trades are anonymous i.e. the Parties to the trades are
parties buyer does not know who is the known
seller
Price Transparency High Comparatively low
Nature of settlement (I) Exchange of asset and cash Only delivery of asset
on delivery date
(II) Cash settlement through a
reverse trade on any day
Settlement period The specific details concerning Settlement occurs at the end
settlement and delivery are quite of the contract.
distinct.
Nature of positions Frequently employed by Frequently employed by
speculators hedgers to curtail volatility
Medium of negotiation Clearing house is needed Privately negotiated and are
standardized
Underlying Exposure Not required Required