Vous êtes sur la page 1sur 69


1. Introduction to Currency Markets


Largest Asset Class Major currencies: Dollar, Euro, Yen, British Pound, Swiss Franc Average turnover is over US$ 4 trillion (daily) Forex derivatives accounts for 40% of ADTV Main trading centers are London, NY, Tokyo & Singapore High volumes low margin game with extreme Liquidity 24 hours trading Range of factor impacting exchange rates Participants

24 Hrs Market (IST) Forex Market: 24 a day 7 days a week










Large banks Central Banks Government Multinationals & Commercial Companies Hedge Funds Institutions Retail Forex Brokers Speculators

Basic Definitions simplified

Tom: One business day after deal date (T+1)

Spot: Buying a different currency for immediate delivery (T+2)

Forward: Contract between counterparties to exchange currency on any day after spot (T+3 or later) Base currency: In the forex market it is the first currency in any currency pair Quote or Term Currency: In the Forex markets, is the second currency in any pair also called the Pip currency. Eg: USD/CHF rate equals 1.1323 (One dollar is worth CHF 1.1323)

Basic Definitions simplified

Bid Price Price at which the market is prepared to buy a specific currency pair in the Forex market and you can sell the base currency (on the left side of the quotation) (eg: in the quote GBP/USD 2.0483/84, the bid price is 2.0483. One can sell one GBP for 2.0483 USD) Ask (or offer)Price Price at which the market is prepared to sell a specific currency pair in the Forex market and you can buy the base currency (on the right side of the quotation) (eg: in the quote EUR/USD 1.4692/94, the ask price is 1.4694. One can buy one Euro for 1.4694 USD)

Global Currency Composition

Market Turnover By Currency Pair Daily Averages in billions of US dollar and per cent
2001 2004 2007

US dollar/euro US dollar/yen US dollar/sterling US dollar/Australian dollar US dollar/Swiss franc US dollar/Canadian dollar US dollar/Swedish Krona US dollar/other Euro/yen Euro/sterling Euro/Swiss franc Euro/other Other Currency pairs All currency pairs 354 231 125 47 57 50 195 30 24 12 21 26 1,173

30 20 11 4 5 4 17 3 2 1 2 2 100

503 298 248 98 78 71 295 51 43 26 39 42 1,794

28 17 14 5 4 4 16 3 2 1 2 2 100

840 397 361 175 143 115 56 572 70 64 54 112 122 3,081

27 13 12 6 5 4 2 19 2 2 2 4 4 100

Factors Affecting USDINR

Performance of Equity Market

Political Factors

Uncertain Events

Performance of Other Asian Currencies

Exchange Rate

Fundamental Factors

Policy Decisions RBI Intervention

Capital Flows

Factors Affecting Currency Market

Interest Rates
Change in interest rates by Reserve Bank of India Interest rates change by Federal Reserve (USA) Interest rates change by European Commercial Bank Expectation of change in interest rates

Interest rates are positively correlated with a strong currency When interest rates increase in a country, its currency strengthens against other currencies

Factors Affecting Currency Market

Inflows of Foreign Funds

Strong economic fundamentals attract funds into the country Political stability and clear economic direction Country specific ratings based on economic indicators Reverse is also true

Foreign funds inflows are positively correlated with a strong currency When funds enter the country, they create a demand for the local currency (read Rupee) resulting in the currency strengthening

2. Foreign Currency Derivatives

What is traded on a Currency exchange?

Futures & Options Markets-Debt, Forex & Stocks

Why do we require Currency Derivatives?

In a Nut Shell: Manage Risk

Transfer Risk Price Discovery Integration of Markets Increase Savings in the long run Speculative trading in a controlled environment

Derivatives: Basic Definitions

Forwards: Customized contracts between two parties where settlement takes place on a pre determined negotiated date price in the future

Futures: Standardized agreement between two parties to buy or sell currency at a certain time in the future at a pre determined price.
Options: Calls & Puts

Warrants: Long dated options LEAPS: Long Term Equity Anticipation Securities (options with upto 3 years maturity SWAPS: Agreement between two parties to exchange cash flows in the future according to a pre-arranged method

Forward Vs. Futures

Forward Contracts OTC Counterparty risk Terms changeable Poor liquidity Few Players No Margins Relationship Skill to Structure

Future Contracts Exchange Traded Exchange assumes risk Terms defined by Exchange High Liquidity Many Players Margins Price Transparency Standard Product

3. Exchange Traded Currency Futures

Futures Terminology
Futures contract is a standardized contract, to buy or sell a certain underlying asset or an instrument at a certain date in the future, at a predetermined price Futures price: price at which a contract trades in the futures market Currency futures are a linear product Settlement date is the last business day of the month

Futures Terminology

Expiry date is the date specified in the contract and will be two business days prior to final settlement date Contract Specifications are details on currency futures contracts as stipulated by RBI-SEBI standing technical committee report on exchange traded currency futures Initial margin is the amount to be deposited in the margin account. Mark- to-Market is the daily adjustment made to the margin account based of the futures closing price.

Contract Specification Snapshot

Underlying Trading Hours Size of Contract Price Quotation Tenor of Contract Available Contracts Settlement Mechanism USD / INR 9:00 AM to 5:00 PM Minimum Lot Size is US$ 1,000 In INR (Tick Size INR 0.0025)

Maximum of 12 Months Monthly In INR

Settlement Reference Rate

RBI USD/INR Reference Rate

Final Settlement Date

Last working day of month, except Saturday.

Note: The above product specification is as per the RBI-SEBI Standing Technical Committee Report on Exchange Traded Currency Futures

Rationale behind Currency Futures

Eliminates risk caused by fluctuation in exchange rates Liquidity to the participant where an existing contract can be offset prior to maturity by entering into an equal and opposite transaction Aids Business Planning Hedging using futures reduces volatility of returns Hedgers could be:Corporates, Producers, Intermediaries in Spot Markets, Merchandisers, Traders, Importers & Exporters etc.

Pricing of Currency Futures

The spot and interest rate differential impact future price perception
Following are three commonly used formulas a) Term: Base Formula b) Spot forward r&p Formula c) Continuous Compounding Formula

Continuous Compounding Formula is preferred

All three methods give very close results

Continuous Compounding Formula

(rd-rf) T

F = S0 e

F = Future Price S0 = Spot Price rd = Domestic Rate of Interest rf = Interest Rate in the foreign country T = Tenure

What is meant by Hedging?

Hedging means taking a position in the future market that is opposite to position in the physical market with a view to reduce risk associated with unpredictable price change Types of Hedges
A long futures hedge is appropriate when you know you will buy an asset in the future and want to lock in the price

A short futures hedge is appropriate when you know you will sell an asset in the future & want to lock in the price The profit (loss) in the cash position is offset by equivalent loss (profit) in the futures position

Appreciation and Depreciation of Currency

Scenario 1
Event Appreciation of USD Depreciation of INR Importer Loses Money Loses Money Exporter Gains Money Gains Money USDINR 53


Scenario 2
Event Depreciation of USD Appreciation of INR Importer Gains Money Gains Money Exporter Loses Money Loses Money



Using Futures to Hedge Currency Risk

Transaction An exporter who has executed an export order and money is to be received on 31 May 13, say USD 500,000. Spot USD/INR was as 54.80 when contract was executed. Risk Rupee will appreciate and export will realize USD 500,000 at a rate lower than 54.80
Hedge Strategy Short (Sell) 500 contracts of each expiry 31 May 13

Payoff of Hedge vis--vis the transaction: Hypothetical Example

Spot is at 54.80 when the exporter Sell future and USDINR Dec futures at 55.10 Short (Sell) 500 USDINR futures contracts expiry May 2013 . On Expiry Date 31st May Spot on Expiry P/L on Exchange P/L on Physical

55.50 54.50

(INR 2,00,000) INR 3,00,000

INR 3,50,000 (INR 1,50,000)

So if rupee moves either way corporate is hedged against currency fluctuation.

Using Futures to Hedge Currency Risk

Transaction On 1st April, 2013 a student enrolled for CMT-USA October 2013 test and he needs to make his payment of USD 1000 on 15th September, 2013. Spot USD/INR was at 53.26 when he got enrolled. Risk USD may strengthen over next 6 months causing the enrolment to cost more
Hedge Strategy Long (Buys)1 USDINR Futures contract

Hedger (Copper Exporter)

On April 1, 2013, an Indian Copper Exporter enters into a contract to Export 1000 MT of Copper with payment to be received in US Dollar (USD) on July 1, 2013.

The price of copper has been fixed at USD 7200/MT at the prevailing exchange rate of 1 USD = INR 54.76 The Cost of One Ton of copper in INR is Rs. 394272 (7200*54.76). The exporter has a risk of Weakening USD over next three months having negative implication on his operating margins hence profitability and long-term sustainability

Risk Management Process using currency futures

Time t1 Is Long on USD 7200000 in the Spot market
Short (Sell) 7200 futures contracts USDINR

Hedge Period


Buys USDINR futures contracts to square-off transaction Sell USD to meet export requirement in the spot market

Time t2

If not hedged and INR weakens, the exporter makes a profit and when INR strengthen, he will make a loss.

Hedger Practical Implication

Spot Market Date USD-INR 1-April-13 1-July-13 54.76 56.53
Market Price Total Value

Futures Market July USD Contract 54.95 56.72

Exit Date

Price of Copper = Rs. 7200/MT Exported Qty. = 1000 MT No Basis Risk : Perfect Hedge situation exists


Entry Date

Market Price Total Value

Profit / Loss



54.76 (L)
54.95 (S)



56.53 (S)
56.72 (L)



The Loss in Futures Market is set off by Profit in Spot Market. By Hedging, we have locked-in the price i.e. Selling price in spot market Rs. 40701600 + loss from Futures market Rs. (-12744000)= Rs. 394272000

What is a Spread? Difference in price of two futures contracts A spread involves buying one futures contract in one month and simultaneously selling another futures contract of a different month.

Participants: Investors / Traders Objective: To earn profit from existing spread between near month futures contract and far month futures contract.

What influences spreads?

Interest Rate Differentials Liquidity in the banking system Monetary policy decisions Inflation Intra-Currency Pair Spread Inter-Currency Pair Spread Normal Market: When the price of the far month futures contract is higher than the near month one, then it is referred to as normal market. Inverted Market: If the price of the far month futures contract is lower than the near month one, then it is referred to as inverted market.


Involves buying a contract on one exchange at one price and simultaneously selling an identical contract on another exchange at a higher price. Inter-market arbitrage is possible only when there are price differences between two exchanges.

Inter Market Arbitrage

Price difference between currency futures traded on different exchanges results in arbitrage positions

E.g. On 2 Feb 2013, following is the USDINR Oct futures contract prices



56.0750 56.0275

Buy on MCX-SX and simultaneously sell on NSE Hold until maturity. Final settlement of both contracts at same price of RBI reference rate

5. Trading

Market Operations: Trading features

Automated screen-based trading on TWS

National reach Order driven trading system Transparent, Objective and Fair system of order matching Identity of the trader undisclosed
Daily Turnover limits for Buy and Sell for each User linked to deposit

Flexibility in placing orders Complete Online Market Information Square-off facility


Tenors of Contracts: Period for which the contract is available for trading also called trading cycle of the contract Final Settlement Rate: is the Reserve Bank Reference rate on the date of expiry.
Expiry Date: Contracts expire on last working day (except Saturday) of the contract month. The last day for the trading of the contract shall be two days prior to the final settlement

Types of order

Price conditions
Limit Order :- specifying the price at which the trade should be executed
Market Order:-To be executed at prevailing price. For such orders, the trading system determines the price. Stop loss Order:- Remains in the system inactive/abeyance mode and is activated only on trigger of a threshold price, defined by member.

Types of order

Time Conditions
Day Order Available for execution during the Trading Day until executed or cancelled Unexecuted Day orders get cancelled at EOD

Good Till Cancelled (GTC) Available for execution till expiry of the contract or till it is cancelled, whichever is earlier

Trading Parameters

Open Price: On the first day is the theoretical futures price & on subsequent trading days will be daily settlement price

Close Price: System generated at the end of the day Close price is the weighted average price of all trades executed during last 30 minutes in a given contract. If less than 5 trades during last 30 minutes, then last 10 trades executed during a trading day If less than 5 trades during the day, then all trades. If no trade is executed, last closing price.

Players In the Trading System

Trading Member Clearing Member Trading-cum-Clearing Member Professional Clearing Member Participants

6. Clearing Settlement and Risk Management

Risk Management Tools

Price Circuit filter (Price Range) Pre-defined in the Contract Specifications Computed on the previous days Close Price +/-3% & +/-5%

Position Limits

Margins Mark-to-Market Above all- Financial soundness of members

Open Position

SEBI has specified Position Limits for Clients, TM and Clearing Member : 1. At Client level Gross Open Position of client across all contracts cannot exceed 6% of total open interest or 10 million USD whichever is higher At Trading Member level Gross Open Position of the Trading Member across all contracts should not exceed 15% of the total open interest or 50 million USD whichever is higher.
At Clearing Member level No separate position limit prescribed. However should ensured that all trading position are within above mentioned limits



Type of Margin Initial Margin Description Subject to a minimum of 1.75 % on the first day of currency futures trading and 1% thereafter. Initial Margin shall be deducted from Liquid Net worth on an online, real-time basis

Extreme Loss Margin

Computed at 1% on the mark to market value of the Gross Open Position. Extreme loss margin shall be deducted from the liquid assets of the Clearing Member.

The SPAN based methodology is adopted

o The client-wise margins would be grossed across various clients

at Trading/Clearing member level o Proprietary positions of the Trading/ Clearing Member treated as that of a client Real Time alerts for margin utilization beyond specified percentages (60%, 75%, 90%)

Margin Calculation
Day 1. Purchase: One contract of $1000 (Launch of new contract)

a) @ say 51.75 X1000 X (1.75%+1%) = Rs.1423.125 (margin blocked) (Initial+ELM) Day 2. Exchange rate weakens a) @ say 51.95 X 1000 X (1%+2.6%) = Rs.1870..200 (margin ) (ELM+SPAN) = 447.075 (further margin blocked) = Rs.200 Payout

b) M2M = 51.95 - 51.75 X 1000

Extreme Loss Margin is calculated at 1% on M2M value of Gross Open Position

Margin Calculation

Day 3. Exchange rate strengthens a) @ say 51.25 X 1000 X (1%+2.4%) (ELM+SPAN) b) M2M = 51.25 - 51.95 X 1000

= Rs.1742.500 (margin) = 127.7 (margin released) = Rs.700 Payin

Day 4. Square up open position ie. sell one contract @ say 52.00 51.25 X 1000 =750 payout + 1742.5 margin released

Calendar Spread Margins

Calendar Spread Margins are only Rs. 250 per lot + (20% of ELM of far month contract )

Far month contract of $1000 @ Rs.50 = Rs 50000 ELM = 1% 20% of ELM = 500 = 100

(note 33.33% instead of 20%)

Spread Margin = 100+250 = Rs. 350

Surveillance System

Large Open interest, cost of carry and volatility monitored Monitor closing prices Capture and process client level details
Automatically generates alerts highlighting material aberrations

Inspections Builds database based on trading information

The Exchange as the first level regulator has an online surveillance capability that monitors prices, positions & volumes in real time so as to deter market manipulation

Online Monitoring

Price Volatility (RPF file captures the information on periodic basis) Daily Price Range ( DPR ) Margin Utilization by Members Marked-to-Market of Members Maximum Allowable Open Position

Clearing Mechanism

Undertaken by Clearing Corporation which undertakes clearing & settlement of all trades executed in currency derivatives Clearing members & Clearing banks Clearing mechanism: Working out open positions & obligations of TM and CM (aggregating) Proprietary positions on net basis Client position by summing buy & sell position Daily margins generated

Example: Open Position (contracts)

TM clearing through CM XYZ

Proprietary Trades Buy 40 Sell 20

Client 1 Buy 30 Sell 10

Client 2 Buy 40 Sell 20

Open Position Long 110 Short 50


Buy 20 Sell 30

Buy 80 Sell 60

Buy 30 Sell 70

Short 160 Long 130


Long 40 Short 50

Long 110 Short 70

Short 90 Long 70

Net Long 30

7. Regulatory Framework

RBI-SEBI standing technical committee on exchange traded currency and interest rate derivatives Provides comprehensive guidelines on the usage of foreign currency forwards, swaps and options in the OTC market Recommends the introduction of exchange traded currency futures Constituted a technical committees on Exchange Traded Currency and Interest Rate Derivatives Foreign Exchange Management Act, 1999 - Provisions Provided different guidelines and notifications for Currency Trading under RBIs regulation in India. Provides the Currency Contract Specifications with limits and regulations to be followed

Regulatory Framework for Exchanges

Recognized Stock exchanges by SEBI having national reach are allowed to set-up Currency Futures Segment. Following guidelines are to be fulfilled: 1. The trading should take place through an online screen-based trading system, which also has a disaster recovery site. 2. Clearing of currency derivatives should be done by an independent Clearing Corporation. 3. The exchange must have an online surveillance capability which monitors positions, prices and volumes in real time so as to deter market manipulation. 4. The exchange shall have a balance sheet net worth of at least Rs. 100 crores. 5. Information about trades, quantities, and quotes should be disseminated by the exchange in real time to at least two information vending networks 6. The exchange should have arbitration and investor grievances redressal mechanism 7. The exchange should have adequate inspection capability.
A recognized stock exchange where other securities are also being traded may set up a separate currency futures segment in the following manner: 1. The trading and the order driven platform of currency futures should be separate from the trading platforms of the other segments. 2. The membership of the currency futures segment should be separate from the membership of the other segments.

Regulatory Framework for Clearing Corporations

A Clearing Corporation can function only after obtaining SEBI approval. Its conditions are as follows: The Clearing Corporation should be a company incorporated under the Companies Act, 1956 and should be distinct from the exchange. The Clearing Corporation must perform full novation. The Clearing Corporation should enforce the stipulated margin requirements, mark to market settlement, electronic funds transfer, etc. A separate settlement guarantee fund should be created and maintained.

Eligibility Criteria's for members

Members in Currency Derivatives segment are required to seek separate registration from SEBI Following Entities are eligible to apply: Individuals Partnership Firms registered under the Indian Partnership Act, 1932; Corporations, Companies or Institutions or subsidiaries of such Corporations, Companies or Institutions set up for providing financial services; Such other person as may be permitted under the Securities Contracts (Regulation) Rules 1957

Eligibility Criteria's for Banks

AD Category - I bank authorized by the Reserve Bank of India under FEMA Act, 1999 are permitted to become trading and clearing members of the currency futures market, subject to fulfilling the following minimum prudential requirements: a) Minimum net worth of Rs. 500 crores. b) Minimum CRAR of 10 per cent. c) Net NPA should not exceed 3 per cent. d) Made net profit for last 3 years.
Banks are required to lay down detailed guidelines with the approval of their Boards for trading and clearing in currency futures contracts & management of risks.

Urban Co-operative banks or State Co-operative banks who cannot fulfill above requirements, can participate in the currency futures market only as clients, subject to approval from the respective regulatory Departments of the Reserve Bank.

Eligibility Criteria's for Corporate

A company shall be eligible to be a member: such company is formed in compliance with the provisions of Section 12 of the said Act
it undertakes to comply with financial requirements and norms as may be specified by the SEBI for the registration of such company

the directors of such company are not disqualified for being members of a stock exchange under the Securities Contracts (Regulation) Rules, 1957 and the directors of the company had not held the offices of the directors in any company which had been a member of the stock exchange and had been declared defaulter or expelled by the exchange.



Accounting at Inception of contract Initial margin will reflect in Current Assets as currency futures account Bank guarantees & securities lodged will be disclosed in notes to accounts Accounting at time of daily settlement Daily credit/debit will reflect in bank account and double entry will be M2M margin currency futures account If client pays lump sum for the purpose of margin/M2M, a separate account to be debited Deposit for M2M Margin account At year end the balance in Deposit for M2M Margin account will be reflected in current assets. Accounting for Open Position Based on valuation on the balance sheet date, profit & loss affected (As30)


Accounting in case of default Amount not paid is adjusted against margin (Debit m2m-currency futures account and credit currency futures account) Losses on the contract will be recognised on the profit & loss account.

Disclosure Requirements AS32 Taxation: Income or loss carried out on recognised exchanges is not taxed as speculative income or loss. Thus loss can be set off against any other income during the year (or subsequent assessment year- can be carried forward upto 8 years)


Code of Conduct

Code of Conduct

Brokers integrity Exercise of skill & care Manipulation (for person gain, rumors, deceptive txn) Malpractices- (False entries/excessively speculative) Compliance with Statutory requirements -(Govt/SEBI/SE) Breach of Trust (disclose discuss client information) Not encourage transactions for sole purpose of brokerage Fairness to client Protect client interest Comply with his obligations in completing settlement of transactions Advertisement & Publicity (unless permitted by exchange)

Code of Conduct
Trading Members Adequate disclosure in his dealings with clients No trading member will guarantee against a loss Observe high standards of commercial honor Adherence to Trading practices Act honestly and fairly Employ resources effectively for performance of business activity Ensue that the fiduciary and other obligations imposed on them and staff by statutory acts, rules & regulations is complied with. Responsible for all actions originating through-trading member id & user id Client is responsibility of the trading member-must ensure compliance No discretionary powers in the constituents account unless written authorization given by client Will not disclose name and beneficial identity of a constituent except to currency derivative segment of the exchange

Code of Conduct

Grievance Redresses Mechanism for Investors Exchange has a dedicated department to handle grievance Investor to submit in a prescribed compliant form along with supporting to substantiate claim Exchange scrutinizes the complaint and issues a complaint number and gives an acknowledgement to the aggrieved Exchange tries to resolve the matter If differences persist then exchange holds meetings with the parties at exchange premises Party at fault is enlightened on the correct position on the matter SEBI has instructed exchanges to have arbitration committees which are governed by exchange by-laws Parties to arbitration are required to select the arbitrator from a panel of arbitrators Arbitration award is binding on both parties Aggrieved party can within 15 days file an appeal to the arbitration tribunal Final award is enforceable as if it were the decree of the court