Management of Foreign Exchange Transactions

Case Study No 1.-Col K S Mohan

Indian Regulators allow currency options on bourses

30 JULY 2010. Punters will now have one more instrument to play in
the currency segment. Nearly two years after the introduction of
currency futures, joint regulators of exchange-traded currencies, RBI
and Sebi, on Friday allowed recognised stock exchanges to launch
European style options in dollar-rupee based on the spot rate, in line
with market expectations.

As in exchange-traded currency futures, no underlying exposure is

mandatory for trading in currency options.

The National Stock Exchange and MCX Stock Exchange will now be
able to offer options in the dollar-rupee pair after seeking capital
market regulator Sebi’s approval. USE, a new stock bourse expected
to go live in September, is also expected to seek the approval of the
regulator for offering currency options. The Bombay Stock Exchange
is the largest shareholder in USE which has over 20 public and
private banks as its stakeholders.

The two exchanges now offer futures trading in four currency pairs —
dollar, euro, yen and pound versus the rupee, respectively. NSE was
the first exchange to launch futures trading in dollar-rupee in August
2008 and was followed by MCX-SX, which went online in October
that year.

Initially, banks were major market makers in the currency futures

segment, but according to one banker, their share has come down
substantially with stock market day traders, jobbers, brokers and
corporates having increased their presence on NSE and MCX-SX.
At the height of trading sometime ago, both exchanges together
totted up a daily volume of $10 billion, twice that of the current daily
turnover. With the launch of options, volumes are expected to rise
further. The advantage of options over futures is that the former limits
the downside to the extent of the premium paid to take exposure
while the upside is unlimited.

A futures contract on the other hand exposes a trader to huge profits

and losses. An option gives the buyer (of a put or a call) the right but
not the obligation to exercise the contract. In a futures contract, a
trader’s position is marked to market at the end of a trading day.

“Worldwide, options in currencies score over options in stocks or

other assets,” said Gaurav Arora, managing director of Jaypee
Capital, a Delhi-based brokerage which runs a sizeable proprietary
book in stock, commodity and currency derivatives. It makes sense to
have a European style option as exchanges cannot deliver the dollar,
with settlement taking place in rupees at the RBI reference rate.”

Exchanges will be able to offer three serial monthly contracts followed

by three quarterly contracts of the cycle, namely, March, June,
September and December. The minimum lot size of the option
contract will be $1,000, the same as that of a futures contract, making
it easy for small clients to take positions. The maximum lot size for
clients has been fixed at $10 million or 6% of total open interest,
whichever is higher.

RBI to allow currency options trading within a week

The Reserve Bank is likely to allow trading of currency options on

bourses within a week, a senior RBI official said on Saturday.
"Maybe another week or so (for the announcement)," RBI Chief
General Manager Foreign Exchange Department (Trade) G
Jaganmohan Rao told reporters here today.

"As of now, they (currency options) are over-the-counter products.

Soon, we will allow them on exchange platforms," Rao said, adding
that the system will be regulated by the Securities and Exchange
Board of India (SEBI).

He said that the decision was taken by a joint committee of the

central bank and market regulator SEBI after more than a year of
discussions.

Currency option is a derivative instrument that gives the owner the

right, but not the obligation, to exchange money denominated in one
currency into another currency at a pre-agreed exchange rate on a
specified date.

Rao said the actual roll-out of currency options trading will happen
after SEBI decides on trading norms.

All exchanges approved by SEBI will be allowed to trade the

derivative. To begin with, it will be in a pair of US dollar and the Indian
rupee.

SEBI had launched currency derivatives in the form of currency

futures in India in August 2008, a month before the global financial
crisis hit the world.

Initially, the currency futures were limited to rupee- dollar only, but
later they were extended to other pairs.

RBI and SEBI jointly regulate these products. While RBI approves the
products, SEBI decides on the trading platforms.

On the likely benefits of exchange-traded currency options, Rao said,

"By doing that, we will have another option in our pocket. Companies
and exporters both will benefit."
Answer the following Questions
1.What are Eureopean and American Style of options?
2.What are the differences between futures and options?
3.What the types of Options?
4.Who are the following:-
(a) Market makers
(b) Jobbers
(c) Day traders
5.What do you understand by Underlying Exposure?

Reference Books
1.International Financial Management-P.G.Apte
2.Deriatives -John C Hull