Académique Documents
Professionnel Documents
Culture Documents
Presented By
Kalpak K Bhore
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ACKNOWLEDGEMENT
our deep sense of gratitude to B.Y.K.C.C for providing us Platform of studies. I thank to
our Faculty members for their moral support during the project.
I am too glad to give our special thanks to our project guide Mr. Vaibhav
and also for their help and tips whenever needed. Without his co-operation it was
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Research Methodology
Type Of Research
The research methodology adopted for carrying out the study was
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Limitation Of The Study
• The study was purely based on the secondary data. So, any error in the
• The currency future is new concept and topic related book was not
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Contents
Currency Derivatives.......................................................................................1
Research Methodology....................................................................................3
Contents..........................................................................................................5
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The Foreign Exchange Market In India........................................................29
FORWARD : .............................................................................................31
FUTURE :..................................................................................................31
SWAP : .....................................................................................................32
OPTIONS : ................................................................................................32
Future Terminology.....................................................................................40
BASIS :......................................................................................................41
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MARKING TO MARKET :............................................................................42
Hedging:...................................................................................................43
Arbitrage:.................................................................................................46
Underlying................................................................................................53
Trading Hours...........................................................................................53
Quotation.................................................................................................53
Available contracts...................................................................................54
Settlement mechanism............................................................................54
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Settlement price......................................................................................54
Conclusion.....................................................................................................56
Bibliography...................................................................................................57
Websites:....................................................................................................57
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INTRODUCTION OF CURRENCY DERIVATIVES
Each country has its own currency through which both national and
For example,
dollars for short or long term then at maturity the same would be refunded in
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 for another. The price of one currency in terms of other currency is
exchanging different currencies with one and another, and thus, facilitating
With the multiple growths of international trade and finance all over the
world, trading in foreign currencies has grown tremendously over the past
the firms are exposed to the risk of exchange rate movements. As a result
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the assets or liability or cash flows of a firm which are denominated in
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
currency swaps.
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INTRODUCTION TO FINANCIAL DERIVATIVES
“By far the most significant event in finance during the past decade has
allocate it to those investors most able and willing to take it- a process that
livings.”
Alan Greenspan,
Former Chairman.
US Federal
Reserve Bank
The past decades has witnessed the multiple growths in the volume of
liberalization all over the world. As a result, the demand for the
global level. In this respect, changes in the interest rates, exchange rate and
stock market prices at the different financial market have increased the
the new financial instruments have been developed in the financial markets,
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DEFINITION OF FINANCIAL DERIVATIVES
The word is formed by word derivatives. Means this word is arise from the
behavior of the price of the one or more basic underlying assets. These
contracts are legally binding agreements, made on the trading screen of the
stock exchanges, to buy or sell an asset in future. These assets can be share,
index, interest rates, bond, rupee dollar exchange rate, sugar crude oil,
The price of curd depends upon the price of milk which intern depends upon
• Interest rates
• Common shares/stocks
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• Stock index value: NSE Nifty
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Types of Financial Derivatives
Financial derivatives are those assets whose values are determined by the
value of some other assets, called as the underlying. Presently there are
innovating newer and newer ones continuously. For example, various types
financial derivatives which are popularly in the market have been described.
In the simple form, the derivatives can be classified into different categories
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One form of classification of derivative instruments is between commodity
pepper, sugar, jute, turmeric, corn, crude oil, natural gas, gold, silver and so
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
matters.
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have been included in the basic derivatives whereas swaps and other
complex derivatives are taken into complex category because they are built
delivery dates and trading units. OTC derivatives are customized contracts
that enable the parties to select the trading units and delivery dates to suit
their requirements.
default by either party. With the exchange traded derivatives, the risk is
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controlled by exchanges through clearing house which act as a contractual
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Introduction of derivatives in India
barriers has also facilitated the integration of domestic economy with world
The first step towards introduction of derivatives trading in India was the
committee under the chairmanship of Dr. L.C. Gupta on November 18, 1996
submitted its report on March 17, 1998. The committee recommended that
derivatives.
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To begin with, SEBI approved trading in index futures contracts based on
S&P CNX Nifty and BSE-30 (Sensex) index. The trading in index options
Each country has its own currency through which both national and
For example,
dollars for short or long term then at maturity the same would be refunded in
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
rate.
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The foreign exchange markets of a country provide the mechanism of
exchanging different currencies with one and another, and thus, facilitating
With the multiple growths of international trade and finance all over the
world, trading in foreign currencies has grown tremendously over the past
the firms are exposed to the risk of exchange rate movements. As a result
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
currency swaps.
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History Of Currency Derivatives
had fixed world exchange rates to a gold standard after World War II. The
were the main derivative contracts traded at CME until then. The concept of
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business, hedge against unfavorable changes in currency rates, or to
with the means and methods by which right to wealth in one country’s
such exchange necessary, the forms which such exchange may take, and the
market in the world, with daily turnover of over USD 2 trillion. It is a 24 hrs
• Corporates
• Commercial banks
• Commercial banks.
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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
between countries.
institutions, large concerns, etc. The large banks usually make markets in
different currencies.
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.
this market. The purchase and sale of currencies stem partly from the need
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to finance trade in goods and services. Another important source of demand
and supply arises from the participation of the central banks which would
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Foreign Exchange Quotations
price.
For example,
Indian rupees will buy one dollar of USA, or that one rupee is worth of 0.022
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$1 = Rs. 45.7250
There are two ways of quoting exchange rates: the direct and indirect.
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,
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,
Exchange rates are quoted in per unit of the base currency. That is the
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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
second currency.
currency in terms of the second currency. Whenever the base currency buys
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
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The Foreign Exchange Market In India
the foreign exchange market. The exchange rate regime, that was earlier
pegged, was partially floated in March 1992 and fully floated in March 1993.
Although liberalization helped the Indian forex market in various ways, it led
foreign currency forwards, swaps and options in the OTC market. At the
same time, RBI also set up an Internal Working Group to explore the
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advantages of introducing currency futures. The Report of the Internal
Committee to analyze the Currency Forward and Future market around the
world and lay down the guidelines to introduce Exchange Traded Currency
Futures in the Indian market. The Committee submitted its report on May 29,
2008. Further RBI and SEBI also issued circulars in this regard on August 06,
2008.
Currently, India is a USD 34 billion OTC market, where all the major
currencies like USD, EURO, YEN, Pound, Swiss Franc etc. are traded. With the
opportunity.
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Currency Derivative Products
Derivative contracts have several variants. The most common variants are
FORWARD :
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
price. The exchange rate is fixed at the time the contract is entered into.
FUTURE :
buy and sell a particular currency at a specified future date, a specified price
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
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SWAP :
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
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 ).
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
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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
dated options are called warrants and are generally traded OTC.
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Introduction To Currency Future
for another currency at a specified date and a specified rate in the future.
Therefore, the buyer and the seller lock themselves into an exchange rate
for a specific value or delivery date. Both parties of the futures contract must
obligation of the seller and buyer. All settlements however, unlike in the case
know both the contract size (the number of currency units being traded) and
also what is the tick value. A tick is the minimum trading increment or price
differential at which traders are able to enter bids and offers. Tick values
differ for different currency pairs and different underlying. For e.g. in the
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case of the USD-INR currency futures contract the tick size shall be 0.25
paise or 0.0025 Rupees. To demonstrate how a move of one tick affects the
price, imagine a trader buys a contract (USD 1000 being the value of each
The value of one tick on each contract is Rupees 2.50. So if a trader buys 5
contracts and the price moves up by 4 tick, she makes Rupees 50.
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Need For Exchange Traded Currency Futures
foreign currency forwards, swaps and options in the OTC market. At the
same time, RBI also set up an Internal Working Group to explore the
as compared to OTC forwards serve the same economic purpose, yet differ in
obligation of the individual equals the forward price at which the contract
the other hand, in the case of an exchange traded futures contract, mark to
the futures market are collected / paid on a daily basis, the scope for building
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Further, in an Exchange traded scenario where the market lot is fixed at a
much lesser size than the OTC market, equitable opportunity is provided to
priority ensuring that the best price is available to all categories of market
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Rationale For Introducing Currency Future
Futures markets were designed to solve the problems that exist in forward
sell an asset at a certain time in the future at a certain price. But unlike
the underlying instrument that can be delivered, (or which can be used for
futures contract may be offset prior to maturity by entering into an equal and
opposite transaction.
• Location of settlement
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The rationale for introducing currency futures in the Indian context has been
The rationale for establishing the currency futures market is manifold. Both
exchange rate remains unchanged from the time of purchase of the asset to
its sale, no gains and losses are made out of currency exposures. But if
exposure would result in gain (loss) for residents purchasing foreign assets
and loss (gain) for non residents purchasing domestic assets. In this backdrop,
Currency futures enable them to hedge these risks. Nominal exchange rates
are often random walks with or without drift, while real exchange rates over
long run are mean reverting. As such, it is possible that over a long – run, the
planning horizon is much smaller than the long-run, which is typically inter-
to hedge currency risk and this need has grown manifold with fast growth in
cross-border trade and investments flows. The argument for hedging currency
goods and services, which results in income flows with leads and lags and get
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in exchange rate are found to have very low correlations with foreign equity
and bond returns. This in theory should lower portfolio risk. Therefore,
sometimes argument is advanced against the need for hedging currency risks.
But there is strong empirical evidence to suggest that hedging reduces the
risks.
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
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, three month up to twelve month
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expiry cycles. In NSE/BSE will have 12 contracts outstanding at any given
point in time.
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
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 :
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
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for each contract. In a normal market, basis will be positive. This reflects
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
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)
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that traders are required to maintain the balance in the account. Due to this
MAINTENANCE 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.
Hedging:
Wants to lock in the foreign exchange rate today so that the value of inflow
Presume that the current spot rate is Rs.43 and ‘USDINR 27 Aug 08’ contract
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Sell one August contract today. The value of the contract is Rs.44,250.
Let us assume the RBI reference rate on August 27, 2008 is Rs.44.0000. The
entity shall sell on August 27, 2008, USD 1000 in the spot market and get Rs.
44,000. The futures contract will settle at Rs.44.0000 (final settlement price
The return from the futures transaction would be Rs. 250, i.e. (Rs. 44,250 –
Rs. 44,000). As may be observed, the effective rate for the remittance
spot rate on that date was Rs.44.0000. The entity was able to hedge its
exposure.
Take the case of a speculator who has a view on the direction of the market.
He would like to trade based on this view. He expects that the USD-INR rate
trade based on this belief? In case he can buy dollars and hold it, by
investing the necessary capital, he can profit if say the Rupee depreciates
months, then he shall make a profit of around Rs.10000. This works out to
an annual return of around 4.76%. It may please be noted that the cost of
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A speculator can take exactly the same position on the exchange rate by
using futures contracts. Let us see how this works. If the INR- USD is Rs.42
and the three month futures trade at Rs.42.40. The minimum contract size is
USD 1000. Therefore the speculator may buy 10 contracts. The exposure
shall be the same as above USD 10000. Presumably, the margin may be
around Rs.21, 000. Three months later if the Rupee depreciates to Rs.
42.50 against USD, (on the day of expiration of the contract), the futures
price shall converge to the spot price (Rs. 42.50) and he makes a profit of
valued and is likely to see a fall in price. How can he trade based on his
to profit from his opinion. Today all he needs to do is sell the futures.
the underlying price rises, so will the futures price. If the underlying price
falls, so will the futures price. Now take the case of the trader who expects to
see a fall in the price of USD-INR. He sells one two-month contract of futures
on USD say at Rs. 42.20 (each contact for USD 1000). He pays a small
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margin on the same. Two months later, when the futures contract expires,
USD-INR rate let us say is Rs.42. On the day of expiration, the spot and the
futures price converges. He has made a clean profit of 20 paise per dollar.
For the one contract that he sold, this works out to be Rs.2000.
Arbitrage:
same or similar product between two or more markets. That is, arbitrage is
the profit being the difference between the market prices. If the same or
similar product is traded in say two different markets, any entity which has
access to both the markets will be able to identify price differentials, if any. If
in one of the markets the product is trading at higher price, then the entity
shall buy the product in the cheaper market and sell in the costlier market
and thus benefit from the price differential without any additional risk.
futures price and forward prices are arrived at using the principle of cost of
carry. Such of those entities who can trade both forwards and futures shall
them is priced higher, the same shall be sold while simultaneously buying
the other which is priced lower. If the tenor of both the contracts is same,
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since both forwards and futures shall be settled at the same RBI reference
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Trading Process And Settlement Process
Like other future trading, the future currencies are also traded at organized
TRADER TRADER
( BUYER ) ( SELLER )
Purchase
Sales order
order
Transaction on the floor
MEMBER (Exchange) MEMBER
( BROKER ) ( BROKER )
Inform
CLEARING
HOUSE
It has been observed that in most futures markets, actual physical delivery of
the underlying assets is very rare and hardly it ranges from 1 percent to 5
percent. Most often buyers and sellers offset their original position prior to
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delivery date by taking an opposite positions. This is because most of futures
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,
foreign currency forwards, swaps and options in the OTC market. At the
same time, RBI also set up an Internal Working Group to explore the
would be constituted. To begin with, the Committee would evolve norms and
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1. To coordinate the regulatory roles of RBI and SEBI in regard to trading
2. To suggest the eligibility norms for existing and new Exchanges for
information.
stability.
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Comparision Of Forward And Futures Currency Contract
parties
Method of Established by the bank or broker Open auction among buyers and seller on the floor of
Participants Banks, brokers, forex dealers, Banks, brokers, multinational companies, institutional
years
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Settlement Actual delivery or offset with cash Daily settlement to the market and variation margin
Market place Over the telephone worldwide and At recognized exchange floor with worldwide
Accessibility Limited to large customers banks, Open to any one who is in need of hedging facilities or has
Delivery More than 90 percent settled by actual Actual delivery has very less even below one percent
delivery
Secured Risk is high being less secured Highly secured through margin deposit.
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Product Definitions Of Currency
Future On NSE/BSE
Underlying
would be permitted.
Trading Hours
The minimum contract size of the currency futures contract at the time of
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
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Available contracts
Settlement mechanism
Settlement price
The settlement price would be the Reserve Bank Reference Rate on the date
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
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Contract specification in a tabular form is as under:
and
(Monday to Friday)
to
Value date
Settlement
settlement
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Conclusion
By far the most significant event in finance during the past decade has been
those investors most able and willing to take it- a process that has
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
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
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.
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Bibliography
Websites:
www.sebi.gov.in
www.rbi.org.in
www.wikipedia.org
www.economywatch.com
www.bseindia.com
www.nseindia.com
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