Define - Currency Futures fine - Currency Futures

A transferable futures contract that specifies the price at which a specified currency can be bought or sold at a future date.

Currency future contracts allow investors to hedge against foreign exchange risk.

Currency Future Market

A currency future, also FX future or foreign exchange future, is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date. Currency futures were first created at the Chicago Mercantile Exchange (CME) in 1972 . In India trading in Currency Future started in August2008. Major Exchange NSE, MCX-SX. SEBI is the regulatory Body for Currency Future Trading in India.

Product Available for Trading

i). US Dollar INR ii). Euro INR iii). Pound INR iv). Yen INR

Product Infomation

Contd.

Benefits of Currency Future Trading for Importer & Exporter

In Todays world Every Financial Instrument has become volatile. It is very important for companies to safeguard their financial Risk in Best Possible way. Exporter & Importer who are dealing in Foreign Currency have always Risk of Currency Rate Fluctuation. Some time it may work in Favour but also may cause huge losses. So its very important for Exporter Importer to cover their Currency Risk. Currency Risk can be mitigated by using Currency Future.

Exporter
Exporter Recieve Foreign Currency, which in normal trading circumstance is received on some Future date from the time when the deal is done. But between these two period Currency might Fluctuate causing loss of Revenue. It can be Explained from below example: On 15th July 2010 Rajshree Diamond which is into Business of Diamond Processing agreed to sell Diamond worth $100 mn to a party in US. Payment is due on 15th Aug. Financial aspect of the Trade for Rajshree is as below:

Exporter contd.
But Exchange Rate on 15th Aug. is not known, so we will do analysis taking different situtation:

We can see that profit get hit by 33% when the Exchange Rate moves to 46 from 46.5.

Importer:
On 15th July 2010 Sindh Engineering Works which is into Business of Importing Machinery agreed to Buy Machinery worth $100 Euro from a party in Germany. Payment is due on 15th Aug. Financial aspect of the Trade for Sindh Engineering is as below:

Importer contd.
But Excahnge Rate on 15th Aug. is not known, so we will do analysis taking different situtation:

We can see that profit get hit by 9% when the Exchange Rate moves to 60 from 59.5.

Why & How to Hedge Currency Risk?

Organization should always focus on their core competencies to improve efficiency and profit. In the example shown a Diamond Processors main business is to process the diamond and sell. Naked currency position can result in Profit for Rajshree Diamond some time but there is huge Risk of wiping of entire profit margin is also attached with this. So Rajshree Diamond should always focus on its main business of Processing Diamond to Maximize Profit rather than speculating on Currency. Also, Hedged Currency Position helps in predicting better Cash Flow Management. Bankers & Creditors feel more comfortable while lending to these Institution. Better Valuation of Equity as Expected profit is less Volatile.

Why & How to Hedge Currency Risk?

Currency Risk can be hedge by using Currency Future Traded on NSE. Exporter - Exporter can hedge their Currency Risk by taking short position on their respective recievable currency. Importer Importer can hedge their Currency Risk by taking Long Position on their respective Payable Currency.

How to Hedge Export Position

E.g. 1 Rajshree Diamond : On 15th July when the deal is done by Rajshree Diamond to receive $100 mn. In month of August, it should take short position of 100000 USD-INR August Future contract. Suppose at that time Aug. Future Contract is trading at 46.6 ( 10 paisa premium) On 15th Aug. Rajshree Diamond will square off the position on Exchange and receive the dollar and convert it into Rupee. Suppose the future premium reduce from 10 paisa to 5 paisa.

Exporter Position:

Profit/ Loss from the future will offset the loss/ Profit due to Fluctuation in Currency Rates.

How to Hedge Import Position ?

E.g. 2 Sindh Machinery : On 15th July when the deal is done by Sindh Machinery to Pay Euro100 mn. In month of August, it should take long position of 100000 Euro-INR August Future contract. Suppose at that time Aug. Future Contract is trading at 59.6 ( 10 paisa premium) On 15th Aug. Palak Diamond will square off the position on Exchange and receive the dollar and convert it into Rupee.

Import Position

Profit/ Loss from the future will offset the loss/ Profit due to Fluctuation in Currency Rates.

OTC vs Future Market

Other Trading Strategy - Arbitrage

Arbitrage Getting the Benefit of Price Mismatch between two Markets. Take long position where market price is lower and simultaneously take short position where market price is higher. Square off the position when the difference between the two market prices is narrowed. e.g. On 15th July $ traded on NSE & MCX is as below: NSE 46.6425 - Buy MCX- SX 46.6575 Sell As per the strategy we will Buy $-INR contract at NSE & sell at MCX. Suppose on 16th July Price on both the exchange equals as follows NSE 46.6025 - Sell ( loss of .04*1000 = 40) MCX- SX 46.6025 Buy ( Profit of .055*1000 = 55) ARBITAGE PROFIT = Rs.5 per lot

Other Trading Strategy - Speculation

View: INR will depreciate against USD, caused by Indias sharply rising import bill and poor FII equity flows Trade: USDINR 31 July contract: 43.5000 Current Spot rate (9 July 10): 43.0000 Buy 1 July contract: Value Rs. 43,500 (USD 1000 * 43.5000) Hold contract to expiry: RBI fixing rate on 29 July 10 44.0000 Economic return: Profit, Rupees 500 (44,000 43,500) A Currency Futures contract is exactly like a futures contract on the NIFTY or on INFOSYTCH. A futures price F is traded on screen. The price is the USDINR exchange rate at a future date.

Factors Affecting Currency Prices

USD sentiment Performance of key commodities affecting trade Policy announcements affecting flows trade or capital REER Real Effective Exchange Rate Data announcements

Macro economic views

Monetary Policy
RBI intervention Flow information Performance of other Asian currencies Performance of equity markets

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