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Currency Derivative
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Table of Contents• Currency Future Market• Why currency Market???• What are the Factor Affecting Currency Market???• Products Information .• Strategies for Currency Market .• Benefits of Currency Trading for Exporter & Importer.
• Effect of Currency Rate Fluctuation on Exporter & Importer• OTC vs Exchange Traded Future• Other Trading Strategy – Arbitrage & Speculation• About Systematix
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 August’2008.• Major Exchange – NSE, MCX-SX.• SEBI is the regulatory Body for Currency Future Trading in India.
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Factors Affecting Currency Prices
• Macro economic views
• Monetary Policy
• RBI intervention
• Flow information
• Performance of other Asian currencies
• Performance of equity markets
• USD sentiment
• Performance of key commodities affecting trade
• Policy announcements affecting flows – trade or capital
• REER – Real Effective Exchange Rate
• Data announcements
Product Available for Tradingi). US Dollar – INRii). Euro –INRiii). Pound – INR iv). Yen – INR
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Product Infomation
Symbol USD-INR EUR-INR GBP-INR JPY-INR
Lot Size 1000 1000 1000 100000*
Tick Size .25 Paisa or INR .0025
Trading Hours Monday – Friday, 09:00 AM – 5:00 PM
Contract Trading Cycle
12 month Trading Cycle
Last Trading Day Two working Days prior to the Last Business Day of of the Expiry month at 12 noon
* Price Quotation is of 100 JPY
Contd.Final Settlement Day Last working Day ( Excluding Saturday) of the Expiry month.
Initial Margin SPAN Based Margin
Settlement Daily Settlement : T+1 Final Settlement : T +2
Mode of Settlement Cash settled in Indian Rupee
Daily Settlement Price Calculated on the basis of the last half an hour weighted average price.
Final Settlement Price RBI Reference Rate
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Currency Strategy - 1 Trade date (11th May):
USDINR 27th May contract: 46.7000
Current OTC rate: 46.4500
Sell 10 May contracts: Value Rs. 4,67,000.00 (USD 1000 *10* 46.7000)
Hold contract to expiry: RBI fixing rate on 27th May 2010 – 46.0000
Futures return: Profit of Rs.7,000.00 (4,67,000.00 – 4,60,000.00) Margins:
Approx. 4.00%: Rs. 18, 680.00
Funding @ 12%: Rs. 186.80 per month (if margins paid in cash) Net return: Rs. 6813.20 (After deducting funding cost and MTM loss)
Margins (collateral) can be paid in FDs, Bank Guarantees, Approved Securities Daily Mark to Market will be in Cash only.
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Currency Strategy – 2 (Other currency pairs)Directional Views
A 3rd currency to INR currency future gives a trader a powerful tool to take a directional views on the 3rd currency versus INR. Incase, the trader wishes to take a position only against the USD, he can do so by synthetically creating a cross currency position. Here is an example to demonstrate the same.
Assume :
EUR/INR May contract is trading at 57.8800 and USD/INR May contract is trading at 46.5400.
View : EUR to strengthen against the USD
Execution : You buy X contracts of EURINR @ 57.8800 AND
You sell 1.2X contracts of USDINR @ 46.5450
Effectively, you have synthetically created a buy Euro against USD position by doing this. There remains some basis risk arising from mismatch in EURINR and USDINR amounts.
Currency Strategy – 3 A Corporate has a view on EURO to appreciate by 3 big figures from 1.2625 and INR to
appreciate to 46.35 from 46.70 levels. Corporate can do the follow hedge:
So when the position is locked at 1.2625, the volatility is of 3 big figures is protected and being an importer he/she would wait to cover the USDINR leg.
In OTC market, premium would be charged for each leg respectively.
Book EURUSD LEG separately
To book EURUSD at 1.2625 before it hits 1.2925
Book USDINR LEG separately
To hold USDINR position with a view towards 46.35 from 46.70
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Benefits of Currency Future Trading for Importer & Exporter• In Today’s 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:
Sale ( In US Dollar) $ 100 mn
Exchange Rate 46.5 (on 15th July)
Sale in Rupee (Exp.) Rs. 465 cr.
Cost of Goods Sold Rs. 450 cr.
Operating Profit Rs. 15 cr.
Exporter contd.
Exchange Rate 46.5 46 47
Sale in Rupee 465 460 470
Cost of Goods Sold 450 450 450
Operating Profit 15 10 20
-33%
•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.
Fig. in cr.
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:
Purchase ( In Euro) Euro 100 mn
Exchange Rate 59.5 (on 15th July)
Purchase in Rupee (Exp.) Rs. 595 cr
Goods agreed to be sold in India Rs. 650 cr.
Operating Profit Rs. 55 cr.
Importer contd.
Exchange Rate 59.5 60 59
Purchase Cost ( In cr.) 595 600 590
Goods Sold in India 650 650 650
Operating Profit 55 50 60
-9%
•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.
Fig. in cr.
Effect of Exchange Rate on Margin
Profit Margin %Change in Interest Rate
1% 2% 5% 10%
05.00% 0.80 0.60 0.00 -1.00
10.00% 0.90 0.80 0.50 0.00
15.00% 0.93 0.87 0.67 0.33
20.00% 0.95 0.90 0.75 0.50
In the above table effect of Exchange Rate on Margin is shown taking different Scenario . For e.g. if the Net Margin of the Project/ Order/ Company is 10% and Exchange Rate moves* by 1% then from the table we can found that Margin will hit by 10%.
*Unfavorable Move
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 Processor’s 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:
Situtation 1 Situtation 2
Sell Rate 46.6 46.6
Buy Rate 46.1 47.1
Profit per Contract 500 -500
Total Profit ( In Cr.) 5 -5
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
Situtation 1 Situtation 2
Buy Rate 59.6 59.6
Sell Rate 60.1 59.1
Profit per Contract 500 -500
Total Profit ( In Cr.) 5 -5
Profit/ Loss from the future will offset the loss/ Profit due to Fluctuation in Currency Rates.
OTC vs Future MarketOTC Market Exchange Traded Futures
Accessibility Low High
Price Transparency Low High
Liquidity Subject to credit limits High
Agreements Customized Standard
Credit Exposure Yes Mitigated through the clearing corporation
Settlement Physical Delivery Net Settled in INR
Underlying exposure Required Not required
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 - SpeculationView: INR will depreciate against USD, caused by India’s sharply rising import bill and
poor FII equity flows
• Trade:USDINR 31 July contract: 43.5000Current Spot rate (9 July 10): 43.0000Buy 1 July contract: Value Rs. 43,500 (USD 1000 * 43.5000)Hold contract to expiry: RBI fixing rate on 29 July 10 – 44.0000Economic 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• Macro economic views
• Monetary Policy
• RBI intervention
• Flow information
• Performance of other Asian currencies
• Performance of equity markets
• USD sentiment
• Performance of key commodities affecting trade
• Policy announcements affecting flows – trade or capital
• REER – Real Effective Exchange Rate
• Data announcements
Market Statistics - June 2010Exchange NSE* MCX- SX
Contracts TurnoverContract
Traded OI Turnover Contracts
Traded OI
USD - INR 13683 2933068 512420 16848 3609036 728429
EURO - INR 329 57800 18200 2031 356110 25109
POUND - INR 19 2869 4000 290 42146 13727
YEN - INR8.2 1596 2060 151 29460 5723
Total 14881 3174433 860550 19322 4038024 772988
Note - Turnover in cr. , OI is Open Interest
* NSE Volume for separate script is For June Month Contract
Market Statistics – contd.Contract Wise Market Share - June
USD- INR
92%
YEN- INR
0%
EURO- INR
7%
POUND- INR
1%
Market Share in % - June 2010
MCX - SX56%
NSE44%
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