What is currency trading?
"While trade is international, currencies are national. As international transactions are settled in global currencies, usually they are brought/sold for one another and this constitutes 'currency trading'." Trading can be done in the spot market at currency price or can be done for a future date using the derivatives platform.
What are Currency Derivatives?
The term 'Derivatives' indicates it derives its value from some underlying i.e. it has no independent value. Underlying can be securities, stock market index, commodities, bullion, currency or anything else. From Currency Derivatives market point of view, underlying would be the Currency Exchange rate. Derivatives are unique product, which helps in hedging the portfolio against the future risk. At the same time, derivatives are used constructively for arbitrage and speculation too.
What is Currency Futures?
A currency futures contract is a standardized form of a forward contract that is traded on an exchange. It's an agreement to buy or sell a specified quantity of an underlying currency on a specified date at a specified price. In India, currently four currency pairs are traded (USD/INR, EURO/INR, GBP/INR and JPY/INR) with a lot size of 1000 units of the base currency, except JPY where the lot size is 100,000. Settlement for the customer is, however, done in Rupee terms and not in the foreign currency.
Advantage of Currency Futures
- Transparent & Efficient price discovery
- Ease of trade
- No paperwork required at branch level unlike forward contracts
- Submitting proof of underlying is not a precondition
- Since, no actual delivery of foreign currency is involved, clients may hedge their indirect currency risks
What are the benefits of trading in Currency Derivatives
Currency Derivatives are very efficient risk management instruments and you can derive the below benefits:
- Hedging: You can protect your foreign exchange exposure in business and hedge potential losses by taking appropriate positions in the same. For e.g. If you are an importer, and have USD payments to make at a future date, you can hedge your foreign exchange exposure by buying USDINR and fixing your pay out rate today. You would hedge if you were of the view that USDINR was going to depreciate. Similarly it would give hedging opportunities to Exporters to hedge thier future receivables, Borrowers to hedge foreign currency (FCY) loans for interest and principal payments, Resident Indians, who can hedge their offshore investments.
- Speculation: You can speculate on the short term movement of the markets by using Currency Futures. For e.g. If you expect gold prices to rise and impact India's import bill, you would buy USDINR in expectation that the INR would depreciate. Alternatively if you believed that strong exports from the IT sector, combined with strong FII flows will translate to INR appreciation you would sell USDINR.
- Arbitrage: You can make profits by taking advantage of the exchange rates of the currency in different markets and different exchanges. If you are an organization with exposure to forex, you can take advantage of the price difference between the rates offered by the banks, and at an exchange.
- Leverage: You can trade in the currency derivatives by just paying a % value called the margin amount instead of the full traded value. This could be a double edged sword, though it gives you a potential to make exponential profits from the movements in the underlying., if the movement in the underlying is against you
How are currency prices determined?
Currency prices are affected by a variety of economic and political conditions, but probably the most important are interest rates, international trade, inflation, and political stability. Sometimes governments (china being a good example) actually participate in the foreign exchange market to influence the value of their currencies. They do this either by flooding the market with their domestic currency in an attempt to lower the price or, conversely, buying in order to raise the price. This is known as central bank intervention. Any of these factors, as well as large market orders, can cause high volatility in currency prices. However, the size and volume of the FOREX market make it impossible for any one entity to drive the market for any length of time.
What are the factors that affect the exchange rate of a currency?
"A country's currency exchange rate is typically affected by the supply and demand for the country's currency in the international foreign exchange market. The demand and supply dynamics is principally influenced by factors like interest rates, inflation, trade balance and economic & political scenarios in the country. The level of confidence in the economy of a particular country also influences the currency of that country."
What are the currencies traded on exchanges (NSE, MCX-SX, USE & BSE)?
In the first phase of operations, only the USDINR currency pair was traded on our exchanges. With the changing need of the participants, the regulators have allowed trading in other major currency pairs as EURINR, GBPINR and JPYINR futures contracts.
What is the minimum trading unit (i.e. contract size) and tenure of the USDINR, EURINR, GBPINR and JPYINR futures contract?
The contract size of the USDINR futures contract is USD 1,000, EURINR future contract is EURO 1,000, GBPINR future contract is GBP 1,000 and JPYINR future contract is YEN 1,00,000. The contracts shall have a maximum maturity of twelve months. All monthly maturities from 1 to 12 months are available.
Who can participate in a currency futures market?
Any resident Indian or company including Banks and financial institutions can participate in the futures market. However, at present, Foreign Institutional Investors (FIIs) and Non-Resident Indians (NRIs) are not permitted to participate in currency futures market at this moment.
Who is eligible to trade in Currency Derivatives?
All Resident Indians as defined in section 2(v) of the Foreign Exchange Management Act, 1999 (FEMA, Act 42 of 1999) are eligible to trade in the Currency Derivatives segment. For participation by regulated entities, concurrence from respective regulators should be obtained. Currently, trading facility in Currency Futures at I-Sec will be offered to all Resident Individuals / HUFs / eligible Corporates fulfilling the FEMA criteria.
Why should one trade in Indian exchanges as compared to international exchanges or online currency trading platforms?
Indian currency futures enable individuals and companies in India to hedge and trade their Indian Rupee risk. Most international exchanges offer contracts denominated in other currencies. To top it all off, it is illegal for Indian nationals to trade on the international trading platform, and it is not safe to do so as there is no regulation for these entities.
Can currency futures help small traders?
Yes. The minimum size of the USDINR futures contract is USD 1,000. Similarly EURINR future contract is EURO 1000, GBPINR future contract is GBP 1000 and JPYINR future contract is YEN 1,00,000. These are well within the reach of most small traders. All transactions on the Exchange are anonymous and are executed on a price time priority ensuring that the best price is available to all categories of market participants irrespective of their size. As the profits or losses in the futures market are also paid / collected on a daily basis, the scope of accumulation of losses for participants gets limited.
What are the Contract specifications of Currency Futures?
Contract Specifications of Currency Futures
||USD/INR, EUR/INR, GBP/INR,JPY/INR
||Unit of trading
||1 (1 unit denotes 1000) except JPY (100,000)
||The exchange rate in INR for USD/EUR/GBP/ JPY
||Monday to Friday (9.00 am to 5.00 pm)
||Contract trading cycle
||12 month trading cycle.
||Final settlement day
||Last working day of the expiry month.
||Clients (per exchange): 6% of total open interest or USD 10 mn, whichever is higher.
||4% of notional value of the contract.
||Extreme loss margin
||1% of notional value of the contract
||Daily debited / credited to the account
||Mode of settlement
||Cash settled in INR
||Daily settlement price (DSP)
||Calculated on the basis of last half an hour weighted average price.
||Final settlement price (FSP)
||RBI reference rate.(Last working day of the month)