Whenever one foreign currency is exchanged for another it is called foreign exchange and the market which deals with it is called foreign exchange market (FOREX). Forex market is the most liquid and largest market in the world. We can exchange the currencies in two ways. outright or a swap. Transaction resulting in exchange of one currency for another is outright and When transaction result in exchange and rexchange of one currency for another in future but with immediate delivery it is called a swap. First currency is base currency and second currency is terms currency. For eg: in dollar –rupee. dollar is base currency and rupee is terms currency.

A futures contract is a contract to buy or sell an underlying asset in the future at a specified price and specified date. When the underlying is an exchange rate, the contract is termed as “currency futures contract”. Both buyer and seller have an obligation to settle the contract at a specified date and price in future. The contract can be cash settled or buyer and seller can fulfill their respective obligations in other forms. like in kind.

Now let us take an hypothetical example that an importer needs to safeguard himself against the currency risk and fluctuations has 1 million USD. The company needed to buy 1000 contracts as one contract is of USD 1000 therefore he buys 1000 contacts. here one contract is for 1000USD. Total comes out to be 1 million USD which is what he wanted as a payment to protect himself against currency risks. now margin would be very less for the company against the total valiue say typically around 45%. Company needs to pay Rs.4.594 crores as against Rs.4.412 crores for increase in the value of USD against INR for return of USD I million. the company already has a long position in this to offset the risk and make profit in the currency market. this strategy is typically called hedging to minimize your risks and exposure to market fluctuations .

PARTICIPANTS OF CURRENCY FUTURE MARKET

There are basically three main participants in the currency futures market, these are hedgers. speculators and arbitragers. These are as follows:

Hedgers

Hedging is measure to counter the risks of currency troughs and peaks the foreign exchange market

Hedging can be used as an insurance cover against risks

Hedgers can safeguard their standing in cash market. therefore they should participate in the currency future market.

Hedgers protect themselves completely by expanding their cash position and holding futures for a long period of time.

Speculators

Speculators participate in the market only for profit making. they anticipate price fluctuations in the economy

Speculators encourage demand and supply in the market. thereby providing liquidity to the currency market

They do not take an offsetting position in the market

They are risk takers whereas hedgers are risk averse and continuity in the flow of transactions in the market

They trade for immediate benefits and are very keen on price movements in the economy but trade for lesser amounts as compared hedgers

Arbitrages

Exchange or we can say buying and selling of the same underlying asset or financial instrument to make immediate profit by experimenting with the price fluctuations in the same or different financial markets in order to avoid risks.

Usually arbitragers are more as compared to hedgers so they provide liquidity to the market and influence market prices

Net profit realized by the arbitragers is very less after the deduction of tax and other cuts therefore they trade in large volumes

CURRENCY TRADING

A. WHO ARE BENEFITED IN CURRENCY FUTURES?

Exporters

Importers

Traders

Industries where payments are denominated in Foreign Exchange

Professionals receiving remuneration & stock options in foreign currency

Commodity traders

Foreign Institutional Investors (FII) and Non-Resident Indian (NRI) are not allowed to participate in this market whereas Indian residents. Indian corporate(due to the nature of their business ) and domestic Indian financial institutions / banks are allowed as per the regulations of the government.

B. CONTRACT SIZE AND SPECIFICATIONS

C. MARKET TIMINGS:

Market timings for trading in currency derivatives is from IST 9 am to IST 5 pm.

D. ORDERS

Order placement will work in the same manner as in the equities market as per time and rate considerations.

E. MARGIN REQUIREMENTS:

For risk reduction margin requirements according to Standardized Portfolio Analysis of Risk (SPAN) are :

1. Initial margin. minimum margin requirements are 1.75% on that day of trade and 1% after that. Calendar spread margin has been specified to be rs 250/- by the exchange.

2. Extreme Loss Margin: it is 1.1% of total value of gross open position of that person/company and additional margin can be imposed if specified by the exchange.

3. Position Limits: US dollar 5 million or 1.6% of open position – higher one among these as the position limit.

4. Member-broker margin as specified by the broker

F. BILLING AND SETTLEMENT

Billing will take place as per the equity derivatives market with MTM profit or loss, initial margin, broker margin etc. clearing and settlement will take place as per RBI reference rate. expiry date and outstanding position of the contract.

USD — INR Volatility:

All the economies of the world are affected by upturns and downturns in the value of US dollar.US dollar has the maximum impact on the foreign exchange market cause US GDP is approximately 25% of world’s GDP, therefore it is one of the strongest nations. Volatility of the INR has been high in the past 7-8 months moving from 46/USD(October,2009) to 47/USD. INR is strengthening against USD which is greatly in favour of importers affecting exporters adversely. On the reverse side of the coin if rupee would have depreciated then it would have adversely affected the importers and benefited the exporters. This can be briefed as follows: