FAQ’s on Currency Futures

Ø What is currency trading?

While trade is international, currencies are national. As international transactions are settled in global currencies, usually they are bought/sold for one another and this constitutes ‘currency trading’.

Ø What are Currency Futures?

Currency Futures traded on Exchange

    • Are standard contracts of a specified quantity
    • To exchange one currency for another
    • At a specified date in the future called settlement date
    • At a price that is fixed on the purchase date called futures price

Ø What are the factors that affect the exchange rate of currency?

A country’s 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 the factors like interest rates, inflation, trade balance and political and economic scenarios in the country. The level of confidence in the economy of a particular country also influences the currency of that country.

Ø How and why does demand and supply of a currency increase and decrease?

There are several reasons. The rise in export earnings of a country increases foreign exchange supply. A rise in import increases demand. These are objective reasons, but there are many subjective reasons too. Some of the subjective reasons are: directional viewpoints of market participants, expectations of national economic performance, confidence in country’s economy and so on.

Ø What is currency futures contract?

A currency futures contract is standardized version of forward contract that is traded on a regulated exchange. It is an agreement to buy of sell a specified quantity of an underlying currency on a specified date in future at specified rate. (USD1 = INR 44.00).

(Note: USD is abbreviation for the US Dollar and INR for the Indian Rupee)

Ø How does the Indian Forex market work?

The Foreign Exchange Management Act is the law which regulates the Forex market. The regulatory authority for the Indian Forex market is the Reserve Bank of India (RBI). However, the Exchange Traded Currency Futures market is regulated by SEBI through the recognized stock exchanges.
Authorized Dealers (ADs) licensed by RBI can participate directly in the Forex market. These are usually Scheduled Commercial Banks. A set of participants who are the Full Fledged Money Changers (FFMCs) have been granted license to undertake certain currency transactions with the general public

Ø What is the meaning of currency appreciation and depreciation?

Suppose today we have rate INR 43/USD, when we say rupee is appreciating against US Dollar then the value of rupee may be INR 42/USD or anything less then INR 43/USD. It means now we can buy 100 USD in INR 4200 instead of INR 4300, so we are paying less.
Now suppose today we have rate INR 43/USD, when we say rupee is depreciating against US Dollar then the value of rupee may be INR 44/USD or anything more then INR 43/USD. It means now we can buy 100 USD in INR 4400 instead of INR 4300, so we are paying more.

Ø Why do we need currency futures?

We need currency futures if our business is influenced by fluctuations in currency exchange rates.

If you are in India and are importing something, you have done costing of your imports on the basis of certain exchange rate between the Indian Rupee and the relevant foreign currency (usually the US Dollar or the Euro). By the time you actually import, the value of the Indian Rupee may have gone down and you may lose out on your income in terms of Indian Rupees by paying higher. On the contrary, if you are exporting something and value of Indian Rupee has gone up, you earn less in terms of Rupees than you had anticipated. Currency Futures help you hedge against these exchange rate risks.

Ø Does the National Economy of India need currency futures?

Every business exposed to foreign exchange risk needs to have a facility to hedge against such risks. Exchange-traded currency futures, are a superior tool for such hedging because of greater transparency, liquidity, counter party guarantee and accessibility. Since the economy is made up of businesses of all sizes, anything that is good for business is also good for national economy.

Ø What is OTC Market?

OTC is abbreviation of ‘Over the Counter’. It has no central marketplace and is linked to a network of dealers/traders who do not physically meet but instead communicate through a network of phones & computers. OTC contracts are typically customized based on negotiations between counter parties. The counter party default risk depends on the counter party credit-worthiness and other factors.

Ø Why exchange-traded futures? What’s wrong with currency forward market that has been existing in India for a long time?

The exchange-traded futures, as compared to OTC forwards, serve the same economic purpose, yet differ in fundamental ways.

Exchange traded contracts are standardized. In an exchange-traded scenario where marker lot is fixed at a much lesser size than OTC market, equitable opportunity is provided to all classes of investors whether large or small to participate in the futures market.

The other advantage of an exchange-traded market would be greater transparency, efficiency and accessibility.

The counter party risk (credit risk) in futures contract is eliminated by the presence of a clearing house / corporation, which by assuming counterparty guarantee, eliminates default risk.

When you trade in currency futures, you have to pay a small amount of brokerage fees and statutory duties and taxes. In overseas forex trading you have to pay commissions to the banks or foreign exchange agents in the form of spread. Spread is the difference in the buy/sell price over the reference rate, which can be very high.

It is possible for you to verify trade details on NSE if you have a doubt that the broker has tried to cheat you.

Internationally it has been established that currency future is a better and efficient mechanism for price discovery. With its state of the art automated electronic trading system where the orders are executed on the basis of price-time priority, Exchanges are well poised to offer efficient price discovery.

Thus introduction of exchange-traded futures help in overall development of the forex market of the country.

Ø Who can participate in currency futures marker?

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.

Ø What are the terms and conditions set up by RBI for banks to participate in exchange traded fx futures?

RBI has allowed banks to participate in currency futures market. AD Category 1 banks, which fulfill stipulated prudential requirements, are eligible to become a clearing member and / or trading member of the currency derivatives segment of MCX-SX. All other banks, including

Urban and State Cooperative banks, can participate in the currency futures market only as clients.

Ø Can currency futures help small traders?

Yes. Minimum size of USD/INR futures contract is USD 1000. This is well within the reach of small traders. All transactions on the exchange are anonymous and are executed on a price time priority ensuing that the best price is available to all the categories of market participants irrespective of their size. Also since the profits / losses in futures market are collected / paid on a daily basis, the scope of of losses for participants gets limited.

Ø If I am an individual with no exposure to foreign exchange risks, does a currency futures exchange mean anything to me?

Yes, It does, if you want to invest purely as an investor. You can benefit from exchange rate fluctuations just as you can benefit by investing in equities in the stock market. However, as in stock markets, you can also stand to loose money if price movements are not keeping with what you had anticipated. Participating in currency futures exchange is risky, just as stock market is. You should therefore be knowledgeable about the currency market if you want to participate as an investor.

Ø How do exchange traded currency futures enable hedging against currency risk?

On a currency exchange platform you can buy or sell currency futures. If you are an importer you can buy futures to ‘lock in’ a price for your purchase of actual foreign currency at a future date. You thus avoid exchange rate risk that you would otherwise have faced. On other hand if you are an exporter, you sell currency futures on the exchange platform and ‘lock in’ a sale price at a future date.

Ø What are the risks involved in the currency futures market?

Risk in currency futures pertain to movements in the currency exchange rate. There is no rule of thumb to determine whether the currency rate will rise or fall or remain unchanged. A judgment on this is the domain of experts with deep knowledge and understanding of the variables that affect currency rates.

Ø Which are the global exchanges that trade in currency futures?

Internationally, exchanges like Chicago Mercantile Exchange (CME), Johannesburg Stock Exchange, Euronext.life, BM &F and Tokyo Stock Exchange trade in currency futures.

Ø Why should one trade in Indian exchanges as compared to international exchanges?

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.

Ø What is the min trading unit (ie contract size) and tenure of the USD / INR futures contract?

The contract size of USD / INR futures contract is USD 1000. The contract shall have the max maturity of twelve months. All monthly maturities from 1 to 12 months are available. Currently the maximum volume is seen in near month contract, but with the gradual participation of more market players (Hedgers) we could see more volumes in middle month and far months

Ø What is the last trading day of USD / INR futures contract?

The last trading day of a futures contract shall be two working days prior to the last working day (excluding Saturdays) of the month. The settlement price is the Reserve Bank of India’s reference rate on the last trading day.

Ø In which currency are the USD / INR contracts settled?

Settled in cash in Indian Rupees.

Ø What are the risk management measures of a clearing house / corporation?

The trading of currency futures is subject to maintenance of initial, extreme loss and calendar spread margins with clearing house / corporation. The initial margin is subject to a min of 1.75% on the first day of currency futures and 1% thereafter. The margins shall be deducted from the liquid net worth of the clearing member on an online and real-time basis.

Ø What are the currencies traded on Exchanges?

In the 1st phase of operations, only the USD / INR currency pair will be traded on exchanges. In course of time, other currency pairs will be introduced as and when allowed by regulatory authorities.

Ø What are trading hours for Exchanges?

Trading on currency futures is on all working days between 9.00am to 5.00pm.

Ø What are the contract specifications for currency futures on MCX-SX?

Underlying

Exchange rate in Indian Rupees for US Dollar

Trading Hrs

9.00am to 5.00pm (Mon to Fri)

Contract Size

USD 1000

Price Quotation

INR per 1 USD

Tick size

INR 0.0025

Min Initial margin

1.75% on first day & 1% thereafter

Contracts

All months with a min maturity of 12 months

Settlement Mechanism

Cash Settled in Indian Rupees

Final Settlement Rate

RBI USDINR Reference Rate

Last Trading Day

Two working days prior to the last business day of the expiry month at 12 noon

Final Settlement Date

Last working day of month, except Saturday. It will be same as that for interbank settlement in Mumbai.

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