CURRENCY FUTURES Forex Trading India Group Global Markets, Treasury

Transcription

1 CURRENCY FUTURES Forex Trading India Group Global Markets, Treasury

2 Table of contents INTRODUCTION FORWARD CONTRACT FUTURES DIFFERENCE BETWEEN FUTURES & FORWARDS CURRENCY FUTURES EXAMPLE FEATURES MARGIN REQUIREMENT PURPOSE HEDGING ARBITRAGE FINANCIAL LEVERAGE

3 INTRODUCTION Difference between Futures & Forwards?

4 FORWARD CONTRACT A forward contract is an agreement between two parties to buy or sell an asset at a specified point of time in the future.

5 FUTURES An agreement to buy or sell a standard quantity of a specific asset at a specified future date and at a price agreed on an Exchange.

6 DIFFERENCE BETWEEN FUTURES & FORWARDS Future contracts are Exchange Traded Standardized Counter party risk is absent (Settlement of trades on organized exchanges is guaranteed) Marked to Market everyday

7 CURRENCY FUTURES An agreement to make or take delivery of a standard quantity of a specific foreign currency at a specified future date and at a price agreed on an Exchange. Example Features

8 EXAMPLE Contract Best Bid Best Offer Spread LTP USDINR Feb end If A has to sell 100 contracts of USDINR expiring on 24/02/09, he will sell at the Best Bid rate If A has to buy 100 contracts of USDINR expiring on 24/02/09, he will buy at the Best Offer rate

9 FEATURES Category Description Underlying Rate of exchange between 1 USD and INR Contract Size USD 1000 Contract months 12 near calendar months Expiry 12:00 noon of Last Trading day of the month Min Price Fluctuations 0.25 ps or INR Contract = USD 1000 USDINR = Contract Value = 1000* = INR If there is 1 tick movement then gain/loss: Tick Value = 1,000 x = INR 2.50/contract Margin requirement Initial, Calendar, Extreme Loss, Marked to Market Features Contd.

10 FEATURES Settlement Settlement Price Last Trading Day Final Settlement Day Position Limits Cash settled in INR. No physical delivery of the underlying currency RBI Reference Rate of Last Trading Day. Two Business days before the Final Settlement day of the contract Last Business day of the month for interbank Forex settlement (as per FEDAI guidelines). Client Level: The gross open positions of the client across all contracts should not exceed 6% of the total open interest or 10 million USD, whichever is higher. Trading Member level: The gross open positions of the trading member across all contracts should not exceed 15% of the total open interest or 50* million USD whichever is higher. (*In case of a Bank it is USD100 million)

11 MARGIN REQUIREMENT Initial margin Calendar Spread Extreme Loss Margin Marked to Market

12 INITIAL MARGIN The initial margin so computed would be subject to a minimum of 1.75% on the first day of currency futures trading and 1 % thereafter. At present the initial margin is in the range of 3% 5%. Cash / Collateral deposited against short term price movement. Initial margin for each contract is set by the Exchange. Exchange has the right to vary initial margins at its discretion, either for the whole market or for individual members.

13 CALENDAR SPREAD When a CF position at one maturity is hedged by an offsetting position at a different maturity, Rs. 250/ Calendar Spread Margin per Calendar Spread contract is charged.

14 EXTREME LOSS MARGIN Extreme Loss Margin is computed at 1% on the MTM value of the gross open position.

15 MARKED TO MARKET Default risk is reduced by marking to market. MTM value would be calculated on the basis of the last half an hour weighted average traded price of the futures contract. MTM value is used for calculation of Profit / loss on open positions. T+1 settlement (pay in / out) with exchange through Trading Member. MTM Explained

16 MTM Explained Jun $/Rs Number of Contracts: 100 Initial Margin = (say) 5% * 48 * 1000 * 100 = 240,000 INR MTM : Change in USDINR rate 1000 No. of Contracts Position: Sell Jun $/Rs Deposit Rs. 240,000/ as initial margin Day USDINR MTM (in INR) = 0.03*1000*100 = = 0.02*1000*100 = POS. SQ =0.07*1000*100 = 7000 In the above transaction Rs. 2000/ ( ) is the MTM profit.

17 Hedgers (Importers) Market Participants Importer To pay USD 1 mio for Oil imports in March. What happens if USD strengthens? He loses money. Hedgers (Exporters) Exporter To receive USD 1 mio for exports in April. What happens if USD weakens? He loses money. Investors Speculators and Day Traders Arbitragers

18 PURPOSE Hedge against risks (exporters, importers, corporates) (Allows hedge for near 12 months) Arbitrage Financial Leverage (Use of Margin to trade) Efficient management of funds and risk (Due to daily margining and daily exchange of MTM value),

19 HEDGING Hedge means to minimize loss or risk. It means taking a position in the futures market that is opposite to a position in the physical market with a view to reduce or limit risk associated with unpredictable changes in the exchange rate. Hence, it entails 2 positions: Underlying Position Hedging Position i.e. position opposite from the underlying position.

20 Overall portfolio in HEDGING Participant Risk Underlying Position Hedging Position Importer Long Hedger INR will weaken Short in Fx Long in CF Exporter Short Hedger INR will strengthen Long in Fx Short in CF

21 HOW TO HEDGE? Example: The Importer enters into a contract on 1 st June to make a payment for USD on 25 th November, 09. He is of the view that Rupee will depreciate. The importer will buy November CF Contract : 1 USD = Rs th November OTC market ongoing rate = Rs. 42 The importer will book actual import at Rs. 42. The importer will wind up the futures contract at Rs. 42. Thereby generating a profit of Rs. 2. Effective rate of import = Rs. 42 Rs. 2 (profit on CF) = Rs. 40 (This is very simplified example, just to introduce the concept.)

22 How to choose a contract if payment is in the middle of the month, say 15th July? It is advisable to book July end contract, instead of June end contract. Reason: The contracts towards their maturity are liquid. It covers its physical position in OTC market (with Axis Bank) for value 15th July.

23 ARBITRAGE It means locking in a profit by simultaneously entering into transactions in two or more markets where there is price differential of the same underlying. If the relation between forward prices and futures price differs, it gives rise to arbitrage opportunities. If there is price differential between two exchanges, it gives rise to arbitrage opportunities.

24 ARBITRAGE Explained USDINR Spot = INR Month Forward Premium = 3 paisa 1 month USDINR Outright Forward Rate = INR month USDINR Currency Futures = INR BUY OUTRIGHT FORWARDS AND SELL FUTURES. NET GAIN = ( ) INR = PS ARBITRAGE Profit per contract = 1000* = INR (Example assumes that both outright and futures contracts are co terminus.

25 ARBITRAGE STRATEGY OUTRIGHT FORWARD RATE IS LESS THAN FUTURES PRICE BUY IN OUTRIGHT FORWARDS AND SELL IN FUTURES OUTRIGHT FORWARD RATE IS HIGHER THAN FUTURES PRICE SELL IN OUTRIGHT FORWARDS AND BUY IN FUTURES

26 FINANCIAL LEVERAGE By putting an upfront margin of (say) 5%, a client can trade in currency futures. Thereby, leveraging his capital.

27 BENEFITS No requirement of an underlying to trade in currency futures. No requirement of a non fund based limit MTM Settlement Minimal cost of trading Fees for corporate clients and individual clients tailored to suit their requirements (Govt./Exchange taxes, charges, levies extra, as applicable)

28 THANK YOU CF CONNECT