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CHAPTER- I
INTRODUCTION
freedom was granted to banks in term of fixing their trading limits, allowed to borrow and
invest funds in the overseas markets up to specified limits, accorded freedom to make use of
derivative products for asset-liability management purposes.
The other feature of forex history in India is that a large sum of foreign exchange
in India came through the large Indian population working in foreign countries. However, the
common man was not much interested in forex trading. The things are changing now and
with the growing economy more and more people are showing interest in forex trading and
are looking out for hedging currency risks.
National Stock Exchange of India popularly known as (NSE) was the first
recognized exchange in Indian forex history to launch forex currency futures trading in India.
These currency futures are beneficial over overseas forex trading especially to comparatively
small traders and retail investors. Another important point to know is that before discussing
the history of forex market in India, it is important to know the central government of India
has the powers to control transactions in foreign exchange and hence forex transactions in
India are managed by the government authorities.
OUTFLOWS
Outward Remittances
Central banks
National central banks play an important role in the foreign exchange markets. They
try to control the money supply, inflation, and/or interest rates and often have official or
unofficial target rates for their currencies. They can use their often substantial foreign
exchange reserves to stabilize the market. Nevertheless, the effectiveness of central bank
"stabilizing speculation" is doubtful because central banks do not go bankrupt if they make
large losses, like other traders would, and there is no convincing evidence that they do make a
profit trading.
The mere expectation or rumor of a central bank foreign exchange intervention might
be enough to stabilize a currency, but aggressive intervention might be used several times
each year in countries with a dirty float currency regime. Central banks do not always achieve
their objectives. The combined resources of the market can easily overwhelm any central
bank.[66] Several scenarios of this nature were seen in the 199293 European Exchange Rate
Mechanism collapse, and in more recent times in Asia.
Hedge funds as speculators
About 70% to 90% of the foreign exchange transactions conducted are speculative.
This means the person or institution that bought or sold the currency has no plan to actually
take delivery of the currency in the end; rather, they were solely speculating on the movement
of that particular currency. Since 1996, hedge funds have gained a reputation for aggressive
currency speculation. They control billions of dollars of equity and may borrow billions
more, and thus may overwhelm intervention by central banks to support almost any currency,
if the economic fundamentals are in the hedge funds' favour.
There are two main types of retail FX brokers offering the opportunity for speculative
currency trading: brokers and dealers or market makers. Brokers serve as an agent of the
customer in the broader FX market, by seeking the best price in the market for a retail order
and dealing on behalf of the retail customer. They charge a commission or mark-up in
addition to the price obtained in the market. Dealers or market makers, by contrast, typically
act as principal in the transaction versus the retail customer, and quote a price they are willing
to deal at.
It is estimated that in the UK, 14% of currency transfers/payments are made via
Foreign Exchange Companies. These companies' selling point is usually that they will offer
better exchange rates or cheaper payments than the customer's bank. These companies differ
from Money Transfer/Remittance Companies in that they generally offer higher-value
services.
Settlements of Foreign Exchange Transactions are made through the following accounts: NOSTRO Account: Our Account with you;
The account maintained by an Authorised Dealer with a foreign bank is called
"NOSTRO" Account or "Our Account with You". When an instrument like a cheque or
an export bill is purchased the same is sent to the overseas bank (correspondent) for
realisation, the amount is collected and credited to Authorised Dealers account with
them. Similarly, when a draft is issued on a banks foreign correspondent it will be paid
at the overseas centre by debiting the NOSTRO Account of the issuing bank.
When our bank deals in an export credit bill on collection basis/on realisation of export
bills negotiated /purchased/discounted, the foreign currency funds is to be credited to our
account. For this purpose, we maintain Foreign Currency accounts with our various
correspondents abroad. The account is called NOSTRO account. Once the proceeds are
credited in our NOSTRO account, we receive the statement, based on which, the concerned
branch, who have handled the transaction, will be informed.
Likewise, when we would like to make remittances, on behalf of our customers
towards import payments, miscellaneous remittances etc., we give instructions to our
correspondents, to debit our NOSTRO account and effect payment.
Market participants
Commercial companies
An important part of the foreign exchange market comes from the financial activities
of companies seeking foreign exchange to pay for goods or services. Commercial companies
often trade fairly small amounts compared to those of banks or speculators, and their trades
often have little short-term impact on market rates. Nevertheless, trade flows are an important
factor in the long-term direction of a currency's exchange rate. Some multinational
corporations (MNCs) can have an unpredictable impact when very large positions are
covered due to exposures that are not widely known by other market participants.
Central banks
National central banks play an important role in the foreign exchange markets. They
try to control the money supply, inflation, and/or interest rates and often have official or
unofficial target rates for their currencies. They can use their often substantial foreign
exchange reserves to stabilize the market. Nevertheless, the effectiveness of central bank
"stabilizing speculation" is doubtful because central banks do not go bankrupt if they make
large losses, like other traders would, and there is no convincing evidence that they do make a
profit trading.
Foreign exchange fixing
Foreign exchange fixing is the daily monetary exchange rate fixed by the national
bank of each country. The idea is that central banks use the fixing time and exchange rate to
evaluate behavior of their currency. Fixing exchange rates reflects the real value of
equilibrium in the market. Banks, dealers and traders use fixing rates as a market trend
indicator.
The mere expectation or rumor of a central bank foreign exchange intervention might
be enough to stabilize a currency, but aggressive intervention might be used several times
each year in countries with a dirty float currency regime. Central banks do not always achieve
their objectives. The combined resources of the market can easily overwhelm any central
bank.[66] Several scenarios of this nature were seen in the 199293 European Exchange Rate
Mechanism collapse, and in more recent times in Asia.
Some investment management firms also have more speculative specialist currency
overlay operations, which manage clients' currency exposures with the aim of generating
profits as well as limiting risk. While the number of this type of specialist firms is quite
small, many have a large value of assets under management and, hence, can generate large
trades.
Retail foreign exchange traders
Individual retail speculative traders constitute a growing segment of this market with
the advent of retail foreign exchange trading, both in size and importance. Currently, they
participate indirectly through brokers or banks. Retail brokers, while largely controlled and
regulated in the USA by the Commodity Futures Trading Commission and National Futures
Association, have in the past been subjected to periodic foreign exchange fraud. To deal with
the issue, in 2010 the NFA required its members that deal in the Forex markets to register as
such (I.e., Forex CTA instead of a CTA).
Those NFA members that would traditionally be subject to minimum net capital
requirements, FCMs and IBs, are subject to greater minimum net capital requirements if they
deal in Forex. A number of the foreign exchange brokers operate from the UK under
Financial Services Authority regulations where foreign exchange trading using margin is part
of the wider over-the-counter derivatives trading industry that includes Contract for
differences and financial spread betting.
There are two main types of retail FX brokers offering the opportunity for speculative
currency trading: brokers and dealers or market makers. Brokers serve as an agent of the
customer in the broader FX market, by seeking the best price in the market for a retail order
and dealing on behalf of the retail customer. They charge a commission or mark-up in
addition to the price obtained in the market. Dealers or market makers, by contrast, typically
act as principal in the transaction versus the retail customer, and quote a price they are willing
to deal at.
It is estimated that in the India, 14% of currency transfers/payments are made via
Foreign Exchange Companies. These companies' selling point is usually that they will offer
better exchange rates or cheaper payments than the customer's bank. These companies differ
from Money Transfer/Remittance Companies in that they generally offer higher-value
services.
SPECULATORS:
This groups, which includes banks, funds, corporations and individuals creates artificial rate
exposure in order to profit from the variations or movements in the price. They play a vital
role in forex market. Speculators are people who analyze and forecast futures price
movement, trading contracts with the hope of making a profit. Speculators put their money at
risk and must be prepared to accept outright losses in the futures market.
de-regulation, the role of self-regulatory organizations like FEDAI has also transformed.
In such an environment, FEDAI plays a catalytic role for smooth functioning of the
markets through closer co-ordination with the RBI, other organizations like FIMMDA, the
Forex Association of India and various market participants. FEDAI also maximizes the
benefits derived from synergies of member banks through innovation in areas like new
customized products, bench marking against international standards on accounting, market
practices, risk management systems, etc.
not about the market doing so. Another issue that often confuses people (even traders and
bankers) is the difference between a currency moving up and its rate going up. We have to
explain this in more detail as any misunderstanding can lead to painful surprises when trading
in the real market.
A foreign exchange rate usually consists of an integer part and 4 decimal points. Thus
the decimals are expressed either at 10th thousands or hundreds. Each such 0.0001 or 0.01 is
called basis point or pip. E.g. a 50 pips change of 1.5000 is either 1.5050 or 1.4950.
Spot Market and the Forwards and Futures Markets
There are actually three ways that institutions, corporations and individuals trade
forex: the spot market, the forwards market and the futures market.
The spot market is where currencies are bought and sold according to the current
price. That price, determined by supply and demand, is a reflection of many things, including
current interest rates, economic performance, sentiment towards ongoing political situations
(both locally and internationally), as well as the perception of the future performance of one
currency against another. When a deal is finalized, this is known as a "spot deal". It is a
bilateral transaction by which one party delivers an agreed-upon currency amount to the
counter party and receives a specified amount of another currency at the agreed-upon
exchange rate value. After a position is closed, the settlement is in cash.
Although the spot market is commonly known as one that deals with transactions in
the present (rather than the future), these trades actually take two days for settlement. Unlike
the spot market, the forwards and futures markets do not trade actual currencies. Instead they
deal in contracts that represent claims to a certain currency type, a specific price per unit and
a future date for settlement. In the forwards market, contracts are bought and sold OTC
between two parties, who determine the terms of the agreement between themselves.
In the futures market, futures contracts are bought and sold based upon a standard
size and settlement date on public commodities markets. Futures contracts have specific
details, including the number of units being traded, delivery and settlement dates, and
minimum price increments that cannot be customized. The exchange acts as a counterpart to
the trader, providing clearance and settlement.
Reading A Quote
There are two ways to quote a currency pair, either directly or indirectly. A direct
currency quote is simply a currency pair in which the domestic currency is the quoted
currency; while an indirect quote, is a currency pair where the domestic currency is the base
currency. So if you were looking at the Canadian dollar as the domestic currency and U.S.
dollar as the foreign currency, a direct quote would be USD/INR, while an indirect quote
would be INR/USD. The direct quote varies the domestic currency, and the base, or foreign
currency, remains fixed at one unit. In the indirect quote, on the other hand, the foreign
currency is variable and the domestic currency is fixed at one unit.
For example,
If Indian Rupee is the domestic currency, a direct quote would be USD/INR and
means that USD$1 will purchase 68.22 Rupees.
In the forex spot market, most currencies are traded against the U.S. dollar, and the
U.S. dollar is frequently the base currency in the currency pair. In these cases, it is called a
direct quote. This would apply to the above USD/INR currency pair, which indicates that
US$1 is equal to 68.22 Indian Rupee
However, not all currencies have the U.S. dollar as the base. The Queen's currencies those currencies that historically have had a tie with Britain, such as the British pound,
Australian Dollar and New Zealand dollar - are all quoted as the base currency against the
U.S. dollar. The euro, which is relatively new, is quoted the same way as well. In these cases,
the U.S. dollar is the counter currency, and the exchange rate is referred to as an indirect
quote.
Most currency exchange rates are quoted out to four digits after the decimal place,
with the exception of the Japanese yen (JPY), which is quoted out to two decimal places.
EXCHANGE
QUOTING
BASE CURRENCY
NOTATION USED
RATES
CURRENCY
USD/INR
USD
INR
INR
EUR/INR
EUR
INR
INR
JPY/INR
JPY
INR
INR
The quote before the slash is the bid price, and the two digits after the slash represent
the ask price (only the last two digits of the full price are typically quoted). Note that the bid
price is always smaller than the ask price. Let's look at an example:
USD/INR=68.210
Bid = 68.180
Ask= 68.240
One of the biggest sources of confusion for those new to the currency market is the
standard for quoting currencies.
Cross Currency
When a currency quote is given without the U.S. dollar as one of its components, this
is called a cross currency. The most common cross currency pairs are the EUR/GBP,
EUR/CHF and EUR/JPY. These currency pairs expand the trading possibilities in the forex
market, but it is important to note that they do not have as much of a following (for example,
not as actively traded) as pairs that include the U.S. dollar, which also are called the majors.
1$/68.21
Bid
68.21
Ask
=
68.21
If you want to buy this currency pair, this means that you intend to buy the base
currency and are therefore looking at the ask price to see how much (in Canadian dollars) the
market will charge for U.S. dollars. According to the ask price, you can buy one U.S. dollar
with 1.2005 Canadian dollars.
However, in order to sell this currency pair, or sell the base currency in exchange for
the quoted currency, you would look at the bid price. It tells you that the market will buy
US$1 base currency (you will be selling the market the base currency) for a price equivalent
to 68.21 Indian Rupees which is the quoted currency.
Whichever currency is quoted first (the base currency) is always the one in which the
transaction is being conducted. You either buy or sell the base currency. Depending on what
currency you want to use to buy or sell the base with, you refer to the corresponding currency
pair spot exchange rate to determine the price
Bid Price
68.180
Ask Price
68.240
One point move, in USD/INR it is
Pip
Spread
7. When value of a currency is fixed in terms of some other currency or in terms of gold, it is
known as Parity value of currency.
2. Flexible Exchange Rate System:
Flexible exchange rate system refers to a system in which exchange rate is determined
by forces of demand and supply of different currencies in the foreign exchange market.
1. The value of currency is allowed to fluctuate freely according to changes in demand and
supply of foreign exchange.
2. There is no official (Government) intervention in the foreign exchange market.
3. Flexible exchange rate is also known as Floating Exchange Rate.
4. The exchange rate is determined by the market, i.e. through interactions of thousands of
banks, firms and other institutions seeking to buy and sell currency for purposes of making
transactions in foreign exchange.
Fixed Exchange Rate System vs Flexible Exchange Rate System:
Basis
Fixed Exchange
Flexible Exchange
Determination of
Rate
Rate
It is officially fixed It is determined by
Exchange Rate:
Government
by government.
exchange.
There is complete There is no
Control:
fluctuates freely
change it.
according to market
conditions.
of market forces. Market forces mean the selling and buying activities by various individuals
and institutions. So far, the managed floating exchange rate system is similar to the flexible
exchange rate system.
But during extreme fluctuations, the central bank under a managed floating exchange
rate system (like the RBI) intervenes in the foreign exchange market. Objective of this
intervention is to minimise the fluctuation in the exchange rate of rupee.
Since, the exchange rate is basically determined by market forces, the upward and
downward movement in the value of rupee are appreciation and depreciation.
What is Depreciation?
Depreciation of the rupee refers to the decrease in the external value of the domestic
currency occurred due to the operation of market forces. Here, the exchange rate is moving
with demand and supply of dollar. Depreciation happens under a flexible exchange rate
system or under a managed floating exchange rate system. (Eg. 1$ = Rs 40 to 1$ = Rs 50)
What is Appreciation?
Appreciation of the rupee refers to the increase in the external value of the domestic
currency occurred due to the operation of market forces. Here, the exchange rate is moving in
accordance with the demand and supply of dollar. Appreciation happens under a flexible
exchange rate system or under a managed floating (Eg. 1$ = Rs 65 to 1$ = Rs 50).
In India, the exchange rate system is managed floating (from 1994 onwards) and hence
the relevant currency movements are appreciation and depreciation. Here, the exchange rate
is determined in the open market through the pressure of buying and selling of foreign
currencies
CHAPTER II
Arbitrage is the simultaneous purchase and sale of equivalent assets at prices which
guarantee a fixed profit at the time of the transactions, although the life of the assets and,
hence, the consummation of the profit may be delayed until some future date. The key
element in the definition is that the amount of profit be determined with certainty. It
specifically excludes transactions which guarantee a minimum rate of return but which also
offer an option for increased profits.
Hedging is the simultaneous purchase and sale of two assets in the expectation of a
gain from different subsequent movements in the price of those assets. Usually the two assets
are equivalent in all respects except maturity.
Speculation is the purchase or sale of an asset in the expectation of a gain from
changes in the price of that asset.
Arbitrage .
Arbitrage is the market activity of buying and selling of same security on exchanges
or between spot prices of a security and its future contract.
Definition:
Arbitrage is the profit making market activity of buying and selling of same security
on different exchanges or between spot prices of a security and its future contract. Here
exchange refers to the stock market where shares are traded, like the NSE and BSE.
Description:
A stock is traded in multiple stock exchanges and on each stock exchange the quoting
price may be a bit different. Hence arbitrage as a practice is followed to take advantage of the
price disparity. Originally arbitrage occurred in the currency market, but now it applies
equally
in
the
commodity,
futures
and
the
stock
market
as
well.
For example:
Infosys is quoting at Rs 2750 on the BSE and Rs 2760 on the NSE. Hence one can
sell the stock on the NSE and buy from the BSE at the same time. This trade will lead to a
profit without any risk.
Forex arbitrage is a risk-free trading strategy that allows retail forex traders to make a
profit with no open currency exposure. The strategy involves acting fast on opportunities
presented by pricing inefficiencies, while they exist. This type of arbitrage trading involves
the buying and selling of different currency pairs to exploit any inefficiency of pricing. If we
take a look at the following example, we can better understand how this strategy works.
capital assets are consistent with a factor structure. Ross argues that if equilibrium prices
offer no arbitrage opportunities over static portfolios of the assets, then the expected returns
on the assets are approximately linearly related to the factor loadings.
The APT is a substitute for the Capital Asset Pricing Model (CAPM) in that both
assert a linear relation between assets expected returns and their covariance with other
random variables. (In the CAPM, the covariance is with the market portfolios return.) The
covariance is interpreted as a measure of risk that investors cannot avoid by diversification.
The slope coefficient in the linear relation between the expected returns and the covariance is
interpreted as a risk premium. The APT is used by arbitrage traders for earning profit in forex
market. The Arbitrage is an International tool for earning profits in Foreign exchange market.
ARBITRAGE IN INDIA
Arbitrage is an often-used term in share markets. The arbitrager is an important
intermediary that helps in price discovery mechanism in all markets be it equity, moneyforex
or derivatives. There are three important participants that are important in a cash market, the
speculator, arbitrager and an investor. In futures market the investor is replaced by a hedger.
Arbitrager and Speculator are often confused and both are termed as Speculators.
Arbitraging in India has been going on for several years. Initially arbitrage activity
was between Stock Exchange Mumbai and all other regional exchanges. Mr. Babulal Bagri
the founder of BLB Securities and Mr. Manubhai Maneklal were legendary arbitragers of that
era. They traded between Mumbai, Delhi and Calcutta markets. Arbitraging in those days was
done manually and not on any online system. The way the fingers of these brokers flew on
telex machines giving trade instructions was an experience by itself. Then it shifted to
cashing on price difference between NSE and BSE limited. Today large amount of arbitrage
happens between cash and derivative markets. Arbitrage is also possible between the current
month and near or far month contracts. In case of Commodity exchanges also there is an
arbitrage opportunity between the local cash markets or mandis and the future markets which
are popularly known as National Commodity Exchanges.
The arbitrager is one who plays the role of balancing the price differences across the
markets. The markets may be two exchanges trading in the same product or two segments
such as cash and derivatives or across international markets and local markets. The arbitrager
continuously tracks prices across the chosen segment. are momentary price differences in two
markets due to difference in level of information as well as demand supply situation in the
market. These price differences are an
Asset Allocation
Instruments
Medium-High 65-80%
Medium-High 20-35%
Arbitrage Strategies
Arbitrage is a strategy involving a simultaneous purchase and sale of identical or
equivalent instruments across two or more markets in order to benefit from a discrepancy in
their price relationship. It is a risk-free transaction, as the long and short legs of the
transaction offset each other exactly. Thus, arbitrage engages in a strategy in order to reduce
risk of loss caused by price fluctuations of securities held in the portfolio. It involves buying
and selling of equal quantities of a security in two different markets, with the expectations
that a future change in price will offset by an opposite change in the other.
Daily turnover in the derivatives segment is around 3.5 times the cash market
volumes and is to the tune of Rs 30,000 crores. Arbitrage activity is largely concentrated in
single stock futures, while index arbitrage is not very popular, although it contributes about
25-30% of the total stock futures volumes. In India, stock borrowing in the cash market is
cumbersome, making the Sell Stock buy Futures strategy Difficult; hence, almost the
entire arbitrage activity is concentrated in Buy Stock-Sell Futures. This strategy helps to
develop both stock & forex market in India as large no of investors are attracted by the
returns gained by them in markets than in other normal investments.
It is safe, as it does not carry equity market risk, as all equity positions are completely
hedged.
Potential returns are higher than comparable investment avenues with similar risks.
Since the arbitrage fund is categorized as equity fund, there will be no tax on LongTerm capital gains;
Potential returns are higher than those in comparable investment avenues with similar
risks like bank
Cross-broker Arbitrage
Arbitrage between broker-dealers is probably the easiest and most accessible form of
arbitrage to retail FX traders. To use this technique you need at least two separate broker
accounts, and ideally, some software to monitor the quotes and alert you when there is a
discrepancy between your price feeds. You can also use software to back-test your feeds for
arbitrage opportunities.
A mainstream broker-dealer will always want to quote in step with the FX interbank
market. In practice, this is not always going to happen. Variances can come about for a few
reasons: Timing differences, software, positioning, as well as different quotes between price
makers. Remember, foreign exchange is a diverse, non-centralized market. There are always
going to be differences between quotes depending on who is making that market.
Features
Symbol
Unit of trading
Underlying
Tick size
Trading hours
Contract trading cycle
Final settlement day
Position limits
i)
Minimum-Initial
margin
j)
Extreme loss margin
l)
Settlement
m)
Mode of settlement
n)
Daily settlement price
Details
USD/INR, EUR/INR, GBP/INR, JPY/INR
1 (1 unit denotes 1000) except JPY (100,000)
The exchange rate in INR for USD/EUR/GBP/ JPY
INR 0.0025
Monday to Friday (9.00 am to 5.00 pm)
12 month trading cycle.
Last working day of the expiry month.
Clients (per exchange): 6% of total open interest or
USD 10mn , whichever is higher
4% of notional value of the contract.
1%
Daily : T+ 1,Final : T+ 2
Cash settled in INR
Calculated on the basis of last half an hour weighted
average price.
o)
The below table shows the following currencies which are most traded currencies in the
world in a year. These are some of the data which are being used by hedgers, speculators &
arbitragers for the prediction and to make the Investment decision in a particular currency.
The below data is also depend upon the countrys development in all sectors & economic
policy, Inflation & Interest rates etc.
Rank
Currency
United States dollar
Euro
Japanese yen
Pound sterling
Australian dollar
Swiss franc
Canadian dollar
Hong Kong dollar
Swedish krona
New Zealand dollar
South Korean won
Singapore dollar
Norwegian krone
Mexican peso
Indian rupee
Other
Symbol
% daily s hare
1
USD ($)
84.90
EUR ()
2
39.10
JPY ()
3
19.00
4
GBP ()
12.90
5
AUD ($)
7.60
6
CHF (Fr)
6.40
7
CAD ($)
5.30
8
HKD ($)
2.40
9
SEK (kr)
2.20
10
NZD ($)
1.60
11
KRW
1.50
12
SGD ($)
1.40
13
NOK (kr)
1.30
14
MXN ($)
1.30
INR ()
15
0.90
16
Other
12.20
Total
200.00%
This table shows the most traded currencies sorted by value in 2010.
Spreads
When arbitraging, it is critical to account for the spread or other trading costs. That is,
you need to be able to buy high and sell low. In the example above, if Broker A had quoted
1.3038/1.3048, widening the spread to 10 pips, this would have made the arbitrage
unprofitable.
The outcome would have been:
Entry trade: Buy 1 lot from A @ 1.3048 / Sell 1 lot to B @ 1.3048
Exit trade: Sell 1 lot to A @ 1.3049 / Buy 1 lot from B @ 1.3053
Profit: -4 pips
In fact, this is what many brokers do. In fast moving markets, when quotes are not in
perfect sync, spreads will blow wide open. Some brokers will even freeze trading, or trades
will have to go through multiple re quotes before execution takes place. By which time the
market has moved the other way. Sometimes these are deliberate procedures to thwart
arbitrage when quotes are off. The reason is simple. Brokers can run up massive losses if they
are arbitraged in volume.
Buy Orders
Contract Details
No. of
Lots
FUT-USDINR-27-Aug-
Qty Rate
1 1000
45
Sell Orders
Order
No. of
Value
Lots
45000
Qty Rate
Order
Value
2009
FUT-USDINR-28-Sep-
1 1000
49
49000
2 2000
52
104000
1 1000
40
40000
2009
FUT-USDINR-28-Oct2009
d) Total
2 2000
94000
3 3000
144000
As explained above, margin is levied on the higher of Buy and Sell Order value. In the above
given example, Sell Order Value is greater than Buy Order Value. Hence margin would be
levied at specified margin % on Rs. 144000.
Cross-currency arbitrage
Trading text books always talk about cross-currency arbitrage, also called triangular
arbitrage. Yet the chances of this type of opportunity coming up, much less being able to
profit from it are remote.With triangular arbitrage, the aim is to exploit discrepancies in the
cross rates of different currency pairs.
CURRENCY TABLE
Currency
Last
Day High
Day Low
% Change
Bid
Ask
EUR/INR
75.658
--
--
+0.03%
75.658
75.721
GBP/INR
98.310
--
--
-0.21%
98.310
98.373
INR/JPY
1.7235
--
--
-0.28%
1.7235
1.7243
INR/CHF
0.014605
--
--
--
0.014605
0.014624
INR/CAD
0.020518
--
--
+0.01%
0.020518
0.020531
AUD/INR
47.880
--
--
-1.50%
47.880
48.023
Without the threat of arbitraging, broker-dealers have no reason to keep quotes fair.
Arbitrageurs are the players who push markets to be more efficient. Without them, clients can
become captive within a market rigged against them.
Disadvantages of Arbitrage
Challenges to the Arbitrage Trader
Arbitraging can be a profitable low risk strategy when correctly used. Before you rush out
and start looking for arbitrage opportunities, there are a few important points to bear in mind.
Liquidity discount/premiums
When checking an arbitrage trade, make sure the price anomaly is not down to vastly
different liquidity levels. Prices may discount in less liquid markets, but this is for a
reason. You may not be able to unwind your trade at your desired exit point. In this case,
the price difference is a liquidity discount, not an anomaly.
Execution speed challenge
Arbitrage opportunities often require rapid execution. If your platform is slow or if you
are slow entering the trades, it may hamper your strategy. Successful arb traders use software
because there are a lot of repetitive checks and calculations.
Lending/borrowing costs
Advanced arbitrage strategies often require lending or borrowing at near risk free rates.
But once fees are added, traders outside of banks cannot lend or borrow at anywhere near
risk free rates. This invalidates many arbitrage opportunities.
Spreads and trade costs
Always factor in all trading costs from the start.
SPECULATION
Currency speculation exists whenever someone buys a foreign currency, not because
she needs to pay for an import or is investing in a foreign business, but because she hopes to
sell the currency at a higher rate in the future (in technical language the currency
"appreciates"). This is nothing more than the old rule of buying low and selling highonly
with foreign money.
Some currency speculation is necessary to facilitate international trade. Take, for
example, a car manufacturer in India which exports cars to the United States. As the U.S.
importer of Indian cars is paying her bill in U.S. dollars, the Indian exporter receives U.S.
currency. But the exporter has to pay her workers and suppliers in Indian currency, and thus
needs to exchange the U.S. currency into Indian Rupees. Someone has to buy U.S. dollars
(U.S.$) so that she can buy INR . Currency traders can make money from simply being
middlemen in this process, buying the U.S.$ and charging transaction fees. But many also act
as speculators, hoping that they can profit from selling the dollars at a higher price in the
future.
Another transaction for which currency speculation is needed is so-called foreign
direct investment (FDI). FDI occurs when residents of one country buy or establish
production facilities in another country.
Examples of FDI in the India include Ford cars plant in Kanchipuram, Hyundai cars
plant in Sriperumbuthur. If a foreign company wants to build a plant here they need to
exchange their foreign currency for U.S.$. Again, they need to find currency speculators who
will buy Yen, DM or French Francs because they expect these currencies to gain in value.
The sum of currency transactions that are directly related to trade and investment is
considered the "primary exchange market," because it is linked to the exchange of real goods
and services. Most currency transactions do not occur in the primary market, though, but in
the secondary, or speculative, marketthrough which five times as much money changes
hands as in the primary market.
The more currency speculators are involved in the secondary market, the easier it is
for traders and investors to buy and sell foreign exchange when they need to. Hence,
"increased liquidity" means easier access to foreign currencies because there is a larger
market for such currencies.
Herd Behavior
While the processing and interpretation of information is an integral part of currency
markets, "herd behavior" among currency traders is equally important, especially since it
makes many interpretations self-fulfilling. If large numbers of traders behave in the same
way, a currency will automatically gain or lose in valuejust like the speculators had
guessed in the first place.
If a country introduces more "business friendly policies," such as deregulation or
lower labor standards, a few speculators will decide that it is worth buying a currency, thus
driving the price of the currency up. To make sure that the value of this currency continues to
rise, the original buyers will provide enough information to convince other speculators to buy
the currency also.
A consensus is formed for a while where everybody believes that the particular
currency will only gain in value, and for a while this is true as everybody continues to buy.
Thus, the profits which the original buyers had expected are generated by more speculators
buying this particular currency.
Speculation Tricks
The trick in making money with currency speculation is to know when to get in or
out. At some point the first speculators decide to get out because they have made enough
money, or they think that the currency is likely to fall in value. Information that signals
speculators to sell are usually indications that local profit opportunities are decreasing.
Such signals include more government regulation, tougher environmental standards,
or an emerging labor movement. Speculators will begin selling the currency, and if many
speculators decide to get out the value of the currency will fall, more speculators will sell, the
value will fall further, and a downward spiral will ensue.
If a currency's sell-off is in response to particular domestic events, most governments
will attempt to halt the fall of their currency by reversing the policies or events that initially
prompted speculators to sell. In the cases of South Korea and Indonesia, the governments
have been reluctant to reverse their initial policies, making speculators wary of buying these
currencies again.
So far we have been focusing on exchanges in the present, or what currency traders
call the "spot market," where U.S.$ are exchanged for French Franc or Dutch Guilder right
now. Speculative purchases in the spot market are done with the intent to sell the currency
relatively quickly. Many speculators will hold foreign currency that they buy in the spot
market for a mere 15 to 20 minutes. After this time a speculator simply decides to take her
gain or loss, and to start all over again.
Profit in Speculation
Surprisingly enough, a speculator can make a handsome profit in that short amount of
time. Let's say that a U.S. speculator thinks that Indian Rupee (INR) are going to rise in
value, so she takes $10 million and buys INR. If the original price is 66.50 per U.S.$ , she
will get 669889500 Rs .
After twenty minutes, the value of the INRhas increased to 66.8 cents. Her 669889500
Rs can now be converted back into U.S.$, yielding $10.020 million (0.668 times of
669889500 Rs), leaving the trader with a profit of $20,000 for less than half an hour of work.
Even though the margins between the selling and buying prices of a currency are usually less
than 1%, the large volume of each transaction, generally $10 million or more, make
handsome profits possible.
Because foreign exchange transactions are potentially so profitable, large speculators
(mainly multinational banks) are devoting more and more of their resources to such
activities.Since these earnings are the fastest growing part of bank incomes, it is not
surprising that billions of new dollars continue to enter the global currency markets, thus
enhancing the power of speculators.
One important side effect of forward transactions is that they can become selffulfilling prophecies, especially in the case of forward sales, which have been at the core of
various currency crises. In a forward sale a speculator guesses that the value of a currency
will fall in the future.
Consequently, she will enter an agreement to sell a fixed amount of this currency at a
specified time in the future, at something close to the current rate. If her guess is correct, at
the specified future date she will be able to buy the currency cheaply in the market and sell it
at the higher contracted exchange rate.
But by offering a forward sales contract to other market participants, the speculator
signals that she thinks the currency is going to depreciate in the future. Since foreign
exchange markets rely on a lot of intangible information, and since the number of large
currency speculators is relatively small, such a signal can have a relatively large impact. If
George Soros, for example, decides to offer a forward sale on Thai bhat, other speculators are
likely to take notice, and adjust their predictions about the future value of the Thai currency
downwards. If a growing number of speculators think that the Thai currency will fall, they
will start selling their holdings, thus driving down the value of the currency, and hence
making George Soros' prediction come true.
Exchange Rate "Regimes"
So far this discussion has assumed that there are no restrictions on exchanging one
currency for another, and that foreign currency exchange rates are set only by the supply of
and demand for each currency. In this case, we have a flexible exchange rate "regime," since
the value of a currency can move whenever supply and demand are out of balance. But to
understand some of the most recent currency crises, it is important to note that many
exchange rates are not flexible, but are fixed either unilaterally by their own governments
against one other currency, or multilaterally in an agreement between different countries.
Contrary to intuition, currency speculation can also occur in fixed exchange rate
regimes. In fact, almost all cases of fixed exchange rates have eventually been abandoned
because of currency speculation. Under such a regime, a government makes a commitment to
buy or sell its own currency to keep it at a fixed exchange rate.
If a currency's exchange rate is set too high (overvalued), the nation's central bank has
to constantly prop it up. The bank does this by buying its own currency (thereby raising
demand relative to supply), or by selling its reserves of other currencies.
But since a central bank holds only limited amounts of foreign currency, it will
eventually be unable to buy more of its own currency. At that point, a government has three
options. The first is to impose austerity on its own people through higher interest rates and
reduced government spendingwhich will reduce imports, raise exports, and so increase
foreign currency reserves.
If the government is unwilling to force a recession, it will have to let its currency
depreciate, either by setting a new, lower exchange rate, or by allowing its currency to be
flexible ("float"). Either way, if speculators regard an exchange rate as too high and likely to
fall soon, they will sell the currency in the forward market. If they guess right, they will be
able to buy it in the future at a low market price, and sell it high at the already-contracted for
rate. If many speculators sell the currency in the forward market, this will signal that the
currency is overvalued, and people will begin selling the currency in the spot market.
Eventually, the central bank will be unable to support the fixed exchange rate and the
currency's value will fall. This is another self-fulfilling prophecy, as the speculators who
originally began the downward trend pull others along with them, thus actually devaluing the
currency.
So through herd behavior and self-fulfilling proposals, speculation creates an
international economy more prone to crisis. It also makes global capitalism more impatient
with reforms that aid the many rather than the fewunion protections, environmental
regulations, welfare provisions, and efforts to promote employment.
These risks and constraints are a problem for more than the developing economies in
Southeast Asia and elsewhere. Nowadays, no single country is large enough to
stabilize its own currency if speculators, who have billions of dollars at their beck and
call, decide to speculate against it. We all, it seems, have to be vigilant against the
risks and ravages of currency speculation. Reducing currency speculation is not an
easy task, and cannot be accomplished by a single country.
USD, JPY, EUR, GBP, CAD, AUD, NZD, CHF, ZAR, MXN, KRW, SEK, ILS
Disadvantages of speculation
Winners Curse:
Auctions are a method of squeezing out speculators from a transaction, but they may
have their own perverse effects. The winners curse says that in an auction, the winner will
tend to overpay in one of two ways:
The winning bid exceeds the value of the auctioned asset such that the winner is
worse off in absolute terms; or
The value of the asset is less than the bidder anticipated, so the bidder may still
have a net gain but will be worse off than anticipated.
The winners curse is not very significant to markets with high liquidity for both
buyers and sellers, as the auction for selling the product and the auction for buying the
product occur simultaneously, and the two prices are separated only by a relatively small
spread. This mechanism prevents the winners curse phenomenon from causing mispricing to
any degree greater than the spread.
Economic Bubbles:
Speculation is often associated with economic bubbles. A bubble occurs when the
price for an asset exceeds its intrinsic value by a significant margin. Speculative bubbles are
HEDGING
When a currency trader enters into a trade with the intent of protecting an existing or
anticipated position from an unwanted move in the foreign currency exchange rates, they can
be said to have entered into a forex hedge. By utilizing a forex hedge properly, a trader that
is long a foreign currency pair, can protect themselves from downside risk; while the trader
that is short a foreign currency pair, can protect against upside risk.
The primary methods of hedging currency trades for the retail forex trader is through:
Spot contracts are essentially the regular type of trade that is made by a retail forex trader.
Because spot contracts have a very short-term delivery date (two days), they are not the most
effective currency hedging vehicle. Regular spot contracts are usually the reason that a hedge
is needed, rather than used as the hedge itself.
Foreign currency options, however are one of the most popular methods of currency
hedging. As with options on other types of securities, the foreign currency option gives the
purchaser the right, but not the obligation, to buy or sell the currency pair at a particular
exchange rate at some time in the future. Regular options strategies can be employed, such as
long straddles, long strangles and bull or bear spreads, to limit the loss potential of a given
trade.
Forex hedging strategy
A forex hedging strategy is developed in four parts, including an analysis of the forex
trader's risk exposure, risk tolerance and preference of strategy. These components make up
the forex hedge:
Analyze risk:
The trader must identify what types of risk (s)he is taking in the current or proposed
position. From there, the trader must identify what the implications could be of taking on
this risk un-hedged, and determine whether the risk is high or low in the current forex
currency market.
Determine risk tolerance:
In this step, the trader uses their own risk tolerance levels, to determine how much of
the position's risk needs to be hedged. No trade will ever have zero risk; it is up to the
trader to determine the level of risk they are willing to take, and how much they are
willing to pay to remove the excess risks.
Determine forex hedging strategy:
If using foreign currency options to hedge the risk of the currency trade, the trader
must determine which strategy is the most cost effective.
Simultaneously sell $25,000 (receipt from overseas party) in the spot market at the
rate of 48.45
Your notional net profit as a result of Hedging transactions would be: 12,500 - 8,750
= 3,750
NOTE: Had you not taken position in the currency futures market, you would have
made a loss of ` 8,750. By taking position in this market, you have not only covered
your loss but also earned a profit from the futures transaction
EXAMPLES OF HEDGING
Suppose an edible oil importer wants to import edible oil worth USD 100,000 and
places his import order on July 15, 2008, with the delivery date being 4 months ahead. At the
time when the contract is placed, in the spot market, one USD was worth say INR 44.50. But,
suppose the Indian Rupee depreciates to INR 44.75 per USD when the payment is due in
October 2008, the value of the payment for the importer goes up to INR 4,475,000 rather than
INR 4,450,000. The hedging strategy for the importer, thus, would be:
Current Spot Rate (15th July '08) Buy 100 USD - INR Oct '08 Contracts on 15th July
08 : 44.5000 (1000 * 44.5500) * 100 (Assuming the Oct '08 contract is trading at 44.5500 on
15th July, '08),Sell 100 USD - INR Oct '08 Contracts in Oct '08 Profit/Loss (futures market) :
44.7500 1000 * (44.75 -44.55) * 100 = 20,000 Purchases in spot market @ 44.75
Total cost of hedged transaction : 44.75 * 100,000 100,000 * 44.75 20,000 = INR
4,455,000
A jeweller who is exporting gold jewellery worth USD 50,000, wants protection
against possible Indian Rupee appreciation in Dec 08, i.e. when he receives his payment. He
wants to lock-in the exchange rate for the above transaction.
One USD - INR contract size : USD 1,000 Sell 50 USD - INR Dec '08 Contracts (on
15th Jul '08) : 44.6500 Buy 50 USD - INR Dec '08 Contracts in Dec '08 : 44.3500 Sell USD
50,000 in spot market @ 44.35 in Dec '08 (Assume that initially Indian rupee depreciated ,
but later appreciated to 44.35 per USD as foreseen by the exporter by end of Dec '08)
Profit/Loss from futures (Dec '08 contract) : 50 * 1000 *(44.65 44.35) = 0.30 *50 * 1000 =
INR 15,000
The net receipt in INR for the hedged transaction would be: 50,000 *44.35 + 15,000 =
2,217,500 + 15,000 = 2,232,500. Had he not participated in futures market, he would have
got only INR 2,217,500. Thus, he kept his sales unexposed to foreign exchange rate risk.
Consider a small Indian company that has exported goods to a U.S. customer and
expects to receive US$50,000 in one year. The Indian CEO views the current exchange rate
of US$1 = 68.22 as favorable, and would like to lock it in, since he thinks that the Indian
Rupees may appreciate over the year ahead (which would result in fewer Indian Rupee for
the U.S. dollar export proceeds when received in a years time). The Indian company can
borrow US$ at 1.75% for one year and can receive 2.5% per annum for Indian Rupees
deposits.
From the perspective of the Indian Company, the domestic currency is the Indian Rupee and
the foreign currency is the US dollar. Heres how the money market hedge is set up.
1. The Indian Rupee borrows the present value of the U.S. dollar receivable (i.e.
US$50,000 discounted at the US$ borrowing rate of 1.75%) = US$50,000 / (1.0175) =
US$49,140.05. Thus, after one year, the loan amount including interest at 1.75%
would be exactly Rs 3350772
2. The amount of US$49,104.15 is converted into Indian Rupee at the spot rate of 1.10,
to get 3290726 Rs.
3. The Indian Rupee amount is placed on deposit at 2.5%, so that the maturity amount
(after one year) is = Rs 3350772 x (1.025) = Rs 3434541.
4. When the export payment is received, the Indian company uses it to repay the US
dollar loan of US$50,000. Since it received Rs 3434541 for this US dollar amount, it
effectively locked in a one-year forward rate = Rs 3350772 / US$50,000.
Potential reasons could be that the company is too small to obtain a forward currency facility
from its banker; or perhaps it did not get a competitive forward rate and decided
To hedge money market hedge instead.
Lack of Awareness
Only near month contracts are liquid and pricing is reasonable, whereas far- month
contracts are illiquid and prices remain distorted.
Fears about receiving margin calls and procedure hassle for corporate in dealing with
futures is keeping away many participants. Also the margin money which remains
idle for few months is viewed as a flaw in managing the cash in many companies, as
the same benefits they can get in the forward market without parking margin money.
Few companies have a policy of not hedging their exchange risk fearing the market
volatility and in some other companies they prefer to hedge only in OTC
markets(Forward contracts)
Hedging in the forward market has a lot in common with a money market hedge. In
both cases of hedging there is a short-term capital movement. In the case of a forward hedge
the short-term capital movement of the hedger is replaced by a capital movement of a bank.
Therefore, such forward transactions can be interpreted as a credit from the bank to the
counterparty in the forward deal . Since forward transactions with customers also involve
counterparty risk for the bank, just like credit risk in case of a loan, they require a certain
amount of collateral.
In principle, hedging of long-term flows should also produce a pattern of long-term
and short-term capital movements flowing in opposite directions. Unlike in the case of
international intermediation these flows do not have to be equal in size. If hedging is not
complete, long-term flows should be larger. Furthermore, once it is taken into account that
hedge ratios may be different for locals and foreigners and that they may change over time, it
becomes clear that hedging may be difficult to detect.
In the end, currency hedging can be an investment trap if you think that it is without
risks. As with any type of investment approach, hedging also has risks that can result in huge
losses. Before you embark on any type of hedging strategy, you need to understand its
underlying concepts clearly.
CHAPTER IV
DATA ANALYSIS
Worlds largest financial market trades at $4.0 trillion values of currency per day in
trades ($3.3 in 2007).
NSE stock exchange of India currently trades about 40 Million Rupee per day.
Major markets open Monday through Friday; Middle East markets also open on
weekends
Trades take place through a network of computer (Reuters screens) and telephone
connections all over the world.
37% of all trades take place through banks located in the U.K. (London);
6% Japan (Tokyo).
USD (86%);
EUR (52%);
GBP (39%);
JPY (27%);
INR (11%)
AUD (8%);
CHF (6%);
USD/EUR (28%);
USD/JPY (14%);
USD/GBP (9%);
USD/AUD (6%)
USD/INR (5%)
EUR/INR (3.5%)
GBP/INR (1%)
Most of the worlds currencies are quoted for trade purposes on the basis of European
terms.
In meeting the needs of their clients and their own trading activities, these global
banks establish the tone of the foreign exchange market.
Traders in this market include large banks, central banks, institutional investors,
currency speculators, corporations, governments, other financial institutions, and retail
investors.
The below table shows us the banks which deal with Forex transactions In a year and
the market share of those banks in dealing in forex & mainly in settlement, handling of INR
transactions in a year
Rank
1
2
Name
State Bank Of India (SBI)
Citi Bank
Market s hare
15.18%
14.90%
3
4
5
6
7
8
9
10
ICICI Bank
HDFC Bank
HSBC
Axis Bank
Deutsche Bank
IDBI Bank
Bank of Baroda
Royal Bank of Scotland
Total
10.24%
10.11%
6.93%
6.07%
5.62%
3.70%
3.15%
3.08%
78.98%
Volume of INR
Cost of INR
11
13
20
The brokerage fee per unit of a base currency becomes negligible since the electronic
dealing/matching system of Reuters places restrictions on the minimum size of a currency
trade. Moreover, it is only possible to trade multiples of the minimum quantity of a currency.
The matching system does not accept trading orders that violate these restrictions. Deposits,
however, do not face such restrictions on quantity traded as
venues.The below table shows the minimum trading volume of Indian Rupee(INR) in an year
Currency pair
USD/INR
100 Billion
EUR/INR
75 Billion
GBP/INR
67 Billion
JPY/INR
10 Billion
The settlement costs are associated with messages/notices that are sent to counterparts
of a trade. In our case, a trade is settled and implemented through the SWIFT (Society for
Worldwide Interbank Financial Telecommunication) network. There are three notices
associated with each transaction: notice of conrmation, payment instructions and notice
of incoming payments.
Conrmation of a deal is sent to both sides of the deal on the trading date. This is
followed by payment instructions to the banks where both parties have accounts that will be
debited.
Finally, a notice of incoming payments may be sent to the banks where both parties
want the incoming payments to be credited.The cost of a notice is 1428 cents and is the
same for transactions in the FX and security markets.
The cost does not depend on the venue of trading, i.e. it is the same for trading
directly or via a broker (voice or electronic). Thus each party incurs a total cost of 0.420.84
cents for the three messages per transaction.
These costs are charged at the end of each month. SWIFT invoices its customers
either in dollars or euros, depending on the country in which the customer is located
irrespective of the invoicing address. The following table illustrates the volume of arbitrage
done in Indian Rupees
YEAR
2007
8243
2008
12992
2009
16758
2010
21663
2011
23112
2012
28004
2013
31850
2014
36487
2015
39009
CURRENCY PAIRS
ARBITRAGE IN
INR(In Crores)
2012
USD/INR
2150
150
2013
GBP/INR
1997
852
2014
JPY/INR
1012
96
2015
EUR/INR
1229
120
TOTAL PROFIT IN %
JANUARY
0.8938
FEBRUARY
1.6179
MARCH
1.2974
APRIL
0.9421
MAY
0.7215
JUNE
0.9473
JULY
1.2565
AUGUST
0.3543
SEPTEMBER
0.2752
OCTOBER
0.4052
NOVEMBER
0.2324
DECEMBER
0.2808
TOTAL
9.244
Currency(mn) Rs (Cr)
Nature of exposure
Reliance Industries
Currency Swaps
1064.49
Options Contracts
2939.76
Forward Contracts
5764.10
Forward Contracts
6411 (INRJPY)
70 ($-INR)
Currency swaps
124.70(USD
-INR)
350 (INR-JPY)
2(INR-EUR)
27.3($-INR)
Currency Swaps
5390 (JPYINR)
2.25 (GBPINR)
Arvind Mills
Forward Contracts
5 (INR-$)
Option Contracts
21.88
Infosys
Forward Contracts
119 ($-INR)
529
Options Contracts
4 ($-INR)
18
8 (INR-$)
36
2 ($-INR)
971
3 (Eur-INR)
Tata Consultancy Services
Forward Contracts
Option Contracts
15 (Eur-INR)
265.75
21 (GBP-INR)
830 ($-INR)
4057
47.5 (Eur-INR)
76.5 (GBPINR)
Ranbaxy
Forward Contracts
2894.589
398 ($-INR)
11(Eur $)
Options Contracts
30 (EUR-$)
goods.
Note:
1.
2.
From the above table it can be seen that earnings of all the firms are linked to either US
dollar, Euro or Pound as firms transact primarily in these foreign currencies globally.
Forward contracts are commonly used and among these firms, Ranbaxy and RIL depend
heavily on these contracts for their hedging requirements. As discussed earlier, forwards
contracts can be tailored to the exact needs of the firm and this could be the reason for their
popularity. The tailorability is a consideration as it enables the firms to match their exposures
in an exact manner compared to exchange traded derivatives like futures that are standardised
where exact matching is difficult.
RIL, Maruti Udyog and Mahindra and Mahindra are the only firms using currency
swaps. Swap usage is a long term strategy for hedging and suggests that the planning
horizons for these companies are longer than those of other firms. These businesses, by
nature involve longer gestation periods and higher initial capital outlays and this could
explain their long planning horizons.
Another observation is that TCS prefers to hedge its exposure to the US Dollar through
options rather than forwards. This strategy has been observed among many firms recently in
India11. This has been adopted due to the marked high volatility of the US Dollar against the
Rupee.
Options are more profitable instruments in volatile conditions as they offer unlimited
upside profitability while hedging the downside risk whereas there is a risk with forwards if
the expectation of the exchange rate (the guess) is wrong as firms lose out on some profit.
The use of Range barrier options by Infosys also suggests a strategy to tackle the high
volatility of the dollar exchange rates. Software firms have a limited domestic market and
rely on exports for the major part of their revenues and hence require additional flexibility in
hedging when the volatility is high. Another implication of this is that their planning horizons
are shorter compared to capital intensive firms.
It is evident that most Indian firms use forwards and options to hedge their foreign
currency exposure. This implies that these firms chose short-term measures to hedge as
opposed to foreign debt. This preference is possibly a consequence of their costs being in
Rupees, the absence of a Rupee futures exchange in India and curbs on foreign debt. It also
follows that most of these firms behave like Net Exporters and are adversely affected by
appreciation of the local currency.
There are a few firms which have import liabilities which would be adversely affected
by Rupee depreciation. However it must be pointed out that the data set considered for this
study does not indicate how the use of foreign debt by these firms hedges their exposures to
foreign exchange risk and whether such a strategy is used as a substitute or complement to
hedging with derivatives
.
INR US $
Total in INR
10
47
Interest
-3
-2
-5
30
42
INR Depreciate by 5 %
31.5 7
43 .5
INR Appreciate by 5 %
28.5 7
40 .5
Fluctuation
*+/-3. 57%
Total in
INR US $ INR
Interest
-5
25
10
47
-5
10
42
INR Depreciate by 5
%
26.25 10
43 .25
40 .75
Fluctuation
+/-2. 98 %
VOLUME
DATE
PROFIT/LOSS PIPS
(P/L)
HOLDED TIME
PERIOD
GBP/INR
0.1
18/01/2013
45.60
45.60
5 mins
USD/INR
0.2
7/02/2013
28.20
14.10
17 mins
EUR/INR
0.1
21/03/2013
40.27
40.00
42 mins
SGD/INR
0.03
8/04/2013
(26.93)
21.00
54 mins
MYR/INR
0.5
10/06/2013
(3.76)
8.93
32 mins
JPY/INR
TOTAL
0.9
27/09/2013
38.69
29.68
152.76
159.31
7 mins