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Derivative Definition

"Never keep all your eggs in one basket"

DEFINITION OF "DERIVATIVE"
A security whose price is dependent upon or derived from one or
more underlying assets. The derivative itself is merely a contract
between two or more parties. Its value is determined by
fluctuations in the underlying asset. The most common
underlying assets include stocks, bonds, commodities,
currencies, interest rates and market indexes. Most derivatives
are characterized by high leverage.
CURRENCY DERIVATIVE
An Exchange Traded Derivative or Over the counter Derivative
with an Underlying reference based on FOREIGN EXCHANGE
rates and flows. A Currency Derivative can be structured as a
Currency Option, Currency Forward, Currency Future,
Currency Swap or Currency Warrant

Lets say there is a farmer


who grows tea in India, which
is exported to the USA.

And there is an importer


of tea in the USA.

Lets assume the current


rate of exchange is Rs. 55
for 1 USD.

Let us also assume that the tea


grower agrees to supply 10
quintals of tea to the importer at 10
dollars a quintal three months
down the line upon harvesting.
(1 Quintal = 100 kgs)

It is important to
understand that the
importer buys tea at 10
dollars a quintal, no matter
what the exchange rate is.

The tea grower thinks that the rate of exchange,

which is currently trading at Rs. 55 to a US

dollar, could fall to Rs. 54 in 3 months.


This would mean that while the importer would

pay her 100 dollars ( $10 per quintal x 10


quintals = $ 100), as per their business deal, she
would earn only Rs. 5400 ( $100 x Rs 54 per
dollar) instead of Rs 5500 ( $100 x Rs 55 per
dollar) thus incurring a loss of Rs. 100. ( Rs 5500
Rs 5400)

In such a scenario, the tea grower goes to

a currency trader and signs a forward

contract which says that at the end of 3


months the currency trader would hedge
her against a possible decrease in
exchange rates.

This means that, at the end of 3 months,

the currency trader would pay her Rs.


5500 for her 100 USD, no matter what the
prevailing exchange rate.

Such a contract is called


a Forward Currency
Derivatives contract
because it is a currency
contract that has to be
executed at some future
date.

Classification of Derivatives
OTC

Exchange Traded

Rupee Interest Rate


Derivatives

Forward Rate agreements,


Interest rate Swaps

Interest Rate futures

Foreign Currency
Derivatives

Forwards, Swaps, Options

Currency Futures, Options

Equity Derivatives

Index Futures, Index


Options, Stock futures,
Stock options

Overview of Currency Derivatives in


India
A currency future, also known as FX future, is a futures
contract to exchange one currency for another at a specified
date in the future at a price (exchange rate) that is fixed on
the purchase date. On Stock Exchange like BSE, NSE the
price of a future contract is in terms of INR per unit of other
currency e.g. US Dollars. Currency future contracts allow
investors to hedge against foreign exchange risk. Currency
Derivatives are available on four currency pairs viz. US
Dollars (USD), Euro (EUR), Great Britain Pound (GBP) and
Japanese Yen (JPY). Currency options are available on US
Dollars ONLY.

What are the benefits of currency


Derivatives?
Currency derivatives are a bundle of opportunities for a number of
players.
It is a new asset class for diversification of investments for all resident
Indians.
It gives hedging opportunities to:
Importers and exporters, who can hedge their future payables
and receivables.
Borrowers, who can hedge foreign currency (FCY) loans for
interest and principal payments, with the need for proof of
documented exposure.
It gives arbitrage opportunities.
It gives trading opportunities because of its volatility and multiplicity.
It provides highly transparent rates to traders as it is exchange-traded.

How Does Currency


Trading Work in India?

Derivatives

Presently, all Futures contracts on Exchanges are settled in cash. There are no physical
contracts. All trades on Currency Exchanges take place on their respective nationwide
electronic trading platforms. These can be accessed from dedicated member terminals at
various locations across India.
All participants on the Currency Exchange trading platform can participate only through
trading members of the Exchange. Participants have to open a trading account and deposit
stipulated cash and/or collaterals with the trading member.
Exchanges stand in as the counter-party for each transaction. Therefore, participants do
not need to worry about defaults . In the event of a default, Exchanges will step in and fulfill
the obligations of the defaulting party, and then proceed to recover dues and penalties from
them.
Those who enter the market either by buying (long) or selling (short) a Futures contract
can close their contract obligations by squaring-off their positions at any time during the
life of that contract by taking an opposite position in the same contract.
A long (buy) position holder has to short (sell) the contract to square-off their position
and vice versa.
Participants will be relieved of their contract obligations to the extent they square-off their
positions.
All contracts that remain open at expiry are settled in INR in cash at the reference rate
specified by the Reserve Bank of India

Currency Derivative Trading & Settlement Process


TRADER
( BUYER )

TRADER
( SELLER )

Sales order

Purchase order

MEMBER
( BROKER )

Transaction on the floor (Exchange)

Informs
CLEARING
HOUSE

MEMBER
( BROKER )

Screen Shot / application of FX derivative

Currency Derivatives Markets in India


Its Development
August 29, 2008 Currency Futures trading launched at

NSE.
October 2008 Currency futures trading launched at MCX
and BSE.
January, 2010 SEBI and RBI permitting the trade of
INRGBP, INREUR, INRYEN.
29th October, 2010 - NSE started currency option trading.
Trades guaranteed by guaranteed by the National
Securities Clearing Corporation Limited (NSCCL)
MCX-SX Average daily turnover increased from Rs. 356 cr
to Rs. 11,650 cr in August 2013 and Average daily turnover
for the year 2014-2015 to Rs. 11,475.08

Figure - Daily movement in the open interest of currency futures in NSE


and MCX

The upward trend of the open interest, number of


contracts traded and average daily turnover since its
inspection explain the whole story in detail.
Suggested future developments:
Introduction of late evening sessions.
Products on other currencies.

Thanks