Bonanza Portfolio Ltd.

, Ahmedabad

Project Report on

“Study of Various Options of Currency Hedging”

Summer Project Report

Submitted

In the partial fulfillment of the Degree of

Master of Business Administration

Semester-II

By

Name:- Brijesh Patel Enrollment No:- 09756059200

Under the Guidance of:

Mr. Mahindra Patel

Sarvoday Charitable M.B.A. College

Submitted To:

Sarvoday Charitable M.B.A. College

Kakanpur

Gujarat Technological University

(June - July,2010)
Project Title: “Study of Various Options of Currency Hedging”

Company Name: Bonanza Portfolio Limited

Address: 403-406 Shital Varsha Arcade,

Nr. Girish Cold Drink Cross Roads,
C.G. Road, Ahmedabad
Phone No.: 79-30014300
Website: www.bonanzaonline.com

Department: Currency Division

Project Guide: Mr. Ashish Mishra,

Manager Research
Currency Division

Mobile: 9898884357

E- mail: ashish_mishra_79@yahoo.com

1
 Preface

Classroom teaching helps the student by making conceptual base clear, but on the job
training is a way, which helps the students to get the applied knowledge of the concept.
Normally the students are not aware of the actual requirement of practical field, keeping in
view this fact; a system of summer training has been established to make the students
acquainted of actual difficulties that are to be faced in the demanding corporate sector.

Summer training at Bonanza portfolio Ltd., has given me a great experience. I was
required to prepare a training report on the topic “The Study of Various Options of Currency
Hedging Tools”. The managers of currency department helped me lot to prepare this report.

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 Acknowledgements

I hereby take the opportunity to express my wholehearted thankfulness to Bonanza

Portfolio Limited, Ahmedabad. Summer project at Bonanza Portfolio Limited, Ahmedabad
has been very fruitful and I have heartily enjoyed work allotted to me. Successful completion
of the project is indebted to the support of all the members of Currency department of
Bonanza Portfolio Limited, involved directly or indirectly with the project. This association
has provided me with a comprehensive insight into the currency market.

I would like to express our gratitude to my project guide Mr. Ashish Mishra,
Manager Research in Currency, Bonanza Portfolio Limited, who gave me an opportunity to
pursue project with the organization.

I would like to place on record my indebtedness to Prof. Mahindra Patel, Faculty

Guide, Sarvoday Charitable MBA College, Kakanpur, Also my colleague for encouraging
me and showing confidence in me to take up as guide for my project, and other faculty
members (specially in the area of finance) at the institute, who trained me not only to
understand the business environment but also to adapt to the demanding needs of the business
community.

Brijesh Patel

SCMC, Kakanpur

Enrollment No:- 09756059200

3
 DECLARATION

I undersigned BRIJESH A PATEL of MBA programme declares that I

have prepared this project report on “VARIOUS OPTIONS OF CURRENCY
HEDGING” at “BONANZA PORTFOLIO Ltd” under guidance of Mr.
Ashish Mishra.

I also declare that this project report is my own preparation and not
copied from anywhere else.

(Signature)

Brijesh Patel

4
 Table of Content

1. Objective of Company Training……………………………………………………...7

2. Executive Summery…………………………………………………………………..8

3. Company Overview…………………………………………………………………..9

4. SWOT Analysis of the Company………………………………………….………...18

5. Introduction………………………………………………………………….……….20

6. Forex and Forex Derivative………………………………………………….……….22

7. Basis of Trading…………………………………………………………….………..24

8. Derivative ………………………………………………………………….………...24

9. Currency Derivative………………………………………………………….………25

10. Margin / Charges…………………………………………………………….……….25

11. Exposure……………………………………………………………………….…….26

12. Foreign Exchange Risk management Process and Necessity……………….……….26

13. Currency Hedging…………………………………………………………….……...30

14. Over the Counter…………………………………………………………….…….…31

15. Tools of Currency Hedging………………………………………………….……....32

16. Exchange Rate……………………………………………………………….…….…38

17. Client Broker Relationship in Derivative Segment………………………….…….…39

18. Current Legal and Regulation Frame work……………………………………..……40

19. Research Methodology……………………………………………………….…..…..43

20. Findings………………………………………………………………………………50

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21. Conclusion………………………………………………………………….……..….51

22. Terminology…………………………………………………………………….……52

23. Bibliography………………………………………………………………..………...55

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 1. OBJECTIVE OF COMPANY TRAINNING

• To develop the current awareness

• To develop Interpersonal skill

• To be familiar with corporate etiquettes

• During this executive training, I have learned about currency hedging that how its
work and why do people hedge.

• I have also learned how to faced challenges during jobs and convert them into
opportunities.

• I have learned about corporate etiquettes and how to familiarize with their
environment.

• I also got platform to develop a network which will be useful in enhancing career
prospects.

• I got an opportunity to apply the concepts learnt in real-life situations.

• I also got awareness about my strengths and weakness.

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 2. Executive Summary

The project is a comprehensive study of various options of currency hedging in India.

Bonanza Portfolio Limited is a leading Financial Services & Brokerage company working
since 1994. It has spread its trustworthy tentacles all over the country with more than 1025
outlets spread across 340 cities. Especially its services in hedging are best among
competitors.

As Indian currency market developed with time, the numbers of users of currency
hedging has grown up rapidly. The variety of hedging instruments available for trading is
also expanding. Still there is scope for development. This project is a study of the various
hedging strategy for currency hedging (for reducing forex risk).

This report represents the analysis of different Indian companies use different hedging
strategy for mitigating foreign f risk which is not forecast because of different factors affect
to foreign exchange rate or foreign currency fluctuation , it has some limitations and many a
time exchange rates or foreign currency fluctuation do not change.

There are many legal binding for currency hedging in India as well. Reserve Bank of
India has made many regulations regarding currency contracts. Further regulatory reform
will help the markets grow faster.

As Indian currency markets grow more sophisticated, greater investor awareness will
become essential. The firms providing these services are bound to understand the customer
needs devote resources to develop the business processes and fulfill them.

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 3. Organization Introduction

Bonanza a leading Financial Services & Brokerage House working diligently since
1994 can be described in a single word as a "Financial Powerhouse". With acknowledged
industry leadership in execution and clearing services on Exchange Traded Derivatives and
cash market products. Bonanza has spread its trustworthy tentacles all over the country with
more than 1025 outlets spread across 340 cities.

It provides an extensive smorgasbord of services in equity, commodities, currency

hedging, wealth management, distribution of third party products etc.

Products and Services

Primary Brokerage Services

Equity

Equity Derivatives

Commodity

Depository Services
Fixed Income

Mutual Fund

IPO

Insurance
Investment Management
Professional Fund Management
Other Services

Dedicated portfolio manager contact

Expert initial and on-going advice

Continual fund monitoring

In-depth reporting on portfolio performance, including graphs &
charts.

9
 Bonanza – it’s a Windfall for you!

Company’s core Mission is clients’ wealth generation through professional advice

backed by thorough research and in-depth analysis. We offer a single point access to the vast
world of financial services. Company’s strengths included a diverse product range, state-of-
the-art technology & vast network across India

Proven and accredited leaders in the Financial Services business, Bonanza provides
you the unique opportunity to trade offline and online while cutting across all geographic
barriers.

• Strategic Tie-ups that provide latest technology for access and processing

• Trading over 425 locations across 160 cities in India

• 24 hour access to Account Information via the Net or Electronic File Transfer (FTP)
facilities.

• Corporate Agents for Life & Non-Life Insurance (both foreign / private and state owned
insurance companies)

• One of the largest distributors of leading Mutual Funds in India

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 Group Representation:-

Bonanza Portfolio Ltd.

Bonanza Global DMCC, Dubai

Bonanza Commodity Brokers Pvt. Ltd.

Bonanza Insurance Brokers Pvt. Ltd.

Bonanza Online.com Ltd.

Bonanza Corporate Solutions Pvt. Ltd.

11
 FOUNDER OF THE COMPANY

Mr. Shiv Kumar Goel :-

He is a Promoter / Director, CA by profession and a qualified Company Secretary.

He has more than 25 yrs of experience in financial service and brokerage. Prior to venturing
into business he was Chief Executive Officer (CEO) of SRF Finance Ltd., New Delhi. He has
been a pioneer in innovating technological advancements and its implementation
methodologies.

Mr. S. P. Goel :-

He is a Promoter/Director, qualified CA operating from the country's financial

capital Mumbai, is credited of having represented on the Board of directors of OTCEIL. Mr.
Goel has represented various prestigious committees of SEBI including that of JR Verma
Committee, NSEIL (Executive Committee, Committee on Settlement of issues), NSCCL. He
has also represented as a member of the Disinvestment and Privatisation Committee of the
Indian Merchants Chamber (IMC).

Mr. S. K. Goel :-

He is a Promoter/Director, a qualified Chartered Accountant by profession and

experience of more than 25 years, has in past worked with leading Indian industrial groups
like Modi's & Oswals's.

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Mr. Vishnu Kumar Agarwal :-

He is a Promoter/Director, is a Bullion Dealer, real estate developers & consultant.

He has been credited with setting up various trading & investment channels in the field of
commodity futures trading for Indian residents & investors.

Mr. Anand Prakash Goel :-

He is a Promoter/Director and a practicing Chartered Accountant with over 23 years

of experience. The management team of Bonanza comprises of Chartered Accountants,
MBAs, in addition to senior professionals in the financial field.

Company Overview

Bonanza, the brainchild of a group of enterprising professionals, begun operations

in 1994 the promoters of bonanza have carved a niche in capital market and served with
distinction on various prestigious committees of SEBI , NSEIL, NSCCL , BSE , The IMC
and other .

Bonanza is a leading Financial Services and Brokerages house. With more then!,50,000
clients comprising of financial Institutions & investors , corporate , mutual fund , high Net
worth Individuals and Retail investors .

Company’s core mission is clients ‘wealth generation through professionals

advice backed by through research and in-depth analysis.

Company’s offer a single point access to the vast ward of financial services. Company’s
strengths includes a diverse product range , state-of-the-art technology & vast network across
India.

Bonanza has wide reach through its branches/ offices in more then 750 location

13
spread over 300 cities. Company’s consistent endeavor is to provide strategic advice and high
quality services to our clients.

Bonanza Portfolio Limited is a financial services and brokerage house. It offers

execution and clearing services on exchange traded derivatives and cash market products;
prime brokerage services, including equities, equity derivatives, indices derivatives,
commodity derivatives, and depository services; fixed income, such as mutual fund, IPO, and
insurance; and investment management, such as equities, derivatives, commodities, sector
track, calculators, and commentaries.

MEMBERSHIP

1. National Stock Exchanges of India Ltd (NSEIL)

2. The Stock Exchange , Bombay (BSE)

3. Multi Commodity Exchange ( MCX)

4. National Commodity & Derivatives Exchanges Ltd (NCDEX)

5. National Multi Commodity Exchange (NMCE)

6. Depository Participant for Equity ( NSDL/CDSL)

7. Depository Participant for Commodities

8. Dubai Gold & Commodities Exchange (DGCX )

9. SEBI Authorized PMS

10. Registered Distributor with AMFI

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 Company’s Recognitions:-

1. Top Equity Broking House

In term of branch expansion for the year 2007 *

2. 6th Largest in terms of Trading Terminals

( for two consecutive year 2007-2008* )

3. Nominated among the Top 3 for Best Financial Advisor Awards 2008
( in the category of National Distributors-Retail**

Progressive Financial Planning

INVEST: - Medium to long term investment which provides income & capital growth

SAVE: - savings & deposits to meet short term cash requirements for you

PROJECT: - Insurance that provides protection to your life.

Company’s Research Desk Philosophy:-

“Investing means laying out money today to receive money in real terms after taking
inflation into account, tomorrow”

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Mission & vision:-

“Company believes in making money, not mistakes.”

“Company’s owe that to you, for trusting us”

Achievements of Bonanza Portfolio L

(1) Top Equity Broking House in Terms of Branch Expansion 2007.

(2) 3rd in Term of Number of Trading Account For 2008*.

(3) 6th in term trading Terminals in for Two Consecutive years 2007& 2008*.

(4) 9th in term of Sub Brokers for 2007*( as per the Studies Carried out by “DUN &
BRADSTREET” for top Equity Broking Firm)

(5) Awards by BSE “Major Volume Drivers 2006-2007 & 2004-2005”.

(6) Nominated among the top 3for the Best Financial Advisor Awards 2008 in the
Category of National Distributors-retail instituted by CNBC-TV18.

(7) Awarded by CNBC channel.

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 (8) Bonanza has 6th position in terms of terminal in India through Economic Times.

(9) Provide 24 hours back office.

(10) More than 100 franchises in Gujarat in short time.

Core Value Of Bonanza Portfolio Ltd.:-

 Customer satisfaction through providing quality services effectively and efficiently

“Smile it enhance your face value” is a service quality stressed on periodic customer service
audits.”

 Maximization of Stakeholder value

 Success through Team Work Integrity and people.

17
 4. SWOT ANALYSIS OF THE COMPANY

STRENGTH

• Large physical reach across India – the company has 700+ branches across India
• Broad product line at a superior value – 16 services and products in 4 different
categories
• Ability to combine people and technology in unique ways – with diversified online
trading facilities and products
• Robust technology infrastructure – all branches networked through VAST, leased
lines and broadband
• Strong risk management systems – risk management parameters support branch level
and client level exposure & margining factors
• Strong reputation and stature with SEBI – promoters participated as members of
prestigious committees
• Extensive research support
• Use high technology for business
• Provide contract note on clients e-mail ID in offline customer
• Dedicated and responsive workforce staff
• Fastest growing company in this field that why company policy is libral
• Wide range of product offer by the company, customer gets all the benefits
• Company’s risk management is the strength of the company
• The positive image of the company’s brand is the biggest strength of the company

WEAKNESSES

• Lack of publicity
• Company should give some more promotional scheme or other scheme so that the
more people should attract
• Less awareness among the people

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OPPORTUNITIES

• Market development- a huge scope is there because of the awareness lacking on

customer’s part
• Futuristic market of online product – the advantage of technology adopted will ripe its
fruits in future due to its capability in global competition
• To tap the untapped market
• Tie up other insurance company and bank also
• To focus on corporate field for all the products with special schemes
• To focus on research for intraday, delivery, BTST tips
• To spread awareness of its brand name

THREATS

• The severity of competition can harm the reputation of company, since the charges
(account opening and brokerage) are high
• Over credit limit – to maintain liquidity and due to risk averseness company may loss
business in future and people might divert to other companies which are offering
longer credit limit
• Government policy
• Existing players in the market
• Lack of aggressiveness
• Prolonged depression and high volatility in the market.

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 5. Introduction

Globalisation and integration of financial markets, coupled with the progressively

increasing cross-border flow of funds, have transformed the intensity of market risk, which,
in turn, has made the issues relating to hedging of such risk exposures very critical. The
economic agents in India currently have a menu of over-the-counter (OTC)
Products, such as forwards, swaps and options, available to them for hedging their currency
risk and the markets for these are quite deep and liquid. However, in the context of growing
integration of the Indian economy with the rest of the world, as also the continued
development of financial markets, a need has been felt to make available a wider choice of
hedging instruments to the market participants to enable them to cope better with their
currency risk exposures. In India currency futures have so far not been allowed in view of the
imperatives of the controls on the capital account. However, in the context of the increased
capital account liberalisation, wider hedging opportunities could strengthen economic agents'
ability to cope with market-induced currency movements. International experiences, albeit of
select countries like South Africa and South Korea, suggest that currency futures could
coexist with the OTC currency markets as well as capital controls. A few emerging market
economies have set up currency futures exchanges onshore, even though they retained some
controls on the capital account.

India has been experiencing heightened cross-border flows in recent times with
globalization and relaxations in the rules governing external transactions. The flows have
been strong on both current and capital accounts. There has also been some increase in
volatility in exchange rates due to global imbalances and changing dimensions of the capital
flows. According to the Bank for International Settlements (BIS) Triennial Central Bank
Survey 2007, the share of India with daily turnover at USD 34 billion (daily average) has
increased from 0.3 per cent in 2004 to 0.9 per cent in 2007. The depth in the domestic foreign
exchange market is validated by the BIS survey data.

Currently, hedging of foreign exchange risk is possible only on the OTC market
using forwards, currency swaps and options. Currency and interest rate swaps are permissible
for hedging long - term exposures. The use of these products is subject to certain

20
requirements as laid down in terms of FEMA Notification 25, which normally permits
hedging of transactions backed by underlying exposures. However, as part of capital account
liberalization and simplification of procedures, resident individuals and Small and Medium
Enterprises (SME) sector have been granted flexibility in hedging their underlying or
anticipated exposures without going through the rigors of complex documentation
formalities. Commodity hedging in overseas exchanges has been permitted to hedge exposure
to commodity price risk in the international markets. The rules have been relaxed to cover
domestic exposures as well in the case of select base metals and Aviation Turbine Fuel (ATF)
for domestic airline companies, as the domestic commodity exchanges are not able to offer
the volume and depth required. The domestic oil marketing and refining companies have also
been allowed to hedge their commodity price risk to the extent of 50 per cent of their
inventory in the international markets.

This study aims to know the currency hedging tools and how to these tools use by
different companies for reducing a risk.

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 6. INTRODUCTION TO FOREX AND FOREX DERIVATIVES

The foreign exchange (currency or forex or FX) market exists wherever one currency
is traded for another. It is the largest and most liquid financial market in the world.
Exchanging currencies can take two basic forms: an outright or a swap. When two parties
exchange one currency for another the transaction is called an outright. When two parties
agree to exchange and reexchange (in future) one currency for another, it is called a swap.

6.1 BASIC FOREIGN EXCHANGE DEFINITIONS

6.1.1 Spot:

Foreign exchange spot trading is buying one currency with a different currency for
immediate delivery. The standard settlement convention for Foreign Exchange Spot trades is
T+2 days, i.e., two business days from the date of trade execution. An exception is the
USD/CAD (US – Canadian Dollars) currency pair which settles T+1. Rates for days other
than spot are always calculated with reference to spot rate.

6.1.2 Forward Outright:

A foreign exchange forward is a contract between two counterparties to exchange one

currency for another on any date after spot.In this transaction, money does not actually
change hands until some agreed upon future date. The duration of the trade can be a few
days, months or years. For most major currencies, three business days or more after deal date
would constitute a forward transaction.

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 Settlement date / Definition
Value Date

Value Cash Trade Date Same day as deal date

Value Tom (Tomorrow) Trade Date + 1 1 business day after

deal date
Spot Trade Date + 2 2 business days after
deal date*

Forward Outright Trade Date + 3 or any 3 business days or more

later date after deal date, always
longer than Spot

* USDCAD is the exception and trades T+1

6.1.3 Base Currency / Terms Currency:

In foreign exchange markets, the base currency is the first currency in a currency pair.
The second currency is called as the terms currency. Exchange rates are quoted in per unit of
the base currency. E.g. the expression Dollar – Rupee, tells you that the Dollar is being
quoted in terms of the Rupee. The Dollar is the base currency and the Rupee is the terms
currency.

Exchange rates are constantly changing, which means that the value of one currency
in terms of the other is constantly in flux. Changes in rates are expressed as strengthening or
weakening of one currency vis-à-vis the second currency. Changes are also expressed as
appreciation or depreciation of one currency in terms of the second currency. Whenever the
base currency buys more of the terms currency, the base currency has strengthened /

23
appreciated and the terms currency has weakened / depreciated. E.g. If Dollar – Rupee moved
from 44.00 to 44.25. The Dollar has appreciated and the Rupee has depreciated.

7. Basis of trading

The NEAT-CDS system supports an order driven market, wherein orders match
automatically. Order matching is essentially on the basis of security, its price and time. All
quantity fields are in contracts and price in Indian rupees. The exchange notifies the contract
size and tick size for each of the contracts traded on this segment from time to time. When
any order enters the trading system, it is an active order. It tries to find a match on the
opposite side of the book. If it finds a match, a trade is generated. If it does not find a match,
the order becomes passive and sits in the respective outstanding order book in the system.

8. DERIVATIVES DEFINED

Derivative is a product whose value is derived from the value of one or more basic
variables, called bases (underlying asset, index, or reference rate), in a contractual manner.
The underlying asset can be equity, foreign exchange, commodity or any other asset. For
example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of
a change in prices by that date. Such a transaction is an example of a derivative. The price of
this derivative is driven by the spot price of wheat which is the "underlying".

In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R)A)
defines "derivative" to include-

1. A security derived from a debt instrument, share, loan whether secured or unsecured, risk
instrument or contract for differences or any other form of security.

2. A contract which derives its value from the prices, or index of prices, of underlying
securities.

24
 Derivatives are securities under the SC(R)A and hence the trading of derivatives is
governed by the regulatory framework under the SC(R)A. The term derivative has also been
defined in section 45U(a) of the RBI act as follows:

An instrument, to be settled at a future date, whose value is derived from change in

interest rate, foreign exchange rate, credit rating or credit index, price of securities (alsocalled
“underlying”), or a combination of more than one of them and includes interest rate swaps,
forward rate agreements, foreign currency swaps, foreign currency-rupee swaps, foreign
currency options, foreign currency-rupee options or such other instruments as may be
specified by the Bank from time to time.

9. Currency Derivative

A currency derivative is a contract between the seller and the buyer, whose value is to
be derived from the underlying asset, the currency amount. A derivative based on currency
exchange rates is a future contract which stipulates the rate at which a given currency can be
exchanged for another currency as at a future date.

10. Margin

Margin is the amount of money needed to open or maintain a position. In essence it is

a loan from a broker to an investor.

The credit risk in futures market is assumed by the exchange. In order to minimize the
credit risk to the exchange, traders are required to post margins, typically in the range of 5 per
cent – 15 per cent of the contracts’ value. In some jurisdictions, different margin regimes are
followed for hedgers and speculators. There are three types of margins

10.1 Initial margin,

10.2 Maintenance margin and

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 10.3 The variation margin.

The initial deposit called the initial margin is the amount a trader (buyer and seller),
must deposit before trading in any futures. This normally is approximately taken as the
maximum daily price fluctuation permitted for the contract being traded. The initial margin
can be kept so small because of the safeguard built into the system of daily mark to market.
Whenever the position held on the exchange shows a loss on mark to market, the same is
deducted from the margin deposited. When this drops below a threshold level called the
maintenance margin, established by the exchange, a margin call is made on the trader to
replenish the margin and the additional amount deposited is called the variation margin.

11.Exposure

An exposure can be defined as a Contracted, Projected or Contingent Cash Flow

whose magnitude is not certain at the moment. The magnitude depends on the value of
variables such as Foreign Exchange Rates and Interest Rates.

12. Foreign Exchange Risk Management: Process & Necessity

Firms dealing in multiple currencies face a risk (an unanticipated gain/loss) on

account of sudden/unanticipated changes in exchange rates, quantified in terms of exposures.
Exposure is defined as a contracted, projected or contingent cash flow whose magnitude is
not certain at the moment and depends on the value of the foreign exchange rates. The
process of identifying risks faced by the firm and implementing the process of protection
from these risks by financial or operational hedging is defined as foreign exchange risk
management. This paper limits its scope to hedging only the foreign exchange risks faced by
firms.

12.1 Kinds of Foreign Exchange Exposure

26
Risk management techniques two type of exposure:

Accounting exposure

Economic exposure

12.1.1 Accounting exposure or translation exposure:

Accounting exposure is the results from the need to restate foreign subsidiaries’
financial statements into the parent’s reporting currency and is the sensitivity of net income to
the variation in the exchange rate between a foreign subsidiary and its parent.

12.1.2 Economic exposure:

Economic exposure is the extent to which a firm's market value, in any particular
currency, is sensitive to unexpected changes in foreign currency. Currency fluctuations affect
the value of the firm’s operating cash flows, income statement, and competitive position,
hence market share and stock price. Currency fluctuations also affect a firm's balance sheet
by changing the value of the firm's assets and liabilities, accounts payable, accounts
receivables, inventory, loans in foreign currency, investments (CDs) in foreign banks; this
type of economic exposure is called balance sheet exposure. Transaction Exposure is a form
of short term economic exposure due to fixed price contracting in an atmosphere of
exchange-rate volatility. The most common definition of the measure of exchange-rate
exposure is the sensitivity of the value of the firm, proxied by the firm’s stock return, to an
unanticipated change in an exchange rate. This is calculated by using the partial derivative
function where the dependant variable is the firm’s value and the Independent variable is the
exchange rate (Adler and Dumas, 1984).

12.2 Necessity of managing foreign exchange risk

A key assumption in the concept of foreign exchange risk is that exchange rate
changes are not predictable and that this is determined by how efficient the markets for

27
foreign exchange are. Research in the area of efficiency of foreign exchange markets has thus
far been able to establish only a weak form of the efficient market hypothesis conclusively
which implies that successive changes in exchange rates cannot be predicted by analysing the
historical sequence of exchange rates.(Soenen, 1979). However, when the efficient markets
theory is applied to the foreign exchange market under floating exchange rates there is some
evidence to suggest that the present prices properly reflect all available information.(Giddy
and Dufey, 1992). This implies that exchange rates react to new information in an immediate
and unbiased fashion, so that no one party can make a profit by this information and in any
case, information on direction of the rates arrives randomly so exchange rates also fluctuate
randomly. It implies that foreign exchange risk management cannot be done away with by
employing resources to predict exchange rate changes.

12.3 Foreign Exchange Risk Management Framework

Once a firm recognizes its exposure, it then has to deploy resources in managing it. A
heuristic for firms to manage this risk effectively is presented below which can be modified
to suit firm-specific needs i.e. some or all the following tools could be used.

Forecasts:

After determining its exposure, the first step for a firm is to develop a forecast on the
market trends and what the main direction/trend is going to be on the foreign exchange rates.
The period for forecasts is typically 6 months. It is important to base the forecasts on valid
assumptions. Along with identifying trends, a probability should be estimated for the forecast
coming true as well as how much the change would be.

Risk Estimation:

Based on the forecast, a measure of the Value at Risk (the actual profit or loss for a
move in rates according to the forecast) and the probability of this risk should be ascertained.
The risk that a transaction would fail due to market-specific problems4 should be taken into

28
account. Finally, the Systems Risk that can arise due to inadequacies such as reporting gaps
and implementation gaps in the firms’ exposure management system should be estimated.

Benchmarking:

Given the exposures and the risk estimates, the firm has to set its limits for handling
foreign exchange exposure. The firm also has to decide whether to manage its exposures on a
cost centre or profit centre basis. A cost centre approach is a defensive one and the main aim
is ensure that cash flows of a firm are not adversely affected beyond a point. A profit centre
approach on the other hand is a more aggressive approach where the firm decides to generate
a net profit on its exposure over time.

Hedging:

Based on the limits a firm set for itself to manage exposure, the firms then decides an
appropriate hedging strategy. There are various financial instruments available for the firm to
choose from: futures, forwards, options and swaps and issue of foreign debt. Hedging
strategies and instruments are explored in a section.

Stop Loss:

The firms risk management decisions are based on forecasts which are but estimates
of reasonably unpredictable trends. It is imperative to have stop loss arrangements in order to
rescue the firm if the forecasts turn out wrong. For this, there should be certain monitoring
systems in place to detect critical levels in the foreign exchange rates for appropriate measure
to be taken.

Reporting and Review:

Risk management policies are typically subjected to review based on periodic

reporting. The reports mainly include profit/ loss status on open contracts after marking to
market, the actual exchange/ interest rate achieved on each exposure, and profitability vis-à-

29
vis the benchmark and the expected changes in overall exposure due to forecasted exchange/
interest rate movements. The review analyses whether the benchmarks set are valid and
effective in controlling the exposures, what the market trends are and finally whether the
overall strategy is working or needs change.

13. Currency Hedging

In finance, a hedge is a position established in one market in an attempt to offset

exposure to price fluctuations in some opposite position in another market with the goal of
minimizing one's exposure to unwanted risk. There are many specific financial vehicles to
accomplish this, including insurance policies, forward contracts, swaps, options, many types
of over-the-counter and derivative products, and future contracts. The type of hedge required
to done at any point of time would depend on the portfolio of the client as well as his risk
appetite.

Why Hedge?

_ Prevent market fluctuations from interfering with the business

_ Secure cash for investments

_ Reduce potential costs of financial distress

_ Increase debt capacity

Since currency matching reduces the probability of financial distress, it allows the
firm to have more earnings stability and more optimal leverage

30
 14. Over the Counter

OTC is the 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 phone calls & via 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.

Derivatives that trade on an exchange are called exchange traded derivatives, whereas
privately negotiated derivative contracts are called OTC derivatives. The OTC derivatives
markets have witnessed rather sharp growth over the last few years which have accompanied
the modernization of commercial and investment banking and globalization of financial
activities.

The recent developments in information technology have contributed to a great extent

to these developments. While both exchange-traded and OTC derivative contracts offer many
benefits, the former have rigid structures compared to the latter.

The OTC derivatives markets have the following features compared to exchange-
traded derivatives:

1) The management of counter-party (credit) risk is decentralized and located within

individual institutions,

2) There are no formal centralized limits on individual positions, leverage, or margining;

limits are determined as credit lines by each of the counterparties entering into these contracts

3) There are no formal rules for risk and burden-sharing,

4) There are no formal rules or mechanisms for ensuring market stability and integrity, and
for safeguarding the collective interests of market participants, and

5) Although OTC contracts are affected indirectly by national legal systems, banking
supervision and market surveillance, they are generally not regulated by a regulatory
authority.

31
 15. Hedging Strategies/ Instruments/Tools

A derivative is a financial contract whose value is derived from the value of some
other financial asset, such as a stock price, a commodity price, an exchange rate, an interest
rate, or even an index of prices. The main role of derivatives is that they reallocate risk
among financial market participants, help to make financial markets more complete. This
section outlines the hedging strategies using derivatives with foreign exchange being the only
risk assumed.

32
15.1 Forwards:

A forward contract is a customized contract between two parties, where settlement

takes place on a specific date in the future at today's pre-agreed price.

A forward is a made-to-measure agreement between two parties to buy/sell a specified

amount of a currency at a specified rate on a particular date in the future. The depreciation of
the receivable currency is hedged against by selling a currency forward. If the risk is that of a
currency appreciation (if the firm has to buy that currency in future say for import), it can
hedge by buying the currency forward. E.g if RIL wants to buy crude oil in US dollars six
months hence, it can enter into a forward contract to pay INR and buy USD and lock in a
fixed exchange rate for INR-USD to be paid after 6 months regardless of the actual INR-
Dollar rate at the time. In this example the downside is an appreciation of Dollar which is
protected by a fixed forward contract. The main advantage of a forward is that it can be
tailored to the specific needs of the firm and an exact hedge can be obtained. On the
downside, these contracts are not marketable, they can’t be sold to another party when they
are no longer required and are binding

15.2 Futures:

A futures contract is an agreement between two parties to buy or sell an asset at a

certain time in the future at a certain price. Futures contracts are special types of forward
contracts in the sense that they are standardized and are generally traded on an exchange.

A futures contract is similar to the forward contract but is more liquid because it is
traded in an organized exchange i.e. the futures market. Depreciation of a currency can be
hedged by selling futures and appreciation can be hedged by buying futures. Advantages of
futures are that there is a central market for futures which eliminates the problem of double
coincidence. Futures require a small initial outlay (a proportion of the value of the future)
with which significant amounts of money can be gained or lost with the actual forwards price
fluctuations. This provides a sort of leverage.

The previous example for a forward contract for RIL applies here also just that RIL
will have to go to a USD futures exchange to purchase standardised dollar futures equal to the
33
amount to be hedged as the risk is that of appreciation of the dollar. As mentioned earlier, the
tailor ability of the futures contract is limited i.e. only standard denominations of money can
be bought instead of the exact amounts that are bought in forward contracts.

15.3 Options:

Options are of two types - calls and puts. Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset, at a given price on or before a
given future date. Puts give the buyer the right, but not the obligation to sell a given quantity
of the underlying asset at a given price on or before a given date.

A currency Option is a contract giving the right, not the obligation, to buy or sell a
specific quantity of one foreign currency in exchange for another at a fixed price; called the
Exercise Price or Strike Price. The fixed nature of the exercise price reduces the uncertainty
of exchange rate changes and limits the losses of open currency positions. Options are
particularly suited as a hedging tool for contingent cash flows, as is the case in bidding
processes. Call Options are used if the risk is an upward trend in price (of the currency),
while Put Options are used if the risk is a downward trend. Again taking the example of RIL
which needs to purchase crude oil in USD in 6 months, if RIL buys a Call option (as the risk
is an upward trend in dollar rate), i.e. the right to buy a specified amount of dollars at a fixed
rate on a specified date, there are two scenarios. If the exchange rate movement is favourable
i.e the dollar depreciates, then RIL can buy them at the spot rate as they have become
cheaper. In the other case, if the dollar appreciates compared to today’s spot rate, RIL can
exercise the option to purchase it at the agreed strike price. In either case RIL benefits by
paying the lower price to purchase the dollar

15.4 Swaps:

Swaps are agreements between two parties to exchange cash flows in the future
according to a prearranged formula. They can be regarded as portfolios of forward contracts.
The two commonly used swaps are:

34
15.4.1• Interest rate swaps: These entail swapping only the interest related cash flows
between the parties in the same currency.

15.4.2• Currency swaps: These entail swapping both principal and interest between the
parties, with the cash flows in one direction being in a different currency than those in the
opposite direction.

A swap is a foreign currency contract whereby the buyer and seller exchange equal
initial principal amounts of two different currencies at the spot rate. The buyer and seller
exchange fixed or floating rate interest payments in their respective swapped currencies over
the term of the contract. At maturity, the principal amount is effectively re-swapped at a
predetermined exchange rate so that the parties end up with their original currencies. The
advantages of swaps are that firms with limited appetite for exchange rate risk may move to a
partially or completely hedged position through the mechanism of foreign currency swaps,
while leaving the underlying borrowing intact. Apart from covering the exchange rate risk,
swaps also allow firms to hedge the floating interest rate risk. Consider an export oriented
company that has entered into a swap for a notional principal of USD 1 mn at an exchange
rate of 42/dollar. The company pays US 6months LIBOR to the bank and receives 11.00%
p.a. every 6 months on 1st January & 1st July, till 5 years. Such a company would have
earnings in Dollars and can use the same to pay interest for this kind of borrowing (in dollars
rather than in Rupee) thus hedging its exposures.

15.5 Warrants:

Options generally have tenors of upto one year; the majority of options traded on
options exchanges have a maximum maturity of nine months. Longer-dated options are called
warrants and are generally traded over-the-counter (OTC).

15.6 Baskets:

35
 Basket options are options on portfolios of underlying assets. The underlying asset is
usually a moving average of a basket of assets. Equity index option is a form of basket
option.

15.7 Foreign Debt:

Foreign debt can be used to hedge foreign exchange exposure by taking advantage of
the International Fischer Effect relationship. This is demonstrated with the example of an
exporter who has to receive a fixed amount of dollars in a few months from present. The
exporter stands to lose if the domestic currency appreciates against that currency in the
meanwhile so, to hedge this, he could take a loan in the foreign currency for the same time
period and convert the same into domestic currency at the current exchange rate. The theory
assures that the gain realized by investing the proceeds from the loan would match the
interest rate payment (in the foreign currency) for the loan.

Hedger

Given the recent geopolitical uncertainties, the foreign currency markets have been in
turmoil. What little returns that can be achieved need protection by locking in your exchange
rate for your exposure through currency futures. The Businessmen and investing public are
increasingly exposed to global markets and the issue of protecting against foreign exchange
risk becomes critical. Business Houses, Entrepreneurs and individuals who can benefit from
hedging through Currency Futures:

Below is the list of the various groups of entrepreneurs and individuals and how they
can benefit from hedging through Currency Futures.

36
Importer: Can hedge his future foreign exchange commitments against
his imports.

Exporter: Can hedge his future foreign exchange receipts against his
exports
Banks: Can hedge its risk from clients’ Foreign Exchange Exposure
Investors: Can hedge Investments (by way of purchase of share or
directly partnering in any business) which is exposed to risk
resulting from foreign exchange fluctuation.

Individuals & Can hedge their expected future receipts or payments

Professionals:
Jewelers, Bullion & Can hedge gold/silver exposure against currency futures as the
Commodity pricing of bullion is directly related to valuation INR against
Traders: USD.

Petroleum Product Can hedge Petro product exposure against currency futures as
Traders: the pricing of petro products is greatly influenced by valuation
INR against USD.

Diamond Traders: Can hedge Diamond exposure against currency futures since
major diamond business is dependent on imports which are
ultimately also influenced by valuation INR against USD.
Money Changers: Can hedge his future foreign exchange receipts or payments
against his exports.

37
16. EXCHANGE RATE

Direct Indirect

The number of units of domestic The number of unit of foreign

Currency stated against one unit currency per unit of domestic

of foreign currency. currency.

Re/$ = 45.7250 ( or ) Re 1 = $ 0.02187

$1 = Rs. 45.7250

There are two ways of quoting exchange rates: the direct and indirect.

Most countries use the direct method. In global foreign exchange market,
two rates are quoted by the dealer: one rate for buying (bid rate), and another
for selling (ask or offered rate) for a currency. This is a unique feature of
this market. It should be noted that where the bank sells dollars against
rupees, one can say that rupees against dollar. In order to separate buying
and selling rate, a small dash or oblique line is drawn after the dash.

For example,

38
 If US dollar is quoted in the market as Rs 46.3500/3550, it
means that the forex dealer is ready to purchase the dollar at Rs 46.3500 and
ready to sell at Rs 46.3550. The difference between the buying and selling
rates is called spread.

It is important to note that selling rate is always higher than the buying rate.

Traders, usually large banks, deal in two way prices, both buying and selling,
are called market makers.

17. Client Broker Relationship in Derivatives Segment

A client of a trading member is required to enter into an agreement with the trading member
before commencing trading. A client is eligible to get all the details of his or her orders and
trades from the trading member. A trading member must ensure compliance particularly with
relation to the following while dealing with clients:

1. Filling of 'Know Your Client' form

2. Execution of Client Broker agreement

3. Bring risk factors to the knowledge of client by getting acknowledgement of client on risk
disclosure document

4. Timely execution of orders as per the instruction of clients in respective client codes.

5. Collection of adequate margins from the client

6. Maintaining separate client bank account for the segregation of client money.

39
7. Timely issue of contract notes as per the prescribed format to the client

8. Ensuring timely pay-in and pay-out of funds to and from the clients

9. Resolving complaint of clients if any at the earliest.

10. Avoiding receipt and payment of cash and deal only through account payee Cheques.

11. Sending the periodical statement of accounts to clients

12. Not charging excess brokerage

13. Maintaining unique client code as per the regulations.

18. Current Legal and Regulatory Framework

There is growing evidence that legal and regulatory frameworks matter for enabling
financial development to contribute to growth. In particular, legal and accounting
reforms that strengthen creditor rights, contract enforcement, and accounting practices boost
financial development and accelerate economic growth3. As such, in respect of currency
futures while the key question is whether currency futures should be introduced or not, its
introduction should also be considered from the viewpoint of appropriate legal and effective
regulatory system being put in place. These aspects merit close attention as in the preceding
Chapters have argued that currency futures are expected to be beneficial in net terms given
that they would widen participation base and hedging choices in face of potential exchange
rate volatility in the framework of open economy macroeconomics.

The Reserve Bank has the overall responsibility of managing the affairs relating to
foreign exchange and exchange rate and also the mandate of maintaining monetary and

40
financial stability. The preamble to the RBI Act provides the objective for the establishment
of the Bank as to regulate the issue of Bank notes and keeping reserves with a view to
securing monetary stability in India and generally to operate the currency and credit system
of the country to its advantage. The preamble makes it clear that operation of currency and
credit system falls within the regulatory ambit of the Bank. Furthermore, promoting orderly
development and maintenance of forex markets is one of the main functions of the Reserve
Bank. The newly incorporated provisions under section 45 U, 45 V and 45 W of the RBI Act
are also relevant in this regard. These provisions have been brought into the statute book by
the Reserve Bank of India (Amendment) Act, 2006 (Act 26 of 2006). The term ‘derivative’ is
defined in section 45U (a) of the RBI Act to mean ” an instrument, to be settled at a future
date, whose value is derived from change in interest rate, foreign exchange rate, credit rating
or credit index, price of securities (also called “underlying”), or a combination of more than
one of them and includes interest rate swaps, forward rate agreements, foreign currency
swaps, foreign currency-rupee swaps, foreign currency options, foreign currency-rupee
options or such other instruments as may be specified by the Bank from time to time”.
Section 45V (1) of the Act provides that ‘notwithstanding anything contained in the
Securities Contracts (Regulation) Act, 1956 (42 of 1956), or any other law for the time being
in force, transactions in such derivatives, as may be specified by the Bank from time to time,
shall be valid, if at least one of the parties to the transaction is the Bank, a scheduled bank, or
such other agency falling under the regulatory purview of the Bank under the Act, the
Banking Regulation Act, 1949 (10 of 1949), the Foreign Exchange Management Act, 1999
(42 of 1999), or any other Act or instrument having the force of law, as may be specified by
the Bank from time to time.”

Further, 45 W deals with the power of the Reserve Bank to regulate transactions in
derivatives. The Reserve Bank is empowered by section 45 W to give directions ‘to all
agencies or any of them, dealing in securities, money market instruments, foreign exchange,
derivatives, or other instruments of like nature as the Bank may specify from time to time’
and also to call for any information, statement or other particulars from such agencies or
cause an inspection of such agencies to be made.

The objective of FEMA as contained in its preamble is of "facilitating external trade

and payment and for promoting orderly development and maintenance of foreign exchange
41
market in India." In terms of Section 3 of the FEMA, no person can deal in or transfer foreign
exchange or foreign security to any person without general or special permission granted by
the Reserve Bank. Sale or drawal of foreign exchange to or from an authorized person is
subject to the reasonable restrictions imposed by the Central Government in consultation with
the Reserve Bank. The Reserve Bank is also empowered under Section 7 of FEMA to
prohibit, restrict or regulate capital account transactions. The Reserve Bank is empowered
under section 10 of FEMA to authorize any person to deal in foreign exchange or foreign
securities, etc. The Reserve Bank is competent to permit any person to trade in foreign
exchange by way of spot, forward or futures in exercise of its powers under the FEMA.

The extant legal framework as discussed above confers on the Reserve Bank the
required powers to enable introduction of currency futures. As discussed above, the RBI Act
casts on it the responsibility of determining the regulatory policies relating to a wide range of
instruments, including interest rates or interest rate products, foreign exchange, derivatives,
or other instruments of like nature. The FEMA also provides the Reserve Bank with
overriding jurisdiction over development and management of foreign exchange markets.
Therefore, the Reserve Bank may specify currency futures as an added instrument.

42
 19. Research Methodology
Hedging Instruments for Indian Firms
The paper has attempted to study the choice of instruments adopted by prominent
firms to stem their foreign exchange exposures. All the data for this has been compiled from
the 2008-2009 Annual Reports of the respective companies. A summary of the foreign
exchange risk hedging behavior of selected Indian firms are given below.

Reliance Industries

Instruments Rs (Crore)

Interest Rate 23,215.50

Swaps

Currency Swaps 4,435.15

Options Contracts 2,492.71

Forward Contracts 30,229.68

Reliance Industries, Looking at the outstanding position as on March 31st ,2009 it seems
that RIL has practice of almost full hedging of Export and Import.

Foreign currency exposures that are not hedged by derivative instruments as on March
31st,2009 amount to Year Rs. 51,432.57 Crore.

Company has Export other than Interest and others item (Excluding captive transfers
to Special Economic Zone of Rs. 6,363.27 Crore) value was Rs. 86,827.52 Crore during the
year 2008-09.
Company has Import including Raw Materials and Traded Goods Stores, Chemicals
and Packing Materials but other than capital goods was Rs.103480.73 Crore during the year
2008-09.

43
Bharti Airtel

Instruments Rs (Crore)

For Loan Related Exposure

Forwards 5858.14

Options 1608.74

Interest Rate Swaps 1257.24

For Trade Related Exposure

Forwards 534.72

Options 53.50

Bharti Airtel, Looking at the outstanding position as on March 31st,2009 it seems that
Bharti Airtel has practice of almost full hedging strategies of Export, Import as well as
Foreign Loan interest and loans.

Company has use currency hedging strategies in against of foreign exchange

fluctuation, the gain was Rs.1714.22 in Crore. And a loss from swap arrangement was Rs.
6.54 Crore. So net gain from currency hedging was Rs.1707.68 Crore.

Infosys

Instruments Rs (Crore)

Forward contracts outstanding

In USD 1,243

44
In Euro 135

In GBP 109

Options contracts outstanding

In USD 877

Infosys uses cross currency forward and option for outstanding contract in the year 2008-09.

Company has import during the year 208-09 from different foreign countries in INR
was Rs.860 Crore as purchase of services, which is 4.24% as a total services income.

Company Export during the year 2008-09 from different countries in INR was Rs.16
Crore as sales of services, which was 0.08% as a total services income.

Tata Motors

Instruments Rs (Crore)

Forward (net) 603.08

US $ / INR
US $ / INR as cash flow 687.05
hedge.

Options (net) 505.49

US $ / JPY

US $ / INR 50.71

US $ / CHF 50.71

45
Tata Motors Ltd uses cross currency forward and options of USD\JPY, USD\INR and
USD\CHF to neutralized the foreign currency fluctuation risk.

Company has total Export during the year 2008-09 is Rs.2436.57 in Crore, Which was
8.52% as a total sales.

Company uses different Hedging strategies for reducing risk in against the foreign
currency fluctuation or fluctuation in different currency exchange rate which are change in
future, Also not predictable because of effect of different factors.

Company was total Import during the year 2008-09 was Rs.2210.08 in Cores, Which
is 7.73% as a total sales.

Company has not hedged amount receivable of sales of goods, investment in

preference shares, loans and interest charges in INR total amount was Rs.6404.46 in Cores.
Also Creditors payable on account of loan and interest charges and other foreign currency
expenditure in INR total amount was Rs.6116.53 in Crore.

Zydus Cadila

Instruments Rs (crore)

Forward 644.6

Options 370.5

Interest Swap 358

Zydus Cadila foreign currency exposures not hedged by derivative transactions are
Payables was Rs.8.1 Crore.

Company has no Gain or Loss on account of fluctuations in foreign exchange rates.

46
Dr. Reddy Laboratory

Instruments Currency (Crore)

Forward

USD\ INR 6.7 Sell

USD\ INR 0.3 Buy

EURO \USD 0.8 Sell

GBP \USD 0.8 Sell

Options USD\INR 12 USD

Dr. Reddy Laboratory also uses cross currency swaps of EURO\USD and
GBP\USD to neutralized the risk in USD.

Company has Export to his subsidiaries and joint venture companies on international
level total value were Rs.1423.5 Crore. This is 35.22% as total sales during the year 2008-09.

Company has Import from his subsidiaries company in Switzerland value was Rs.65.3
Crore. This is 1.62% as total sales during the year 2008-09.

Company has net loss Rs.363 Million during the year 2008-09 from forward and
options hedging strategies.

Ranbaxy

Instruments Currency
(Crore)

Forward

USD\ INR USD 2.00

47
EUR\ USD USD 0.144

Options USD 103.85

USD INR

Currency Swaps JPY 10,35.00(Buy)

JPY \USD

Interest rate swap (JPY JPY 11,80.00

LIBOR)

Ranbaxy also uses cross currency forward of USD\INR and EUR\USD to

neutralized the risk in USD.

From the above table it seems that remarkable uses various hedging strategies for its
operational as well as term loans interest risk pertaining to foreign exchange fluctuation.

Company has net gained from foreign exchange including loan hedging was
Rs.328.353 Crore. Company has not hedged which was included receivable, payable, Bank
balance, or Loans was Rs.3746.16 Crore.

Nirma ltd has not use hedging strategy for securing the foreign currency fluctuation in the
year 2008-09.

Torrent power has not use of hedging strategy for securing the foreign currency
fluctuation in the year 2008-09.

48
Company Name Interest Rate Currency Forward Options
Swaps Swaps

Reliance Industries    

Bharti Airtel   

Infosys  

Tata Motors Ltd  

Zydus Cadila   

Dr. Reddy  
Laboratory

Ranbaxy    

Total 4 2 7 7

49
 20. Findings

RIL, Bharti Airtel, Zydus Cadila, Ranbaxy all have adopted almost full hedging
strategies including Import, Export, and Interest on foreign currency term loan.

Evan Infosys, Dr. Reddy laboratories have used hedging strategies like plan vanilla
forward contracts in USD\INR. Further they have also used some cross currency forward
contracts. In some cases options contract strategies have also been observe.

It was little surprising to know that Nirma Ltd, Torrent Power Ltd both have opted to
remain unhedged

It is even evident some imperical studies that there are several small and medium
corporates in India who do not use hedging tools for their foreign currency exposure.

Hence, considering all it seems that there is vast scope for improvement in foreign
currency market. .

In India currency markets growing rapidly various users such as Impoter, Expoter,
and Money changers so on are using different hedging tools for currency hedging.

Basically it is new concept in Indian market. NSE and BSE both have started forex
transactions from August, 2008

In the whole world daily transaction is approximately 3.4 to 4 trillion where as an

exchange traded currency derivative market in India made its debut (entrance) only in
August, 2008 with the introduction of INR with USD, YEN, EUR, Pound sterling contracts
were given the go ahead only recently the size of the market has growing exponentially.
From a modest beginning of a few hundrered crore Rupees, the daily turnover now crosses
$7.8 billion (About Rs.35000 crore) on a daily basis.

Recently, C.B. Bhave chairman of SEBI announce options in currency derivatives to

be launched soon. This is good for industry participations who have been waiting eagerly
options contracts in this segment options account for nearly 20 percent global foreign
exchange trade volume. A forex option market is considered to be the largest and the most
liquid market for options of any kind in the world.

50
 21. Conclusion

In terms of the growth of currency markets, and the variety of currency users, the
Indian market has equalled or exceeded many other regional markets. While the growth is
being spearheaded mainly by retail investors, private sector institutions and large
corporations, smaller companies and state-owned institutions are gradually getting into the
act. Foreign brokers such as JP Morgan Chase are boosting their presence in India in reaction
to the growth in derivatives. The variety of currency hedging tools available for trading is
also expanding.

There remain major areas of concern for Indian currency users. Large gaps exist in the
range of hedging tools that are traded actively. In foreign currency transaction, Indian
companies majorly uses of Forward and options, and less uses of Interest rate swap or
currency swap. Exchange-traded derivatives based on interest rates and currencies are
virtually absent.

Liquidity and transparency are important properties of any developed market. Liquid
markets require market makers who are willing to buy and sell, and be patient while doing so.
In India, market making is primarily the province of Indian private and foreign banks, with
public sector banks lagging in this area. A lack of market liquidity may be responsible for
inadequate trading in some markets. Transparency is achieved partly through financial
disclosure. Financial statements currently provide misleading information on institutions’ use
of derivatives. Further, there is no consistent method of accounting for gains and losses from
derivatives trading. Thus, a proper framework to account for derivatives needs to be
developed.

Further regulatory reform will help the markets grow faster. For example, Indian
commodity derivatives have great growth potential but government policies have resulted in
the underlying spot/physical market being fragmented (e.g. due to lack of free movement of
commodities and differential taxation within India). Similarly, credit derivatives, the fastest
growing segment of the market globally, are absent in India and require regulatory action if
they are to develop.

51
 As Indian currency markets grow more sophisticated, greater investor awareness will
become essential. NSE has programmes to inform and educate brokers, dealers, traders, and
market personnel. In addition, institutions will need to devote more resources to develop the
business processes and technology necessary for currency derivatives trading.

FUTURES TERMINOLOGY

Spot price:
The price at which an asset trades in the spot market. In the case of USDINR, spot value is T
+ 2.

Futures price:

The price at which the futures contract trades in the futures market.

Contract cycle:

The period over which a contract trades. The currency futures contracts on the NSE have
one-month, two-month, three-month up to twelve-month expiry cycles. Hence, NSE will
have 12 contracts outstanding at any given point in time.

Value Date/Final Settlement Date:

The last business day of the month will be termed the Value date / Final Settlement date of
each contract. The last business day would be taken to the same as that for Inter-bank
Settlements in Mumbai. The rules for Inter-bank Settlements, including those for ‘known
holidays’ and ‘subsequently declared holiday’ would be those as laid down by FEDAI
(Foreign Exchange Dealers Association of India).

Expiry date:

52
It is the date specified in the futures contract. This is the last day on which the contract will
be traded, at the end of which it will cease to exist. The last trading day will be two business
days prior to the Value date / Final Settlement Date.

Contract size:

The amount of asset that has to be delivered under one contract. Also called as lot size. In the
case of USDINR it is USD 1000.

Basis:

In the context of financial futures, basis can be defined as the futures price minus the spot
price. There will be a different basis for each delivery month for each contract. In a normal
market, basis will be positive. This reflects that futures prices normally exceed spot prices.

Cost of carry:

The relationship between futures prices and spot prices can be summarized in terms of what
is known as the cost of carry. This measures (in commodity markets) the storage cost plus
the interest that is paid to finance or ‘carry’ the asset till delivery less the income earned on
the asset. For equity derivatives carry cost is the rate of interest.

Initial margin:

The amount that must be deposited in the margin account at the time a futures contract is
first entered into is known as initial margin.

Marking-to-market:

53
In the futures market, at the end of each trading day, the margin account is adjusted to reflect
the investor's gain or loss depending upon the futures closing price. This is called marking-to-
market.

Maintenance margin:

This is somewhat lower than the initial margin. This is set to ensure that the balance in the
margin account never becomes negative. If the balance in the margin account falls below the
maintenance margin, the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day.

Meaning of a Pip
In the Forex market, prices are quoted in pips. “Pip stands for "percentage in point" and
is the fourth decimal point, which is 1/100th of 1%. In EUR/USD, a 3 pip spread is quoted
as 1.2500/1.2503, spread defining the difference between the bid and ask prices.

Among the major currencies, the only exception to that rule is the Japanese yen. In
USD/JPY, the quotation is only taken out to two decimal points (i.e. to 1/100 th of yen, as
opposed to 1/1000th with other major currencies). In USD/JPY, a 3 pip spread is quoted as
114.05/114.08

54
 Bibliography

NCFM currency trading book

Currency Derivatives work book

Business Standard, July 9th 2010.

Websites:-

http://www.eforexindia.com/classroom.asp

www.ril.com

www.drreddys.com

www.airtel.in

www.infosys.com

www.tatamotors.com

www.torrentpower.com

www.zyduscadila.com

www.nirma.com

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www.torrentpower.com

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