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Currency futures –Introduction to currency market

• Type of currencies –Base and counter currencies

• USD-INR• GBP-INR• Japanese yen –USD • First currency – Base currency• Second currency – Counter /terms /qoute

currency

Exchange rate regimes

Exchange Rate

Fixed

Floating

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Fixed and Floating exchange rates

• Govt action towards buying and selling of domestic currency-in open market

• Buying at value is coming down

• Selling at value is going up

• Self correcting mechanism

• Demand and supply of the currency

• Demand for currency is low-import is costlier and export is cheaper

• When exports- payment leads to appreciation of domestic currency

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Factors –Exchange rates • Fundamental factors : inflation, BOP,

unemployment , capacity utilisation , trends in import and exports-BOP surplus- Favourable exchange rate and vice versa

• Technical factors : Interest rates ,Inflation rate and Exchange rate policy

• Political factors• Speculation-over valuation

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Important reasons for Rupee Depreciation

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Quotes

• Direct quote : in the expression of USD ;1USD =INR 45.000

• Indirect quote : in the expression of terms currency ; 1INR=.021 USD

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Tick size

• NSE tick size :.0025• Value of one on each contract =Rs 2.5• Example 4 ticks improvement and 5 contracts • Bid price – willing of the buyer to pay • Ask price- willing of the price to sell • Spread

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Highlight –Forex Futures Contract

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Currency Future-Contract cycle

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Contract specification

• Last trading day :Two working days prior to final settelment

• Settlement :Cash settlement• Final settlement price: The reference rate fixed

by RBI two working days prior to the final settlement date will be used for final settlement .

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RBI Reference rate

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Currency futures contract trading process

Trader seller

TraderBuyer

Member Broker

Member Broker

Clearing house

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Pricing of futures contract-interest rate parity

• A theory in which the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate. Interest rate parity plays an essential role in foreign exchange markets, connecting interest rates, spot exchange rates and foreign exchange rates.

F/S= (1+Rh)/(1+Rf)• F=S *e(rh-rf)*r

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Example problems

• Assume on March10,2002 annual interest rate was 10% p.a on indian rupees and US dollar was 7% per annum . The spot Re/$ exchange rate was 44 using the above futures ,calculate the theoretical futures price on one year forward exchange rate

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Interest rate parity theory

• Spot rate Rs48.000 per USD • 2years• Interest rate in India 7%• Interest rate in USA 5%• 49.50• 50.25

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