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Atharva school of
    business
Derivatives and risk management
           PROF. MANISHA SANGHAVI
Currency derivatives-
Futures and options
•   Harshang V. Bhatt   06
•   Gaurav Chhabria     11
•   Alkesh S. Desai     18
•   Viral Parikh        21
•   Purvi Doshi         24
•   Nirav K. Dhruve     25
•   Mansi Kothari       48
•   Akash Shah          71
•   Meghana Kapadia     42
•   Rinku Jain          37
INTRODUCTION TO
CURRENCY MARKETS
        Akash shah
BASIC FOREIGN EXCHANGE
DEFINITIONS
• 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. An exception is the
  USD/CAD (USD–Canadian Dollars)
  currency pair which settles T+1.
• Forward Outright: A
                 foreign exchange
  forward is a contract between two
  counterparties to exchange one
  currency for another on any day after
  spot.
• The duration of the trade can be a few
  days, months or years.
Currency options
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.
• Eg. The expression US Dollar–Rupee, tells you
  that the US Dollar is being quoted in terms of
  the Rupee. The US 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 other currency.
CONTD…
• Changes are also expressed as
  appreciation or depreciation of one
  currency in terms of the other
  currency.
• Eg. If US Dollar–Rupee moved from
  43.00 to 43.25, the US Dollar has
  appreciated and the Rupee has
  depreciated.
SWAPS
• A foreign exchange swap is a
  simultaneous purchase and sale, or
  sale and purchase, of identical
  amounts of one currency for another
  with two different value dates.
• Foreign Exchange Swaps are
  commonly used as a way to facilitate
  funding in the cases where funds are
  available in a different currency than
  the one needed.
EXCHANGE RATE MECHANISM
• Foreign Exchange - The exchange rate
  is a price - the number of units of one
  nation’s currency that must be
  surrendered in order to acquire one unit
  of another nation’s currency.
• A foreign exchange transaction is still a
  shift of funds or short-term financial
  claims from one country and currency to
  another. Thus, within India, any money
  denominated in any currency other than
  the Indian Rupees (INR) is, broadly
  speaking, “foreign exchange.
Contd…
• Foreign Exchange can be cash, funds
  available on credit cards and debit
  cards, travellers’ cheques, bank
  deposits, or other short-term claims.
• Foreign currencies are usually
  needed for payments across national
  borders.
• The exchange rate is a price - the
  number of units of one nation’s
  currency that must be surrendered in
  order to acquire one unit of another
  nation’s currency.
Contd….


• The participants in the foreign exchange
  market are thus a heterogeneous group.
• The various investors, hedgers, and
  speculators may be focused on any time
  period, from a few minutes to several
  years.
• The exchange rate important price in an
  open economy, influencing consumer
  prices, investment decisions, interest
  rates, economic growth, the location of
  industry, and much more.
MAJOR CURRENCIES OF THE WORLD
• The US Dollar is by far the most widely
  traded currency.
• The market practice is to trade each of
  the two currencies against a common
  third currency as a vehicle, rather than to
  trade the two currencies directly against
  each other.
• The vehicle currency used most often is
  the US Dollar, although very recently
  euro also has become an important
  vehicle currency.
• Thus, a trader who wants to shift funds
  from one currency to another, say from
  Indian Rupees to Philippine Pesos, will
  probably sell INR for US Dollars and
  then sell the US Dollars for Pesos.
• The US Dollar took on a major vehicle
  currency role with the introduction of the
  Bretton Woods par value system, in
  which most nations met their IMF
  exchange rate obligations by buying and
  selling US Dollars.
OTHER
MAJOR
CURRENCIES
• The Euro: Like the US
  Dollar, the Euro has a strong
  international presence and
  over the years has emerged as
  a premier currency, second
  only to the US Dollar.
• The Japanese Yen : The
  Japanese Yen is the third most
  traded currency in the world. It
  has a much smaller
  international presence than the
  US Dollar or the Euro. The Yen
  is very liquid around the world,
  practically around the clock.
• The British Pound: Until the
  end of World War II, the Pound
  was the currency of reference.
  The nickname Cable is derived
  from the telegrams used to
  update the GBP/USD rates
  across the Atlantic. The
  currency is heavily traded
  against the Euro and the US
  Dollar.
• The Swiss Franc : The Swiss
  Franc is the only currency of a
  major European country that
  belongs neither to the
  European Monetary Union nor
  to the G-7 countries.
CURRENCY TABLE.
Harshang Bhatt
Overview of Currency
    Markets

•   24-hour market
•   Business is heavy
•   Each nation’s market has its own infrastructure
•   Cross-border foreign exchange trading
Introduction of Currency
Derivatives
•   Introduced in Chicago, 1972.
•   Chicago Mercantile Exchange.
•   Guided by Leo Melamed.
•   Abolishment of Bretton-woods agreement.
ECONOMIC VARIABLES
IMPACTING EXCHANGE RATE
MOVEMENTS
•   GDP.
•   Inflation rate.
•   Interest rate.
•   Economic variables.
Currency Derivatives in
India
• Launched on 29th August 2008 on NSE.
• Launched on 7th October 2008 on MCX-
  SX.
• Launched on 14th October 2008 on BSE.
• Current Daily average turnover is Rs.
  4500 crore, on each NSE & MCX-SX. (
  last year the figure was only Rs. 300
  crore).
• July 6th 2009, was the most active day,
  to hit the total turnover of Rs. 11,600
  crore from 24 lakh contracts.
Currency futures
    Mansi Kothari
CURRENCY FUTURES
• A futures contract is a standardized
  contract, traded on an exchange, to
  buy or sell a certain underlying asset
  or an instrument at a certain date in
  the future, at a specified price.
• In other words, it is a contract to
  exchange one currency for another
  currency at a specified date and a
  specified rate in the future.
• For example:
TERMINOLOGY

•   Spot price
•   Future price
•   Contract cycle
•   Value date
•   Expiry date
•   Contract size
•   Basis
•   Cost of carry
•   Initial margin
•   Marking to market
RATIONALE BEHIND
CURRENCY FUTURES
• Hedging of risk

• Price transparency

• Economy wide perspective.
INTEREST RATE PARITY AND
  PRICING OF CURRENCY
        FUTURES

                RINKU JAIN
Interest Rate Parity
• Interest rate parity is a non-arbitrage condition

• If the returns are different, an arbitrage transaction could,
  in theory, produce a risk-free return.
DERIVATION OF FUTURE
RATE FROM SPOT RATE
• The price of future can be derived by
  following:
              Term : Base Formula

              Spot-Forward r& p Formula

              Continuous Compounding
              Formula
Term: Base Formula
  •   Forward = Spot + Points



              Points =Spot 1 + terms i * days
                                         basis        _1
                           1 + base i * days
                                        basis


    i    = rate of interest
basis    = day count basis
(Most currencies use a 360-day basis, except the pound sterling and a few
others, which use a 365-day year.)
Spot-Forward r& p
Formula

• F(0,T) = (1+ r)T/ (1+p)T
      CONTINUOUS COMPOUNDING FORMULA
•   F(0,T) =(r-p)T
SPECULATION IN FUTURE
      MARKET
• Speculators play a vital role in the futures
  markets.

• Assist Hedgers

• Speculation is not similar to manipulation.
Long Position In Future
       Market
• Long position in a currency futures
  contract without any exposure in the
  cash market is called a speculative
  position.

•   If the exchange rate strengthens  Profit
• If the exchange rate weakens      Loss
Long Position In Future
Observation: The trader has effectively analysed the market conditions
and has taken a right call by going long on futures and thus has made a
gain of Rs. 1,880.
SHORT POSITION IN
  FUTURES
• Short position in a currency futures contract without any
  exposure in the cash market is called a speculative transaction.


     If the exchange rate weakens  Profit
     If the exchange rate strengthens  Loss
Observation: The trader has effectively analysed the market
conditions and has taken a right call by going short on futures and
thus has made a gain of Rs. 362.50 per contract with small
investment (a margin of 3%, which comes to Rs. 1270.80)
in a span of 6 days.
Trading
     Alkesh.S.Desai
TRADING
   – USD INR Currency Derivatives

Underlying Rate of exchange between one USD and
INR
Contract Size USD 1000
Tick Size Re. 0.0025
Price Bands
Trading Cycle .
Expiry Day
Last Trading Day
Settlement Basis.
Settlement Price.
Settlement
Final Settlement Price
Final settlement date.
TRADING PARAMETERS
• Base Price
• Closing Price
• Dissemination                 of
  Open, High, Low, and Last-Traded
  Prices
TENORS OF FUTURES
CONTRACT
• Expiry Date
• Final Settlement Rate
ENTITIES IN THE TRADING
SYSTEM
•   Trading Members (TM)
•   Clearing Members (CM)
•   Trading-cum-Clearing Member (TCM)
•   Professional Clearing Members (PCM)
•   Participants
TYPES OF ORDERS
• Time conditions
 Day order
 Immediate or Cancel (IOC)
• Price condition
 Market price
 Limit price
 Stop-loss
• Other conditions
Pro
Cli
• Price Limit Circuit Filter
MARK-to-MARKET
POSITION LIMITS
Surveillance System
Rules, regulations and bye
laws of Exchange
Purvi and Meghna
HEDGING USING CURRENCY
FUTURES
A hedger has an Overall Portfolio (OP)
composed of (at least) 2 positions:

1. Underlying position
2. Hedging position with negative correlation with
   underlying position
Types of FX Hedgers using
Futures
• Long hedge

• Short hedge
The proper size of the Hedging
position
• Basic Approach: Equal hedge

• Modern Approach: Optimal hedge
Long Futures Hedge Exposed to the
Risk of Strengthening USD
Currency options
Currency options
Short Futures Hedge Exposed to
the Risk of Weakening USD
Currency options
Currency options
TRADING SPREADS USING
CURRENCY FUTURES
Spread movement is based on following
  factors:
• Interest Rate Differentials
• Liquidity in Banking System
• Monetary Policy Decisions (Repo, Reverse
  Repo and CRR)
• Inflation
• Intra-Currency Pair Spread

• Inter-Currency Pair Spread

• Example
ARBITRAGE
• Arbitrage means locking in a profit by
  simultaneously entering into
  transactions in two or more markets.
  If the relation between forward prices
  and futures prices differs, it gives rise
  to arbitrage opportunities.
• Difference in the equilibrium prices
  determined by the demand and
  supply at two different markets also
  gives opportunities to arbitrage.
• Example – Let’s say the spot rate for
  USD/INR is quoted @ Rs. 44.325 and one
  month forward is quoted at 3 paisa
  premium to spot @ 44.3550 while at the
  same time one month currency futures is
  trading @ Rs.44.4625. An active
  arbitrager realizes that there is an
  arbitrage opportunity as the one month
  futures price is more than the one month
  forward price.
Futures trading
Clearing , settlement
and risk management
           Nirav K. Dhruve
Clearing entities

• Clearing members
• Clearing banks
Clearing mechanism
• It involves working out open position and
  obligations of CM
• This position is considered for exposure and
  daily margin purposes
• The open positions of Clearing Members
  (CMs) are arrived at by aggregating the
  open positions of all the TMs and all
  custodial participants clearing through him,
  in contracts in which they have traded.
• TMs are required to identify the orders,
  whether its proprietary or client based
Determinant of open position of a clearing member
Settlement mechanism
• Settlement of futures contract

1) Mark to market settlement
 P/L are computed as the difference
   between trade price and day’s settlement
   price during that day which are not squared
   up
 The previous day;s settlement price and
   today’s settlement price if the contract is b/f
 Buy/sell price of the contract if it is squared
   up
Contd…
2) Final settlement:

 On the last trading day of the futures
 contracts, after the close of trading
 hours, the Clearing Corporation
 marks all positions of a CM to the final
 settlement price and the resulting
 profit/loss is settled in cash
Settlement price of a future
contract
• Daily settlement price on a trading day is the
  closing price of the respective futures
  contracts on such day
• Last half an hour weighted average price of
  the contract
• The final settlement price is the RBI
  reference rate for the last trading day of the
  futures contract
• All open positions will be mark to market on
  the final settlement price
Risk management measures
•   The financial soundness
•   Initial margin
•   Open positions are MOM based
•   Members positions are based on
•   Separate settlement guarantee
    funds are created
Margin requirements
•   Initial margin
•   Portfolio based margin
•   Real time computation
•   Calendar spread margins
•   Extreme loss margin
•   Liquid net worth
•   MOM settlement
Currency Options
          Gaurav Chhabria
Over the counter Options
Market
 Used mainly by Multinational
 companies and large commercial
 international banks.
 Options are frequently written for U.S
 dollars against Pound Sterling,
 Deusche Marks, Swiss francs,
 Canadian Dollar, Euro,etc.
 Maturity ranges from 2 to 6 months.
 Divided into subparts: Retail Market
 and Wholesale Market
Limitations faced
 Market is relatively illiquid because of
 its tailor made nature
 Contracts are not standardized
 because of which there is lack of
 secondary market operators.
 Counter party risk
 Mispricing
Exchange-traded currency
options
 First trading commenced in 1982 by
 Philadelphia Stock Exchange(PHLX).
 In June 1987, Currency Exchange
 Warrants (CEW) were introduced on
 American Stock Exchange (AMEX)
 with long maturity exceeding 1 year.
 In February 1988, CEWs traded in
 AMEX had foreign currency put
 options with 5 years to expiration.
Basics of Currency Options
 Call Option: Option to buy
 foreign currency

 Sell Option: Option to sell
 foreign currency
Price element
 Exercise or Strike Price: Rate at
 which foreign currency can be bought
 and sold

 Premium: Which is the cost or price
 of the option itself

 Underlying or Actual Spot exchange
 rate: Rate in the currency market
 exists on exercise date.
Types
 American Options: Can be exercised
 at any time between the writing date
 and expiration date.

 European Option: Can only be
 exercised at the expiration date and
 not before this date. Mostly popular in
 Switzerland and Germany.
Viral Parikh
Determinants of the
     currency option value
 Changes in forward rate
 Changes in spot rate
 Time to Maturity
 Impact of changing volatility
 Changes in interest rate differential
 Alternative option strike price
Changes in Forward Rate
(Sensitivity)
• The standard foreign currency is
  priced around the forward rate.
• It gives an idea how the future rate
  will move because the forward rate is
  determined after considering the
  interest rate differential of both the
  currencies
• Forward rate also provides
  information to the trader to manage
  the position
Spot Rate Changes (Delta)
• It has direct impact on the time value of the option
• As long as the option has time remaining the option
  will posses the time value element
• The sensitivity of the option premium to a small
  change in the spot exchange is called as delta
For Example
•    The change in the spot rate is $1.70 to $1.72 and
     also assume that option premium changes from
     $0.038/£ to $0.032/£

    Delta=ΔPremium = 0.038-0.032= 0.60
            Δspot rate 1.72-1.76
Time To Maturity(Theta)
• Longer the period to maturity the greater will be the
  option value.
• This relation is referred as Theta.
• Rule of thumb is trader will normally find longer
  maturity options better value, giving the trader to alter
  an option position without suffering Time value
  deteriotion.
Theta = Δ Premium
        Δ Time
Impact of changing volatility
(Lambda)
• Volatility in the context of option may
  be defined as The standard deviation
  of daily percentage changes in the
  underlying exchange rate.
• If exchange rate volatility increases
  then risk in option increases.
• It will result in increase in option
  premium.
Example

• Option has annual volatility of 10.5%, so
Daily volatility = Annual volatility/√365.
                     = 10.5/19.105
                     = 0.55%.
Lambda = Δpremium
              Δvolatility.
Thumb rule- Traders who believe volatility will fall,
  will sell options and buy-back for a profit after
  volatility falls and cause option premium to fall.
Changes in interest rate
differentials. (Rho and Phi)
• The expected change in option
  premium from a small change in
  domestic interest rate is called Rho
• The expected change in option
  premium from a small change in
  Foreign interest rate is called Phi
formula
RHO = Δ Premium
       Δ Re interest rate

PHI= Δ Premium
     Δ Foreign interest rate

Rule of thumb- A trader who is purchasing a call option
  on foreign currency should do so before the domestic
  interest rate rises.
Alternative strike price and
option premiums
• The most important thing in option valuation
  is the availability of alternative strike price In
  the market and finally selecting the same.
• How to choose?
• This is determined by exercising various
  strike prices and respective option premium
  at each strike price. The option which has
  more option premium will be selected and
  then finally a final strike price will be
  selected.
Options trading
THANK YOU, VERY MUCH

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Currency options

  • 1. Atharva school of business
  • 2. Derivatives and risk management PROF. MANISHA SANGHAVI
  • 4. Harshang V. Bhatt 06 • Gaurav Chhabria 11 • Alkesh S. Desai 18 • Viral Parikh 21 • Purvi Doshi 24 • Nirav K. Dhruve 25 • Mansi Kothari 48 • Akash Shah 71 • Meghana Kapadia 42 • Rinku Jain 37
  • 6. BASIC FOREIGN EXCHANGE DEFINITIONS • 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. An exception is the USD/CAD (USD–Canadian Dollars) currency pair which settles T+1.
  • 7. • Forward Outright: A foreign exchange forward is a contract between two counterparties to exchange one currency for another on any day after spot. • The duration of the trade can be a few days, months or years.
  • 9. 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. • Eg. The expression US Dollar–Rupee, tells you that the US Dollar is being quoted in terms of the Rupee. The US 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 other currency.
  • 10. CONTD… • Changes are also expressed as appreciation or depreciation of one currency in terms of the other currency. • Eg. If US Dollar–Rupee moved from 43.00 to 43.25, the US Dollar has appreciated and the Rupee has depreciated.
  • 11. SWAPS • A foreign exchange swap is a simultaneous purchase and sale, or sale and purchase, of identical amounts of one currency for another with two different value dates. • Foreign Exchange Swaps are commonly used as a way to facilitate funding in the cases where funds are available in a different currency than the one needed.
  • 13. • Foreign Exchange - The exchange rate is a price - the number of units of one nation’s currency that must be surrendered in order to acquire one unit of another nation’s currency. • A foreign exchange transaction is still a shift of funds or short-term financial claims from one country and currency to another. Thus, within India, any money denominated in any currency other than the Indian Rupees (INR) is, broadly speaking, “foreign exchange.
  • 14. Contd… • Foreign Exchange can be cash, funds available on credit cards and debit cards, travellers’ cheques, bank deposits, or other short-term claims. • Foreign currencies are usually needed for payments across national borders. • The exchange rate is a price - the number of units of one nation’s currency that must be surrendered in order to acquire one unit of another nation’s currency.
  • 15. Contd…. • The participants in the foreign exchange market are thus a heterogeneous group. • The various investors, hedgers, and speculators may be focused on any time period, from a few minutes to several years. • The exchange rate important price in an open economy, influencing consumer prices, investment decisions, interest rates, economic growth, the location of industry, and much more.
  • 16. MAJOR CURRENCIES OF THE WORLD
  • 17. • The US Dollar is by far the most widely traded currency. • The market practice is to trade each of the two currencies against a common third currency as a vehicle, rather than to trade the two currencies directly against each other. • The vehicle currency used most often is the US Dollar, although very recently euro also has become an important vehicle currency.
  • 18. • Thus, a trader who wants to shift funds from one currency to another, say from Indian Rupees to Philippine Pesos, will probably sell INR for US Dollars and then sell the US Dollars for Pesos. • The US Dollar took on a major vehicle currency role with the introduction of the Bretton Woods par value system, in which most nations met their IMF exchange rate obligations by buying and selling US Dollars.
  • 20. • The Euro: Like the US Dollar, the Euro has a strong international presence and over the years has emerged as a premier currency, second only to the US Dollar. • The Japanese Yen : The Japanese Yen is the third most traded currency in the world. It has a much smaller international presence than the US Dollar or the Euro. The Yen is very liquid around the world, practically around the clock.
  • 21. • The British Pound: Until the end of World War II, the Pound was the currency of reference. The nickname Cable is derived from the telegrams used to update the GBP/USD rates across the Atlantic. The currency is heavily traded against the Euro and the US Dollar. • The Swiss Franc : The Swiss Franc is the only currency of a major European country that belongs neither to the European Monetary Union nor to the G-7 countries.
  • 24. Overview of Currency Markets • 24-hour market • Business is heavy • Each nation’s market has its own infrastructure • Cross-border foreign exchange trading
  • 25. Introduction of Currency Derivatives • Introduced in Chicago, 1972. • Chicago Mercantile Exchange. • Guided by Leo Melamed. • Abolishment of Bretton-woods agreement.
  • 26. ECONOMIC VARIABLES IMPACTING EXCHANGE RATE MOVEMENTS • GDP. • Inflation rate. • Interest rate. • Economic variables.
  • 27. Currency Derivatives in India • Launched on 29th August 2008 on NSE. • Launched on 7th October 2008 on MCX- SX. • Launched on 14th October 2008 on BSE. • Current Daily average turnover is Rs. 4500 crore, on each NSE & MCX-SX. ( last year the figure was only Rs. 300 crore). • July 6th 2009, was the most active day, to hit the total turnover of Rs. 11,600 crore from 24 lakh contracts.
  • 28. Currency futures Mansi Kothari
  • 29. CURRENCY FUTURES • A futures contract is a standardized contract, traded on an exchange, to buy or sell a certain underlying asset or an instrument at a certain date in the future, at a specified price. • In other words, it is a contract to exchange one currency for another currency at a specified date and a specified rate in the future. • For example:
  • 30. TERMINOLOGY • Spot price • Future price • Contract cycle • Value date • Expiry date • Contract size • Basis • Cost of carry • Initial margin • Marking to market
  • 31. RATIONALE BEHIND CURRENCY FUTURES • Hedging of risk • Price transparency • Economy wide perspective.
  • 32. INTEREST RATE PARITY AND PRICING OF CURRENCY FUTURES RINKU JAIN
  • 33. Interest Rate Parity • Interest rate parity is a non-arbitrage condition • If the returns are different, an arbitrage transaction could, in theory, produce a risk-free return.
  • 34. DERIVATION OF FUTURE RATE FROM SPOT RATE • The price of future can be derived by following:  Term : Base Formula  Spot-Forward r& p Formula  Continuous Compounding Formula
  • 35. Term: Base Formula • Forward = Spot + Points Points =Spot 1 + terms i * days basis _1 1 + base i * days basis i = rate of interest basis = day count basis (Most currencies use a 360-day basis, except the pound sterling and a few others, which use a 365-day year.)
  • 36. Spot-Forward r& p Formula • F(0,T) = (1+ r)T/ (1+p)T CONTINUOUS COMPOUNDING FORMULA • F(0,T) =(r-p)T
  • 38. • Speculators play a vital role in the futures markets. • Assist Hedgers • Speculation is not similar to manipulation.
  • 39. Long Position In Future Market
  • 40. • Long position in a currency futures contract without any exposure in the cash market is called a speculative position. • If the exchange rate strengthens  Profit • If the exchange rate weakens  Loss
  • 42. Observation: The trader has effectively analysed the market conditions and has taken a right call by going long on futures and thus has made a gain of Rs. 1,880.
  • 43. SHORT POSITION IN FUTURES • Short position in a currency futures contract without any exposure in the cash market is called a speculative transaction. If the exchange rate weakens  Profit If the exchange rate strengthens  Loss
  • 44. Observation: The trader has effectively analysed the market conditions and has taken a right call by going short on futures and thus has made a gain of Rs. 362.50 per contract with small investment (a margin of 3%, which comes to Rs. 1270.80) in a span of 6 days.
  • 45. Trading Alkesh.S.Desai
  • 46. TRADING – USD INR Currency Derivatives Underlying Rate of exchange between one USD and INR Contract Size USD 1000 Tick Size Re. 0.0025 Price Bands Trading Cycle . Expiry Day Last Trading Day Settlement Basis. Settlement Price. Settlement Final Settlement Price Final settlement date.
  • 47. TRADING PARAMETERS • Base Price • Closing Price • Dissemination of Open, High, Low, and Last-Traded Prices
  • 48. TENORS OF FUTURES CONTRACT • Expiry Date • Final Settlement Rate
  • 49. ENTITIES IN THE TRADING SYSTEM • Trading Members (TM) • Clearing Members (CM) • Trading-cum-Clearing Member (TCM) • Professional Clearing Members (PCM) • Participants
  • 50. TYPES OF ORDERS • Time conditions  Day order  Immediate or Cancel (IOC) • Price condition  Market price  Limit price  Stop-loss
  • 51. • Other conditions Pro Cli • Price Limit Circuit Filter
  • 55. Rules, regulations and bye laws of Exchange
  • 57. HEDGING USING CURRENCY FUTURES A hedger has an Overall Portfolio (OP) composed of (at least) 2 positions: 1. Underlying position 2. Hedging position with negative correlation with underlying position
  • 58. Types of FX Hedgers using Futures • Long hedge • Short hedge
  • 59. The proper size of the Hedging position • Basic Approach: Equal hedge • Modern Approach: Optimal hedge
  • 60. Long Futures Hedge Exposed to the Risk of Strengthening USD
  • 63. Short Futures Hedge Exposed to the Risk of Weakening USD
  • 66. TRADING SPREADS USING CURRENCY FUTURES Spread movement is based on following factors: • Interest Rate Differentials • Liquidity in Banking System • Monetary Policy Decisions (Repo, Reverse Repo and CRR) • Inflation
  • 67. • Intra-Currency Pair Spread • Inter-Currency Pair Spread • Example
  • 68. ARBITRAGE • Arbitrage means locking in a profit by simultaneously entering into transactions in two or more markets. If the relation between forward prices and futures prices differs, it gives rise to arbitrage opportunities. • Difference in the equilibrium prices determined by the demand and supply at two different markets also gives opportunities to arbitrage.
  • 69. • Example – Let’s say the spot rate for USD/INR is quoted @ Rs. 44.325 and one month forward is quoted at 3 paisa premium to spot @ 44.3550 while at the same time one month currency futures is trading @ Rs.44.4625. An active arbitrager realizes that there is an arbitrage opportunity as the one month futures price is more than the one month forward price.
  • 71. Clearing , settlement and risk management Nirav K. Dhruve
  • 72. Clearing entities • Clearing members • Clearing banks
  • 73. Clearing mechanism • It involves working out open position and obligations of CM • This position is considered for exposure and daily margin purposes • The open positions of Clearing Members (CMs) are arrived at by aggregating the open positions of all the TMs and all custodial participants clearing through him, in contracts in which they have traded. • TMs are required to identify the orders, whether its proprietary or client based
  • 74. Determinant of open position of a clearing member
  • 75. Settlement mechanism • Settlement of futures contract 1) Mark to market settlement  P/L are computed as the difference between trade price and day’s settlement price during that day which are not squared up  The previous day;s settlement price and today’s settlement price if the contract is b/f  Buy/sell price of the contract if it is squared up
  • 76. Contd… 2) Final settlement: On the last trading day of the futures contracts, after the close of trading hours, the Clearing Corporation marks all positions of a CM to the final settlement price and the resulting profit/loss is settled in cash
  • 77. Settlement price of a future contract • Daily settlement price on a trading day is the closing price of the respective futures contracts on such day • Last half an hour weighted average price of the contract • The final settlement price is the RBI reference rate for the last trading day of the futures contract • All open positions will be mark to market on the final settlement price
  • 78. Risk management measures • The financial soundness • Initial margin • Open positions are MOM based • Members positions are based on • Separate settlement guarantee funds are created
  • 79. Margin requirements • Initial margin • Portfolio based margin • Real time computation • Calendar spread margins • Extreme loss margin • Liquid net worth • MOM settlement
  • 80. Currency Options Gaurav Chhabria
  • 81. Over the counter Options Market  Used mainly by Multinational companies and large commercial international banks.  Options are frequently written for U.S dollars against Pound Sterling, Deusche Marks, Swiss francs, Canadian Dollar, Euro,etc.  Maturity ranges from 2 to 6 months.  Divided into subparts: Retail Market and Wholesale Market
  • 82. Limitations faced  Market is relatively illiquid because of its tailor made nature  Contracts are not standardized because of which there is lack of secondary market operators.  Counter party risk  Mispricing
  • 83. Exchange-traded currency options  First trading commenced in 1982 by Philadelphia Stock Exchange(PHLX).  In June 1987, Currency Exchange Warrants (CEW) were introduced on American Stock Exchange (AMEX) with long maturity exceeding 1 year.  In February 1988, CEWs traded in AMEX had foreign currency put options with 5 years to expiration.
  • 84. Basics of Currency Options  Call Option: Option to buy foreign currency  Sell Option: Option to sell foreign currency
  • 85. Price element  Exercise or Strike Price: Rate at which foreign currency can be bought and sold  Premium: Which is the cost or price of the option itself  Underlying or Actual Spot exchange rate: Rate in the currency market exists on exercise date.
  • 86. Types  American Options: Can be exercised at any time between the writing date and expiration date.  European Option: Can only be exercised at the expiration date and not before this date. Mostly popular in Switzerland and Germany.
  • 88. Determinants of the currency option value  Changes in forward rate  Changes in spot rate  Time to Maturity  Impact of changing volatility  Changes in interest rate differential  Alternative option strike price
  • 89. Changes in Forward Rate (Sensitivity) • The standard foreign currency is priced around the forward rate. • It gives an idea how the future rate will move because the forward rate is determined after considering the interest rate differential of both the currencies • Forward rate also provides information to the trader to manage the position
  • 90. Spot Rate Changes (Delta) • It has direct impact on the time value of the option • As long as the option has time remaining the option will posses the time value element • The sensitivity of the option premium to a small change in the spot exchange is called as delta
  • 91. For Example • The change in the spot rate is $1.70 to $1.72 and also assume that option premium changes from $0.038/£ to $0.032/£ Delta=ΔPremium = 0.038-0.032= 0.60 Δspot rate 1.72-1.76
  • 92. Time To Maturity(Theta) • Longer the period to maturity the greater will be the option value. • This relation is referred as Theta. • Rule of thumb is trader will normally find longer maturity options better value, giving the trader to alter an option position without suffering Time value deteriotion.
  • 93. Theta = Δ Premium Δ Time
  • 94. Impact of changing volatility (Lambda) • Volatility in the context of option may be defined as The standard deviation of daily percentage changes in the underlying exchange rate. • If exchange rate volatility increases then risk in option increases. • It will result in increase in option premium.
  • 95. Example • Option has annual volatility of 10.5%, so Daily volatility = Annual volatility/√365. = 10.5/19.105 = 0.55%. Lambda = Δpremium Δvolatility. Thumb rule- Traders who believe volatility will fall, will sell options and buy-back for a profit after volatility falls and cause option premium to fall.
  • 96. Changes in interest rate differentials. (Rho and Phi) • The expected change in option premium from a small change in domestic interest rate is called Rho • The expected change in option premium from a small change in Foreign interest rate is called Phi
  • 97. formula RHO = Δ Premium Δ Re interest rate PHI= Δ Premium Δ Foreign interest rate Rule of thumb- A trader who is purchasing a call option on foreign currency should do so before the domestic interest rate rises.
  • 98. Alternative strike price and option premiums • The most important thing in option valuation is the availability of alternative strike price In the market and finally selecting the same. • How to choose? • This is determined by exercising various strike prices and respective option premium at each strike price. The option which has more option premium will be selected and then finally a final strike price will be selected.