7. Let us understand what is Hedging? Hedging means taking a position in the future market that is opposite to a position in the physical market with a view to reduce or limit the risk associated with unpredictable changes in the exchange rate
9. Let us understand what is Speculation? The main objective of speculation is to take risks and profit from anticipated price changes in futures price of an asset A speculator will buy futures contracts (long position) if he anticipates an increase in the price of the currency in future and vice versa
10. Speculators play a vital role in the futures markets. Futures are designed primarily to assist hedgers in managing their exposure to price risk; however, this would not be possible without the participation of speculators Speculators, or traders, assume the price risk that hedgers attempt to lay off in the markets. In other words, hedgers often depend on speculators to take the other side of their trades (i.e., act as counter party) and to add depth and liquidity to the markets that are vital for the functioning of a futures market The speculators therefore have a big hand in making the market Speculation
11. Long position in a currency futures contract without any exposure in the cash market is called a speculative position. Long position in futures for speculative purpose means buying futures contract in anticipation of strengthening of the exchange rate (which actually means buy the base currency (USD) and sell the terms currency (INR) and you want the base currency to raise in value and then you would sell it back at a higher price). If the exchange rate strengthens before the expiry of the contract then the trader makes a profit on squaring off the position, and if the exchange rate weakens then the trader makes a loss Short position in a currency futures contract without any exposure in the cash market is called a speculative transaction. Short position in futures for speculative purposes means selling a futures contract in anticipation of decline in the exchange rate (which actually means sell the base currency (USD) and buy the terms currency (INR) and you want the base currency to fall in value and then you would buy it back at a lower price). If the exchange rate weakens before the expiry of the contract, then the trader makes a profit on squaring off the position, and if the exchange rate strengthens then the trader makes loss Two ways of speculation Short position Long position
12. Letâs take an example Long position On May 1, 2008, an active trader in the currency futures market expects INR will depreciate against USD caused by Indiaâs sharply rising import bill and poor FII equity flows. On the basis of his view about the. USD/INR movement, he buys 1 USD/INR August contract at the prevailing rate of Rs. 40.5800. He decides to hold the contract till expiry and during the holding period USD/INR futures actually moves as per his anticipation and the RBI Reference rate increases to USD/INR 42.46 on May 30, 2008. He squares off his position and books a profit of Rs. 1880 (42.4600 x 1000 - 40.5800 x 1000) on 1 contract of USD/INR futures contract.
13. Long position Observation The trader has effectively analyzed the market conditions and has taken a right call by going long on futures and thus has made a gain of Rs. 1,880.
14. Letâs take an example Short position On August 1, 2008, an active trader in the currency futures market expects INR will appreciate against USD, caused by softening of crude oil prices in the international market and hence improving Indiaâs trade balance. On the basis of his view about the USD/INR movement, he sells 1 USD/INR August contract at the prevailing rate of Rs. 42.3600. On August 6, 2008, USD/INR August futures contract actually moves as per his anticipation and declines to 41.9975. He decides to square off his position and earns a profit of Rs. 362.50 (42.3600 x 1000 â 41.9975 x 1000) on squaring off the short position of 1 USD/INR August futures contract
15. Short position Observation The trader has effectively analyzed 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.
