The Currency Futures Market

This article was written after the inauguration of the currency futures market at the National Stock Exchange (NSE) by the Finance Minister in August, 2009.

Despite the fact that currency futures products like swap, forwards and options were permitted to companies in India after the Reserve Bank of India's (RBI) allowed it from April 2007 they were not traded on any recognised exchanges in India and were available like OTC products only. OTC F&Os in currencies had the same financial objective as the newly introduced exchange traded currency F&Os in 2008 but there is a basic distinction between the two.

If one booked a currency forward (OTC) say US dollar- Indian rupee (INR) at a certain rate then on maturity of the forward contract, the responsibility of the forward purchaser and forward seller equals the forward price, at which the contract was executed. So in case of OTC forward currency contract apart from maturity, there is no exchange of funds. While with the help of a third party, i.e. clearing corporations of exchanges, on which the contract will be traded; coming into picture between currency option purchaser and currency option seller, there will be daily mark-to-market settlement between buyer and seller of the contract based on the daily change of prices of underlying currencies.

Hence, the exchange traded currency future will ensure that there will be no case of Indian companies losing due to adverse movements of forex rates in between option booking date and option expiry date since the daily mark-to-market device will guarantee effective hedge. Had this feature been offered to Indian companies earlier, the extent of losses they incurred could have been precluded. Now this will bring a comprehensive forex derivative market in India as developed countries.

It starts with only future contracts on US dollar- Indian rupee (INR). That is hedging will happen when the exposure is in US dollar only. The minimum contract size will be US dollars 1000.00. The currency future contract shall have a maximum maturity of 12 months only. Contracts of varied maturity from 1 month to 12 months will be available. The currency future will be settled in INR only. The settlement price will be RBI’s reference rate on the last trading date. With the introduction of currency futures different queries also come up like: How will the currency futures work out in India? What are the safety measures to guarantee that our investment is looked after in the currency futures market? Is it of assistance for the small traders?

Exchange traded currency futures will succeed just like F&Os in the stock market. The only difference is that while in stock F&O, the underlying are stocks but in case of currency F&Os it will be various global currencies. This will offer the facility to trade currency F&Os to recognised exchanges like stock F&Os being traded on National Stock Exchange (NSE) or Bombay Stock Exchange (BSE).


Exchange traded futures as compared to forwards serve the same economic purpose yet differ in important ways. One entering into a forward contract agrees to transact at a forward price on a future date. On the maturity date, the obligation equals the forward price at which the contract was executed. Except on the maturity date, no money changes hands.

In the case of an exchange traded futures contract, mark-to-market (MTM) obligations are settled on a daily basis. MTM is the practice of revaluing securities and financial instruments using current market prices and is used mostly in the mutual fund industry where the current net asset value (NAV) gives the MTM price. Since the profits or losses in the futures market are collected or paid on a daily basis, the scope for building up of MTM losses in the books of various participants gets limited.

The RBI is the apex authority issuing guidelines for currency futures market in India. The Securities and Exchanges Board of India (SEBI) is the currency futures market regulator.

The price of a currency or the forex rate is determined by simple demand and supply principle. Economics teaches us that if the supply of goods increases, and nothing else changes, its price decreases and vice versa.

Currencies are traded on the forex market, and their supply on that market will alter over time. Forex supply increases due to a variety of reasons. These include rise in export earnings, higher FDI and greater speculation among others. Higher demand for foreign currency results from increase in imports, higher investment in foreign locations and also speculation.

As there had been no currency future trading in India earlier, companies were hedging their currency risk by entering into forward deals with banks where they agreed to buy or sell the dollar at a future date at a pre-defined exchange rate. As compared to currency futures, this method is less flexible, less liquid, and less transparent. Hence, it does not help companies fetch the maximum possible price. Despite these limitations, the dollar forward market in India has a daily turnover of around $3.5 billion.

The RBI guidelines have specified the minimum size of the contract at $1,000 and so that traders can even hedge small amounts of dollar exposure. Under the futures contract, an importer buys the required currency futures contract and “locks in” a price for the purchase of foreign currency. He thereby hedges or avoids risk due to exchange rate fluctuations. An exporter, on the other hand, sells the expected currency futures contract “locks in” a price for the sale to hedge risks.

The following are the advantages of exchange traded currency future markets. There is a daily MTM clearance between the respective parties. The counter-party risk of non obligation of contract could be avoided due to mediator like clearing corporation, which will become a guarantor for both the parties. The introduction of exchange traded currency option will ensure reasonable involvement of both large and small investors in currency trading. As compared to OTC contract market lot will be smaller. The minimum lot size of the newly introduced scheme has been fixed as US dollar 1000 only. It will show the way to greater transparency, efficiency, effectiveness and ease of use in currency F&Os market.

It was the collective effort of RBI and SEBI to commence futures contracts in rupee-dollar contracts. The roadmap is to initiate contracts on other currencies after the preliminary trading stage and should carry on modernizing and improving in the blueprint of financial products, its customer advantage as well as all India delivery. The financial sector needs to be opened up to better competition so as to be able to offer world class financial services at economic rates. They should work towards elimination of entry barriers to domestic corporate players and foreign financial firms in all segments of the financial services industry. Legal complications in currency futures can be avoided for growth of exchange traded currency futures. When all these begin, this market will really grow in size.