INDIAN CURRENCY FUTURES: A FINANCIAL DERIVATIVE TOOL TO HEDGE FOREX

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1 Indian Currency Futures: A Financial Derivative Tool to Hedge Forex 37 INDIAN CURRENCY FUTURES: A FINANCIAL DERIVATIVE TOOL TO HEDGE FOREX Mrs. Nidhi Khurana* ABSTRACT Currency is highly uncertain and unpredictable instrument. The introduction of currency derivatives in India took place ten years back, till then many changes have been implemented in the trading system in this regard. There are number of factors affecting movement of currency future. People have started using currency futures as an investment option and they can trade various currencies as per the current economic condition of the country. This paper highlights the development of currency derivatives in India in relation to the number of contracts traded, and the turnover at National Stock Exchange. Keywords: Currency futures, Contract traded, Currency derivatives, Derivative tool, Financial instruments, Options, Turnover. INTRODUCTION The term derivatives refers to a broad class of financial instruments which mainly include options and futures. These instruments derive their value from the price and other related variables of the underlying asset. They do not have worth of their own and derive their value from the claim they give to their owners to own some other financial assets or security. The derivatives can be financial or non financial derivatives. Derivatives which are of financial nature are called financial derivatives. They are Forwards, Futures, Options and Swap. Those derivatives which are not of financial nature are called non-financial derivatives. They are Commodities, Metals, Weather and Others. A currency future, also known as FX future, is a futures contract to exchange one currency for another at a certain date in the future, at a specified price. In 2008 currency derivatives were allowed to be traded in the exchanges in India. On August 29, 2008 Union Finance Minister P. Chidambaram launched the first Currency Futures Trading in the country at the National Stock Exchange (NSE) with the following features: Only USD-INR contracts were allowed to be traded. The size of each contract shall be USD * Asst.Professor, St. Aloysius College(Auto.) Jabalpur, (M.P.) Global Journal of Business Management

2 38 Nidhi Khurana The contracts shall be quoted and settled in Indian Rupees. The maturity of the contracts shall not exceed 12 months. The settlement price shall be the Reserve Bank s Reference Rate on the last trading day. Only Indian residents shall be eligible for the contracts. Besides National Stock Exchange (NSE), country s largest commodity bourse the Multi Commodity exchange of India (MCX) and Bombay Stock Exchange (BSE) has started trading the currency futures from October, 2008 respectively. Indian Foreign Exchange ( Forex) market got another boost when the SEBI and Reserve Bank of India permitted the trade of derivative contract at the leading stock exchanges NSE and MCX for three new currency pairs. The Reserve Bank of India accepted the proposal of SEBI, permitted the trade of INRGBP (Indian Rupee and Great Britain Pound), INREUR (Indian Rupee and Euro) and INRYEN (Indian Rupee and Japanese Yen). This was in addition with the existing pair of currencies that is US$ and INR. From inclusion of these three currency pairs in the Indian Forex circuit the Indian Forex scene is expected to boost even further as these are some of the most widely traded currency pairs in the world. All the trades done on the recognized exchanges are guaranteed by the clearing corporation of National Securities Clearing Corporation Limited (NSCCL) and hence it eliminates the risks associated with counter party default. Another derivative is currency option which is a type of foreign exchange derivative contract that confers to its holder the right, but not the obligation, to engage in a foreign exchange transaction. The major objective of using currency derivatives is hedging the risk. Suppose, if an investor in India has some business set-up in Japan and he is scheduled to receive sum of Yen 30, 000 in the next 8 months. The investor is planning to utilize this return to buy further investments in India. If the value of Yen fluctuates in another 8 months, there may be a loss for the investor. In this way the investor can utilize currency futures to minimize the risk which can occur due to foreign exchange rate fluctuation and can use foreign currency hedging thus avoiding the risk. This avoidance of risk is known as hedging. In this way, Currency futures are an important trading tool for foreign currency hedging. REVIEW OF LITERATURE Guru (2009) indicated that the global markets (mainly USA) become active only after Indian markets close at 5.00 pm and as a result there is an evident fear about the risks associated with overnight fluctuations in the currency pair. Once the Indian markets close, the positions cannot be reversed by the traders till the next day. Dr. Devajit Mahanta (2012) studied that currency derivative trade in India had experienced explosive growth, both in volumes and value over the years. In terms of the open interest currency derivatives trade in MCX is more as compared to the NSE. It is imperative that any evaluation, projection on Indian currency futures market should be undertaken keeping the international market in perspective. The currency futures market will have greater price transparency for the end-user. By the introduction of exchange traded currency futures in India can now avoided the legal tangle and also bring the Vol. 12, No. 2, December 2018

3 Indian Currency Futures: A Financial Derivative Tool to Hedge Forex 39 platform of foreign exchange in India same as developed countries. According to him, the currency futures market will get more success in the coming future and the economy and the risk hedgers will definitely be benefited from this trade. Dr. E.V.P.A.S. Pallavi (2015) undertook this study to assess the development of currency derivatives in India. For this, the number of contracts traded, trading volume and open interest at NSE were studied. As per the study, the currency derivatives have received a good response from the investors as well as the hedgers. Currently, only resident Indians (including individuals, companies and financial institutions) can trade in the four currency pairs available in the local market-dollar/rupee, pound/rupee, euro/rupee and yen/rupee. The risk involved is comparatively low in this case and currency derivatives has proved to be a good tool for hedging the risk involved in the currency of a country (currency risk). It is hoped that the currency derivatives market will develop faster and it will be a good choice for all the market participants in the near future and it will find its way in the Indian economy. Aabha S Singhvia, Rutu A Pandya (2016) studied the impact currency future, to check rules of the currency and useful prediction models for currency futures closing prices. Indian markets are predictable because of its liveliness and it attains a leading position in the global financial system. In the current scenario of the financial condition, the inconsistencies in the currencies, the rate of interest, the stocks and bonds is something very new. The study on impact of currency derivative trading is important because increased spot market instability resulting from futures trading may suggest a need for regulations. The results of this study are crucial to investors, stock exchange officials and regulators. An important role played by the currency derivatives in the discovery of price and completing the market. In risk management, its role for institutional investors and mutual fund managers hardly need any attention. Objective of the Study To know the development of currency futures and options trading by assessing the number of contract volume and its turnover in Indian market with respect to National Stock Exchange (NSE). RESEARCH METHODOLOGY Research design: Descriptive Analytical Research. Source of Data: The data is collected mainly from websites and journals. Data collection and Data sample: The analysis will be done with the help of secondary data. Sample from 2008 to 2018 were taken. Coefficient of correlation will be applied to know the relation between two variables contract volume and turnover. GROWTH OF CURRENCY FUTURES The Indian markets have shown a remarkable growth both in terms of volumes and numbers of contracts. NSE is one of the major stock exchanges in India and accounts for 99% of the derivatives trading in Indian markets. The business growth of Currency Futures Segment is shown below in Table -1 Global Journal of Business Management

4 40 Nidhi Khurana Table 1: Business Growth of Currency Derivatives Segment at NSE Currency Futures Currency Options Total Year No. of Turnover No. of Notional Premium No. of Turnover* Average Daily contracts (Rs. cr.) contracts Turnover Turnover** contracts (Rs. cr.) Turnover* (Rs. cr.) (Rs. cr.) (Rs. cr.) ,73,87,811 31,28, ,19,95,071 24,02, , ,93,82,882 55,31, , ,04,33,137 25,95, ,45,30,592 24,32, , ,49,63,729 50,28, , ,26,15,931 24,89, ,98,35,508 23,67, , ,24,51,439 48,57, , ,97,59,364 27,49, ,38,23,800 17,52, , ,35,83,164 45,01, , ,55,88,963 22,47, ,50,75,731 7,75, , ,06,64,694 30,23, , ,83,01,579 29,40, ,18,90,951 10,71, , ,01,92,530 40,12, , ,41,59,263 37,65, ,50,84,185 15,09, , ,92,43,448 52,74, , ,13,71,974 33,78, ,19,72,158 12,96, , ,33,44,132 46,74, , ,21,81,928 32,79, ,74,20,147 1,70, ,96,02,075 34,49, , ,86,06,983 17,82, ,86,06,983 17,82, , ,26,72,768 1,62, ,26,72,768 1,62, , Source: Vol. 12, No. 2, December 2018

5 Indian Currency Futures: A Financial Derivative Tool to Hedge Forex 41 From the above table, it is observed that there has been a tremendous increase in the number of contracts and the turnover in currency futures and options. To assess the growth, Karl Pearson s Coefficient of correlation will be applied to know the relation between two variables contract volume and turnover. Let the contract volume (in crores) be denoted as x and the turnover (in crores) be denoted by the y variable. Calculation for Correlation Coefficient (Currency futures and options) Year X Y dx=x- - x dy=y-y dx2 Dy2 dxdy , , Σx=711 Calculation of Mean ΣX_ 711 = = 65 n 11 Σy_ 418 = = 38 n 11 Σdy=0 Σdx2=7,228 Σdxdy Coefficient (r) = = = = = Σdx2. Σdy2 7228* , 775, Σdy2=27,36 Σdxdy=4142 Hence, it is observed from the above calculation that there is a fairly high degree of positive correlation between the number of contract volume and turnover. An increase in the number of contract volume has led to increase in the turnover ratio. It may be therefore concluded that high contract volume will result in a relatively high turnover ratio, whereas a low volume will produce a relatively low turnover ratio. FINDINGS This study shows that there is a high degree of positive correlation between the number of contract volume and turnover. It is also evidenced from table 1 that increase in the volume Global Journal of Business Management

6 42 Nidhi Khurana results in increase in the turnover ratio and vice-versa. It can be aptly said that the currency futures market will get more success in the coming future and the economy and the risk hedgers will definitely be benefited from this trade. Currency futures has proved to be a good tool for hedging the risk involved in the currency of a country (currency risk). CONCLUSION The Indian currency derivatives market has experienced an impressive growth since its introduction of currency futures and options. Stock exchange will enable their large network of clients, traders, jobbers, arbitrators and speculators to trade in currency derivatives; the commodity exchange MCX will enable the hedgers, namely importers and exporters, who have genuine hedging needs for protection against bank rate fluctuation. It is hoped that the currency futures market will develop faster and it will be a good choice for all the market participants in the near future and it will find its way in the Indian economy. REFERENCES Aabha, S. Singhvia, Rutu, A Pandya (2016). International Academic, Journal of Accounting and Financial Management, Vol. 3, No. 7, pp Dr. Devajit Mahanta (2012). International Journal of Marketing, Financial Services & Management Research Vol.1 Issue 11, November, Online available at www. indian researchjournals.com Dr. E.V.P.A.S. Pallavi, (2015). A New Era of Currency Derivatives Market in India, IOSR Journal of Economics and Finance, Vol. 6, Issue 3. Ver. III (May-June), PP DOI: / Page Guru, A. (2009). Forex derivative markets in India: Developments thus far and road ahead. Retrieved from SSRN: Vol. 12, No. 2, December 2018