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Workbook for
NISM-Series-I Currency Derivatives Certification Examination (NISM-Series-I: CD
Examination)
National Institute of Securities Markets
This workbook has been developed to assist candidates in preparing for the Natio
nal Institute of Securities Markets (NISM) NISM-Series-I: Currency Derivatives C
ertification Examination (NISM-Series-I: CD Examination). Workbook Version: Apri
l 2009 Published by: National Institute of Securities Markets © National Institu
te of Securities Markets, 2009 Plot 82, Sector 17, Vashi, Navi Mumbai - 400705,
India. All rights reserved. Reproduction of this publication in any form without
prior permission of the publishers is strictly prohibited. Disclaimer The conte
nts of this publication do not necessarily constitute or imply its endorsement,
recommendation, or favoring by the National Institute of Securities Market (NISM
) or the Securities and Exchange Board of India (SEBI). This publication is mean
t for general reading and educational purpose only. It is not meant to serve as
guide for investment. The views and opinions and statements of authors or publis
hers expressed herein do not constitute a personal recommendation or suggestion
for any specific need of an Individual. It shall not be used for advertising or
product endorsement purposes. The statements/explanations/concepts are of genera
l nature and may not have taken into account the particular objective/move/aim/n
eed/circumstances of individual user/reader/organization/institute. Thus NISM an
d SEBI do not assume any responsibility for any wrong move or action taken based
on the information available in this publication. Therefore before acting on or
following the steps suggested on any theme or before following any recommendati
on given in this publication user/reader should consider/seek professional advic
e. The publication contains information, statements, opinions, statistics and ma
terials that have been obtained from sources believed to be reliable and the pub
lishers of this title have made best efforts to avoid any errors. However, publi
shers of this material offer no guarantees and warranties of any kind to the rea
ders/users of the information contained in this publication. Since the work and
research is still going on in all these knowledge streams, NISM and SEBI do not
warrant the totality and absolute accuracy, adequacy or completeness of this inf
ormation and material and expressly disclaim any liability for errors or omissio
ns in this information and material herein. NISM and SEBI do not accept any lega
l liability what so ever based on any information contained herein. While the NI
SM Certification examination will be largely based on material in this workbook,
NISM does not guarantee that all questions in the examination will be from mate
rial covered herein.
About NISM In pursuance of the announcement made by the Finance Minister in his
Budget Speech in February 2005, Securities and Exchange Board of India (SEBI) ha
s established the National Institute of Securities Markets (NISM) in Mumbai. SEB
I, by establishing NISM, has articulated the desire expressed by the Indian gove
rnment to promote securities market education and research. Towards accomplishin
g the desire of Government of India and vision of SEBI, NISM has launched an eff
ort to deliver financial and securities education at various levels and across v
arious segments in India and abroad. To implement its objectives, NISM has estab
lished six distinct schools to cater the educational needs of various constituen
cies such as investor, issuers, intermediaries, regulatory staff, policy makers,
academia and future professionals of securities markets. NISM brings out variou
s publications on securities markets with a view to enhance knowledge levels of
participants in the securities industry. NISM is mandated to implement certifica
tion examinations for professionals employed in various segments of the Indian s
ecurities markets.
Acknowledgement This workbook has been developed by NISM in close cooperation wi
th the Examination Committee for NISMSeries-I: Currency Derivatives Certificatio
n Examination (NISM-Series-I: CD Examination) consisting of representatives of S
ecurities and Exchange Board of India (SEBI), Bombay Stock Exchange (BSE), Natio
nal Stock Exchange (NSE), MCX Stock Exchange (MCX-SX) and Foreign Exchange Deale
rs Association of India (FEDAI). NISM gratefully acknowledges the contribution o
f all committee members. Parts of the content of this workbook have been provide
d by BSE, NSE and MCX-SX. NISM is grateful for their contribution.
About the NISM-Series-I: Currency Derivatives Certification Examination (NISM-Se
ries-I: CD Examination) The examination seeks to create a common minimum knowled
ge benchmark for persons working in the currency derivative segment, in order to
enable a better understanding of currency markets and exchange traded currency
future products, better quality investor service, operational process efficiency
and risk controls. Examination Objectives On successful completion of the exami
nation the candidate should: • Know the basics of currency markets and specifica
lly Exchange Traded Currency Futures markets. • Understand the trading, clearing
and settlement mechanisms related to Exchange Traded Currency Futures markets a
nd basic investment strategies that use currency futures products. • Know the re
gulatory environment in which the Exchange Traded Currency Futures markets opera
te in India. Assessment Structure The NISM-Series-I: Currency Derivatives Certif
ication Examination (NISM-Series-I: CD Examination) will be of 100 marks, will h
ave 60 questions, and should be completed in 2 hours. There will be negative mar
king of 25% of the marks assigned to a question. The passing score for the exami
nation is 60%. How to register and take the examination To find out more and reg
ister for the examination please visit www.nism.ac.in
Table of Contents
CHAPTER 1
1.1 1.2 1.3 1.4 1.5
INTRODUCTION TO CURRENCY MARKETS
7
7 7 9 10 11
BASIC FOREIGN EXCHANGE DEFINITIONS EXCHANGE RATE MECHANISM MAJOR CURRENCIES OF T
HE WORLD OVERVIEW OF INTERNATIONAL CURRENCY MARKETS ECONOMIC VARIABLES IMPACTING
EXCHANGE RATE MOVEMENTS
CHAPTER 2
2.1 2.2 2.3 2.4 2.5 2.6
FOREIGN EXCHANGE DERIVATIVES
13
13 13 14 14 15 16
DERIVATIVES – DEFINITION DERIVATIVE PRODUCTS GROWTH DRIVERS OF DERIVATIVES MARKE
T PLAYERS KEY ECONOMIC FUNCTION OF DERIVATIVES EXCHANGE-TRADED vs. OVER –THE- CO
UNTER DERIVATIVES
CHAPTER 3
3.1 3.2 3.3 3.4 3.5
EXCHANGE TRADED CURRENCY FUTURES
19
19 20 20 22 23
CURRENCY FUTURES -DEFINITION FUTURES TERMINOLOGY RATIONALE BEHIND CURRENCY FUTUR
ES DISTINCTION BETWEEN FUTURES AND FORWARD CONTRACTS INTEREST RATE PARITY AND PR
ICING OF CURRENCY FUTURES
CHAPTER 4
4.1 4.2 4.3 4.4 4.5 4.6
STRATEGIES USING CURRENCY FUTURES
27
27 27 28 29 38 38
SPECULATION IN FUTURES MARKETS LONG POSITION IN FUTURES SHORT POSITION IN FUTURE
S HEDGING USING CURRENCY FUTURES TRADING SPREADS USING CURRENCY FUTURES ARBITRAG
E
CHAPTER 5
5.1 5.2 5.3 5.4
TRADING
41
41 41 42 42
CURRENCY FUTURES CONTRACT SPECIFICATION TRADING PARAMETERS TENORS OF FUTURES CON
TRACT TRADER WORKSTATION SCREEN (TWS)
5.5 5.6 5.7 5.8
ENTITIES IN THE TRADING SYSTEM TYPES OF ORDERS MARK-to-MARKET POSITION LIMITS
42 43 44 44
CHAPTER 6
6.1 6.2 6.3 6.4 6.5
CLEARING, SETTLEMENT AND RISK MANAGEMENT
47
47 47 49 51 52
CLEARING ENTITIES CLEARING MECHANISM SETTLEMENT MECHANISM RISK MANAGEMENT MEASUR
ES MARGIN REQUIREMENTS
CHAPTER 7
7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8
REGULATORY FRAMEWORK FOR CURRENCY DERIVATIVES
55
55 56 56 57 59 60 60 60
SECURITIES CONTRACTS (REGULATION) ACT, 1956 [SC(R)A] SECURITIES AND EXCHANGE BOA
RD OF INDIA ACT, 1992 RBI-SEBI STANDING TECHNICAL COMMITTEE ON EXCHANGE TRADED C
URRENCY AND INTEREST RATE DERIVATIVES FOREIGN EXCHANGE MANAGEMENT ACT, 1999 - PR
OVISIONS REGULATORY FRAMEWORK FOR EXCHANGES REGULATORY FRAMEWORK FOR CLEARING CO
RPORATIONS GOVERNING COUNCIL OF THE EXCHANGE AND CLEARING CORPORATION ELIGIBILIT
Y CRITERIA FOR MEMBERS
CHAPTER 8
8.1 8.2
ACCOUNTING AND TAXATION
65
65 68
ACCOUNTING TAXATION OF DERIVATIVE TRANSACTION IN SECURITIES
CHAPTER 9
9.1 9.2 9.3
CODES OF CONDUCT AND INVESTOR PROTECTION MEASURES
69
69 73 75
ADHERENCE TO SEBI CODES OF CONDUCT FOR BROKERS/ SUB-BROKERS ADHERENCE TO CODES O
F CONDUCT SPECIFIC TO ETCF SEGMENT GRIEVANCE REDRESSAL MECHANISM FOR INVESTORS
APPENDIX A APPENDIX B APPENDIX C
SAFEGUARDS FOR INVESTORS SAMPLE QUESTIONS EXCHANGES TRADING IN CURRENCY FUTURES
79 83 91 93
LIST OF ABBREVATIONS
CHAPTER 1 INTRODUCTION TO CURRENCY MARKETS
1.1 BASIC FOREIGN EXCHANGE DEFINITIONS
Spot: Foreign exchange spot trading is buying one currency with a different curr
ency for immediate delivery. The standard settlement convention for Foreign Exch
ange 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
. Rates for days other than spot are always calculated with reference to spot ra
te. Forward Outright: A foreign exchange forward is a contract between two count
erparties to exchange one currency for another on any day after spot. In this tr
ansaction, money does not actually change hands until some agreed upon future da
te. The duration of the trade can be a few days, months or years. For most major
currencies, three business days or more after deal date would constitute a forw
ard transaction. Settlement date / Value Date Trade Date Trade Date + 1 Trade Da
te + 2 Trade Date + 3 or any later date Definition Same day as deal date 1 busin
ess day after deal date 2 business days after deal date* 3 business days or more
after deal date, always longer than Spot
Value Cash Value Tom (Tomorrow) Spot Forward Outright * USD/CAD is the exception
Base Currency / Terms Currency: In foreign exchange markets, the base currency i
s the first currency in a currency pair. The second currency is called as the te
rms currency. Exchange rates are quoted in per unit of the base currency. Eg. Th
e expression US Dollar–Rupee, tells you that the US Dollar is being quoted in te
rms 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 e
xpressed as strengthening or weakening of one currency vis-à-vis the other curre
ncy. Changes are also expressed as appreciation or depreciation of one currency
in terms of the other currency. Whenever the base currency buys more of the term
s currency, the base currency has strengthened / appreciated and the terms curre
ncy has weakened / depreciated. 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 iden
tical amounts of one currency for another with two different value dates. Foreig
n Exchange Swaps are commonly used as a way to facilitate funding in the cases w
here funds are available in a different currency than the one needed. Effectivel
y, each party to the deal is given the use of an amount of foreign currency for
a specific time. The Forward Rate is derived by adjusting the Spot rate for the
interest rate differential of the two currencies for the period between the Spot
and the Forward date. Liquidity in one currency is converted into another curre
ncy for a period of time.
1.2
EXCHANGE RATE MECHANISM
“Foreign Exchange” refers to money denominated in the currency of another nation
or a group of nations. Any person who exchanges money denominated in his own na
tion’s currency for money denominated in another nation’s currency acquires fore
ign exchange.
7
This holds true whether the amount of the transaction is equal to a few rupees o
r to billions of rupees; whether the person involved is a tourist cashing a trav
ellers’ cheque or an investor exchanging hundreds of millions of rupees for the
acquisition of a foreign company; and whether the form of money being acquired i
s foreign currency notes, foreign currency-denominated bank deposits, or other s
hort-term claims denominated in foreign currency. A foreign exchange transaction
is still a shift of funds or short-term financial claims from one country and c
urrency to another. Thus, within India, any money denominated in any currency ot
her than the Indian Rupees (INR) is, broadly speaking, “foreign exchange.” Forei
gn Exchange can be cash, funds available on credit cards and debit cards, travel
lers’ cheques, bank deposits, or other short-term claims. It is still “foreign e
xchange” if it is a short-term negotiable financial claim denominated in a curre
ncy other than INR. Almost every nation has its own national currency or monetar
y unit - Rupee, US Dollar, Peso etc.- used for making and receiving payments wit
hin its own borders. But foreign currencies are usually needed for payments acro
ss national borders. Thus, in any nation whose residents conduct business abroad
or engage in financial transactions with persons in other countries, there must
be a mechanism for providing access to foreign currencies, so that payments can
be made in a form acceptable to foreigners. In other words, there is need for “
foreign exchange” transactions—exchange of one currency for another. The exchang
e rate is a price - the number of units of one nation’s currency that must be su
rrendered in order to acquire one unit of another nation’s currency. There are s
cores of “exchange rates” for INR and other currencies, say US Dollar. In the sp
ot market, there is an exchange rate for every other national currency traded in
that market, as well as for various composite currencies or constructed monetar
y units such as the Euro or the International Monetary Fund’s “SDR”. There are a
lso various “trade-weighted” or “effective” rates designed to show a currency’s
movements against an average of various other currencies (for eg US Dollar index
, which is a weighted index against world major currencies like Euro, Pound Ster
ling, Yen, and Canadian Dollar). Apart from the spot rates, there are additional
exchange rates for other delivery dates in the forward markets. The market pric
e is determined by the interaction of buyers and sellers in that market, and a m
arket exchange rate between two currencies is determined by the interaction of t
he official and private participants in the foreign exchange rate market. For a
currency with an exchange rate that is fixed, or set by the monetary authorities
, the central bank or another official body is a participant in the market, stan
ding ready to buy or sell the currency as necessary to maintain the authorized p
egged rate or range. But in countries like the United States, which follows a co
mplete free floating regime, the authorities are not known to intervene in the f
oreign exchange market on a continuous basis to influence the exchange rate. The
market participation is made up of individuals, non-financial firms, banks, off
icial bodies, and other private institutions from all over the world that are bu
ying and selling US Dollars at that particular time. The participants in the for
eign exchange market are thus a heterogeneous group. The various investors, hedg
ers, and speculators may be focused on any time period, from a few minutes to se
veral years. But, whatever is the constitution of participants, and whether thei
r motive is investing, hedging, speculating, arbitraging, paying for imports, or
seeking to influence the rate, they are all part of the aggregate demand for an
d supply of the currencies involved, and they all play a role in determining the
market price at that instant. Given the diverse views, interests, and time fram
es of the participants, predicting the future course of exchange rates is a part
icularly complex and uncertain exercise. At the same time, since the exchange ra
te influences such a vast array of participants and business decisions, it is a
pervasive and singularly important price in an open economy, influencing consume
r prices, investment decisions, interest rates, economic growth, the location of
industry, and much more. The role of the foreign exchange market in the determi
nation of that price is critically important.
8
1.3
MAJOR CURRENCIES OF THE WORLD
The US Dollar is by far the most widely traded currency. In part, the widespread
use of the US Dollar reflects its substantial international role as “investment
” currency in many capital markets, “reserve” currency held by many central bank
s, “transaction” currency in many international commodity markets, “invoice” cur
rency in many contracts, and “intervention” currency employed by monetary author
ities in market operations to influence their own exchange rates. In addition, t
he widespread trading of the US Dollar reflects its use as a “vehicle” currency
in foreign exchange transactions, a use that reinforces its international role i
n trade and finance. For most pairs of currencies, the market practice is to tra
de each of the two currencies against a common third currency as a vehicle, rath
er than to trade the two currencies directly against each other. The vehicle cur
rency used most often is the US Dollar, although very recently euro also has bec
ome 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 probab
ly sell INR for US Dollars and then sell the US Dollars for Pesos. Although this
approach results in two transactions rather than one, it may be the preferred w
ay, since the US Dollar/INR market and the US Dollar/Philippine Peso market are
much more active and liquid and have much better information than a bilateral ma
rket for the two currencies directly against each other. By using the US Dollar
or some other currency as a vehicle, banks and other foreign exchange market par
ticipants can limit more of their working balances to the vehicle currency, rath
er than holding and managing many currencies, and can concentrate their research
and information sources on the vehicle currency. Use of a vehicle currency grea
tly reduces the number of exchange rates that must be dealt with in a multilater
al system. In a system of 10 currencies, if one currency is selected as the vehi
cle currency and used for all transactions, there would be a total of nine curre
ncy pairs or exchange rates to be dealt with (i.e. one exchange rate for the veh
icle currency against each of the others), whereas if no vehicle currency were u
sed, there would be 45 exchange rates to be dealt with. In a system of 100 curre
ncies with no vehicle currencies, potentially there would be 4,950 currency pair
s or exchange rates [the formula is: n(n-1)/2]. Thus, using a vehicle currency c
an yield the advantages of fewer, larger, and more liquid markets with fewer cur
rency balances, reduced informational needs, and simpler operations. The US Doll
ar took on a major vehicle currency role with the introduction of the Bretton Wo
ods par value system, in which most nations met their IMF exchange rate obligati
ons by buying and selling US Dollars to maintain a par value relationship for th
eir own currency against the US Dollar. The US Dollar was a convenient vehicle b
ecause of its central role in the exchange rate system and its widespread use as
a reserve currency. The US Dollar’s vehicle currency role was also due to the p
resence of large and liquid US Dollar money and other financial markets, and, in
time, the Euro-US Dollar markets, where the US Dollars needed for (or resulting
from) foreign exchange transactions could conveniently be borrowed (or placed).
Other Major Currencies include: The Euro Like the US Dollar, the Euro has a str
ong 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 mo
st traded currency in the world. It has a much smaller international presence th
an the US Dollar or the Euro. The Yen is very liquid around the world, practical
ly around the clock.
9
The British Pound Until the end of World War II, the Pound was the currency of r
eference. The nickname Cable is derived from the telegrams used to update the GB
P/USD rates across the Atlantic. The currency is heavily traded against the Euro
and the US Dollar, but it has a spotty presence against other currencies. The t
wo-year bout with the Exchange Rate Mechanism, between 1990 and 1992, had a soot
hing effect on the British Pound, as it generally had to follow the Deutsche Mar
k s fluctuations, but the crisis conditions that precipitated the pound s withdr
awal from the Exchange Rate Mechanism had a psychological effect on the currency
. The Swiss Franc The Swiss Franc is the only currency of a major European count
ry that belongs neither to the European Monetary Union nor to the G-7 countries.
Although the Swiss economy is relatively small, the Swiss Franc is one of the m
ajor currencies, closely resembling the strength and quality of the Swiss econom
y and finance. Switzerland has a very close economic relationship with Germany,
and thus to the Euro zone. Typically, it is believed that the Swiss Franc is a s
table currency. Actually, from a foreign exchange point of view, the Swiss Franc
closely resembles the patterns of the Euro, but lacks its liquidity. Currency T
able The Currency Table is a a user-friendly table that provides information on
currency movements.
USD USD EUR GBP JPY 1 1.339 1.509 0.0101
EUR GBP JPY 0.7468 0.6627 99.19 1 0.8869 132.66 1.1275 1 149.53 0.0075 0.0067 1
1.4
OVERVIEW OF INTERNATIONAL CURRENCY MARKETS
During the past quarter century, the concept of a 24-hour market has become a re
ality. Somewhere on the planet, financial centres are open for business; banks a
nd other institutions are trading the US Dollar and other currencies every hour
of the day and night, except on weekends. In financial centres around the world,
business hours overlap; as some centres close, others open and begin to trade.
The foreign exchange market follows the sun around the earth. Business is heavy
when both the US markets and the major European markets are open -that is, when
it is morning in New York and afternoon in London. In the New York market, nearl
y two-thirds of the day’s activity typically takes place in the morning hours. A
ctivity normally becomes very slow in New York in the mid-to late afternoon, aft
er European markets have closed and before the Tokyo, Hong Kong, and Singapore m
arkets have opened. Given this uneven flow of business around the clock, market
participants often will respond less aggressively to an exchange rate developmen
t that occurs at a relatively inactive time of day, and will wait to see whether
the development is confirmed when the major markets open. Some institutions pay
little attention to developments in less active markets. Nonetheless, the 24-ho
ur market does provide a continuous “real-time” market
10
assessment of the ebb and flow of influences and attitudes with respect to the t
raded currencies, and an opportunity for a quick judgment of unexpected events.
With many traders carrying pocket monitors, it has become relatively easy to sta
y in touch with market developments at all times. The market consists of a limit
ed number of major dealer institutions that are particularly active in foreign e
xchange, trading with customers and (more often) with each other. Most of these
institutions, but not all, are commercial banks and investment banks. These inst
itutions are geographically dispersed, located in numerous financial centres aro
und the world. Wherever they are located, these institutions are in close commun
ication with each other; linked to each other through telephones, computers, and
other electronic means. Each nation’s market has its own infrastructure. For fo
reign exchange market operations as well as for other connected matters, each co
untry enforces its own laws, banking regulations, accounting rules, taxation and
operates its own payment and settlement systems. Thus, even in a global foreign
exchange market with currencies traded on essentially the same terms simultaneo
usly in many financial centres, there are different national financial systems a
nd infrastructures through which transactions are executed, and within which cur
rencies are held. With access to all of the foreign exchange markets generally o
pen to participants from all countries, and with vast amounts of market informat
ion transmitted simultaneously and almost instantly to dealers throughout the wo
rld, there is an enormous amount of cross-border foreign exchange trading among
dealers as well as between dealers and their customers. At any moment, the excha
nge rates of major currencies tend to be virtually identical in all the financia
l centres where there is active trading. Rarely are there such substantial price
differences among major centres as to provide major opportunities for arbitrage
. In pricing, the various financial centres that are open for business and activ
e at any one time are effectively integrated into a single market.
1.5
ECONOMIC VARIABLES IMPACTING EXCHANGE RATE MOVEMENTS
Various economic variables impact the movement in exchange rates. Interest rates
, inflation figures, GDP are the main variables; however other economic indicato
rs that provide direction regarding the state of the economy also have a signifi
cant impact on the movement of a currency. These would include employment report
s, balance of payment figures, manufacturing indices, consumer prices and retail
sales amongst others. Indicators which suggest that the economy is strengthenin
g are positively correlated with a strong currency and would result in the curre
ncy strengthening and vice versa. Currency trader should be aware of government
policies and the central bank stance as indicated by them from time to time, eit
her by policy action or market intervention. Government structures its policies
in a manner such that its long term objectives on employment and growth are met.
In trying to achieve these objectives, it sometimes has to work around the econ
omic variables and hence policy directives and the economic variables are entwin
ed and have an impact on exchange rate movements. For instance, if the governmen
t wants to stimulate growth, one of the measures it could take would be cutting
interest rates and if such a measure is seen to bear expected results then the m
arket would react positively and its impact would also be seen in the strengthen
ing of the home currency. Inflation and interest rates are opposites. In order t
o reduce inflation, which reduces the purchasing power of money, often the polic
y of high interest rate is followed but such a policy hinders growth therefore a
policy to balance inflation and interest rates is considered ideal and the perc
eption of the success of such a policy by the participants in the foreign exchan
ge market will impact the movement and direction of the currency.
11
CHAPTER 2
2.1
FOREIGN EXCHANGE DERIVATIVES
DERIVATIVES - DEFINITION
Derivative is a product whose value is derived from the value of one or more bas
ic variables, called bases (underlying asset, index, or reference rate), in a co
ntractual manner. The underlying asset can be equity, foreign exchange, commodit
y or any other asset. For example, wheat farmers may wish to sell their harvest
at a future date to eliminate the risk of a change in prices by that date. Such
a transaction is an example of a derivative. The price of this derivative is dri
ven by the spot price of wheat which is the "underlying". In the Indian context
the Securities Contracts (Regulation) Act, 1956 [SC(R)A] defines "derivative" to
include1. 2. A security derived from a debt instrument, share, loan whether sec
ured or unsecured, risk instrument or contract for differences or any other form
of security. A contract which derives its value from the prices, or index of pr
ices, of underlying securities.
Derivatives are securities under the SC(R)A and hence the trading of derivatives
is governed by the regulatory framework under the SC(R)A. The term derivative h
as also been defined in section 45U(a) of the RBI act as follows: An instrument,
to be settled at a future date, whose value is derived from change in interest
rate, foreign exchange rate, credit rating or credit index, price of securities
(also called “underlying”), or a combination of more than one of them and includ
es interest rate swaps, forward rate agreements, foreign currency swaps, foreign
currency-rupee swaps, foreign currency options, foreign currency-rupee options
or such other instruments as may be specified by the Bank from time to time. Der
ivative products initially emerged as hedging devices against fluctuations in co
mmodity prices, and commodity-linked derivatives remained the sole form of such
products for almost three hundred years. Financial derivatives came into spotlig
ht in the post-1970 period due to growing instability in the financial markets.
However, since their emergence, these products have become very popular and by 1
990s, they accounted for about two-thirds of total transactions in derivative pr
oducts. In recent years, the market for financial derivatives has grown tremendo
usly in terms of variety of instruments available, their complexity and also tur
nover. Box 2.1: Emergence of financial derivative products
2.2
DERIVATIVE PRODUCTS
Derivative contracts have several variants. The most common variants are forward
s, futures, options and swaps. We take a brief look at various derivatives contr
acts that have come to be used. Forwards: A forward contract is a customized con
tract between two parties, where settlement takes place on a specific date in th
e future at today s pre-agreed price. Futures: A futures contract is an agreemen
t between two parties to buy or sell an asset at a certain time in the future at
a certain price. Futures contracts are special types of forward contracts in th
e sense that they are standardized and are generally traded on an exchange. Opti
ons: Options are of two types - calls and puts. Calls give the buyer the right b
ut not the obligation to buy a given quantity of the underlying asset, at a give
n price on or before a given future date. Puts give the buyer the right, but not
the obligation to sell a given quantity of the underlying asset at a given pric
e on or before a given date.
13
Warrants: Options generally have tenors of upto one year; the majority of option
s traded on options exchanges have a maximum maturity of nine months. Longer-dat
ed options are called warrants and are generally traded over-the-counter (OTC).
LEAPS: The acronym LEAPS means Long Term Equity Anticipation Securities. These a
re options having a maturity of upto three years. Baskets: Basket options are op
tions on portfolios of underlying assets. The underlying asset is usually a movi
ng average of a basket of assets. Equity index option is a form of basket option
. Swaps: Swaps are agreements between two parties to exchange cash flows in the
future according to a prearranged formula. They can be regarded as portfolios of
forward contracts. The two commonly used swaps are: • • Interest rate swaps: Th
ese entail swapping only the interest related cash flows between the parties in
the same currency. Currency swaps: These entail swapping both principal and inte
rest between the parties, with the cash flows in one direction being in a differ
ent currency than those in the opposite direction.
Swaptions: Swaptions are options to buy or sell a swap that will become operativ
e at the expiry of the options. Thus a swaption is an option on a forward swap.
Rather than have calls and puts, the swaptions market has receiver swaptions and
payer swaptions. A receiver swaption is an option to receive fixed and pay floa
ting. A payer swaption is an option to pay fixed and receive floating.
2.3
GROWTH DRIVERS OF DERIVATIVES
Over the last three decades, the derivatives market has seen a phenomenal growth
. A large variety of derivative contracts have been launched at exchanges across
the world. Some of the factors driving the growth of financial derivatives are:
1. Increased volatility in asset prices in financial markets, 2. Increased inte
gration of national financial markets with the international financial markets,
3. Marked improvement in communication facilities and sharp decline in their cos
ts, 4. Development of more sophisticated risk management tools, providing a wide
r choice of risk management strategies, and 5. Innovations in the derivatives ma
rkets, which optimally combine the risks and returns over a large number of fina
ncial assets, leading to higher returns, reduced risk and lower transactions cos
ts as compared to individual financial assets.
2.4
MARKET PLAYERS
The following three broad categories of participants - hedgers, speculators, and
arbitrageurs - trade in the derivatives market. Hedgers face risk associated wi
th the price of an asset and they use futures or options markets to reduce or el
iminate this risk. Speculators wish to bet on future movements in the price of a
n asset. Futures and options contracts can give them an extra leverage; that is,
they can increase both the potential gains and potential losses in a speculativ
e venture. Arbitrageurs are in business to take advantage of a
14
discrepancy between prices in two different markets. If, for example, they see t
he futures price of an asset getting out of line with the cash price, they will
take offsetting positions in the two markets to lock in a profit.
2.5
KEY ECONOMIC FUNCTION OF DERIVATIVES
Despite the fear and criticism with which the derivative markets are commonly lo
oked at, these markets perform a number of economic functions. 1. Prices in an o
rganized derivatives market reflect the perception of market participants about
the future and lead the prices of underlying to the perceived future level. The
prices of derivatives converge with the prices of the underlying at the expirati
on of the derivative contract. Thus derivatives help in discovery of future pric
es. 2. The derivatives market helps to transfer risks from those who have them b
ut may not like them to those who have an appetite for risks. 3. Derivatives, du
e to their inherent nature, are linked to the underlying cash markets. With the
introduction of derivatives, the underlying market witnesses higher trading volu
mes because of participation by more players who would not otherwise participate
for lack of an arrangement to transfer risk. 4. Speculative trades shift to a m
ore controlled environment of derivatives market. In the absence of an organized
derivatives market, speculators trade in the underlying cash markets. Margining
, monitoring and surveillance of the activities of various participants become e
xtremely difficult in these types of mixed markets. Early forward contracts in t
he US addressed merchants concerns about ensuring that there were buyers and se
llers for commodities. However credit risk" remained a serious problem. To deal
with this problem, a group of Chicago businessmen formed the Chicago Board of T
rade (CBOT) in 1848. The primary intention of the CBOT was to provide a centrali
zed location known in advance for buyers and sellers to negotiate forward contra
cts. In 1865, the CBOT went one step further and listed the first exchange trad
ed" derivatives contract in the US, these contracts were called futures contrac
ts". In 1919, Chicago Butter and Egg Board, a spin-off of CBOT, was reorganized
to allow futures trading. Its name was changed to Chicago Mercantile Exchange (C
ME). The CBOT and the CME were, until recently the two largest organized futures
exchanges, which have merged to become the “CME Group”. The first stock index f
utures contract was traded at Kansas City Board of Trade. Currently the most pop
ular stock index futures contract in the world is based on S&P 500 index, traded
on Chicago Mercantile Exchange. During the mid eighties, financial futures beca
me the most active derivative instruments generating volumes many times more tha
n the commodity futures. Index futures, futures on T-bills and Euro-Dollar futur
es are the three most popular futures contracts traded today. Other popular inte
rnational exchanges that trade derivatives are LIFFE in England, DTB in Germany,
SGX in Singapore, TIFFE in Japan, MATIF in France, Eurex etc. Box 2.2: History
of derivatives markets 5. An important incidental benefit that flows from deriva
tives trading is that it acts as a catalyst for new entrepreneurial activity. Th
e derivatives have a history of attracting many bright, creative, well-educated
people with an entrepreneurial attitude. They often energize others to create ne
w businesses, new products and new employment opportunities, the benefits of whi
ch are immense. In a nut shell, derivatives markets help increase savings and in
vestment in the long run. Transfer of risk enables market participants to expand
their volume of activity.
15
2.6
EXCHANGE-TRADED VS. OVER –THE- COUNTER DERIVATIVES
Derivatives have probably been around for as long as people have been trading wi
th one another. Forward contracting dates back at least to the 12th century, and
may well have been around before then. Merchants entered into contracts with on
e another for future delivery of specified amount of commodities at specified pr
ice. A primary motivation for pre-arranging a buyer or seller for a stock of com
modities in early forward contracts was to lessen the possibility that large swi
ngs would inhibit marketing the commodity after a harvest. As the name suggests,
derivatives that trade on an exchange are called exchange traded derivatives, w
hereas privately negotiated derivative contracts are called OTC derivatives. The
OTC derivatives markets have witnessed rather sharp growth over the last few ye
ars which have accompanied the modernization of commercial and investment bankin
g and globalisation of financial activities. The recent developments in informat
ion technology have contributed to a great extent to these developments. While b
oth exchange-traded and OTC derivative contracts offer many benefits, the former
have rigid structures compared to the latter. The OTC derivatives markets have
the following features compared to exchange-traded derivatives: 1) The managemen
t of counter-party (credit) risk is decentralized and located within individual
institutions, 2) There are no formal centralized limits on individual positions,
leverage, or margining; limits are determined as credit lines by each of the co
unterparties entering into these contracts 3) There are no formal rules for risk
and burden-sharing, 4) There are no formal rules or mechanisms for ensuring mar
ket stability and integrity, and for safeguarding the collective interests of ma
rket participants, and 5) Although OTC contracts are affected indirectly by nati
onal legal systems, banking supervision and market surveillance, they are genera
lly not regulated by a regulatory authority. Some of the features of OTC derivat
ives markets embody risks to financial market stability. The following features
of OTC derivatives markets can give rise to instability in institutions, markets
, and the international financial system: (i) (ii) (iii) (iv) (v) the dynamic na
ture of gross credit exposures; information asymmetries; the effects of OTC deri
vative activities on available aggregate credit; the high concentration of OTC d
erivative activities in major institutions; and the central role of OTC derivati
ves markets in the global financial system.
Instability arises when shocks, such as counter-party credit events and sharp mo
vements in asset prices that underlie derivative contracts occur, which signific
antly alter the perceptions of current and potential future credit exposures. Wh
en asset prices change rapidly, the size and configuration of counter-party expo
sures can become unsustainably large and provoke a rapid unwinding of positions.
There has been some progress in addressing these risks and perceptions. However
, the progress has been limited in implementing reforms in risk management, incl
uding counter-party, liquidity and operational risks, and OTC derivatives market
s continue to pose a threat to international financial stability. The problem is
more
16
acute as heavy reliance on OTC derivatives creates the possibility of systemic f
inancial events, which fall outside the more formal clearing corporation structu
res.
17
CHAPTER 3 EXCHANGE TRADED CURRENCY FUTURES
3.1 CURRENCY FUTURES -DEFINITION
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. When the underlying asset is a commodity, e.g. Oil or Wh
eat, the contract is termed a “commodity futures contract”. When the underlying
is an exchange rate, the contract is termed a “currency futures contract”. In ot
her words, it is a contract to exchange one currency for another currency at a s
pecified date and a specified rate in the future. Therefore, the buyer and the s
eller lock themselves into an exchange rate for a specific value and delivery da
te. Both parties of the futures contract must fulfill their obligations on the s
ettlement date. Internationally, currency futures can be cash settled or settled
by delivering the respective obligation of the seller and buyer. All settlement
s, however, unlike in the case of OTC markets, go through the exchange. Currency
futures are a linear product, and calculating profits or losses on Currency Fut
ures will be similar to calculating profits or losses on Index futures. In deter
mining profits and losses in futures trading, it is essential to know both the c
ontract size (the number of currency units being traded) and also what the “tick
” value is. A tick is the minimum trading increment or price differential at whi
ch traders are able to enter bids and offers. Tick values differ for different c
urrency pairs and different underlyings. For e.g. in the case of the USD-INR cur
rency futures contract the tick size shall be 0.25 paise or 0.0025 Rupee. To dem
onstrate how a move of one tick affects the price, imagine a trader buys a contr
act (USD 1000 being the value of each contract) at Rs. 42.2500. One tick move on
this contract will translate to Rs.42.2475 or Rs.42.2525 depending on the direc
tion of market movement. Purchase price: Price increases by one tick: New price:
Purchase price: Price decreases by one tick: New price: Rs.42.2500 +Rs.00.0025
Rs.42.2525 Rs.42.2500 –Rs.00.0025 Rs.42.2475
The value of one tick on each contract is Rupees 2.50 (1000X 0.0025). So if a tr
ader buys 5 contracts and the price moves up by 4 ticks, he makes Rupees 50.00 S
tep 1: 42.2600 – 42.2500 Step 2: 4 ticks * 5 contracts = 20 points Step 3: 20 po
ints * Rupees 2.5 per tick = Rupees 50.00 (Note: The above examples do not inclu
de transaction fees and any other fees, which are essential for calculating fina
l profit and loss)
19
3.2
• • •
FUTURES TERMINOLOGY
Spot price: The price at which an asset trades in the spot market. In the case o
f USD/INR, spot value is T + 2. Futures price: The price at which the futures co
ntract trades in the futures market. Contract cycle: The period over which a con
tract trades. The currency futures contracts on the SEBI recognized exchanges ha
ve one-month, two-month, and three-month up to twelve-month expiry cycles. Hence
, these exchanges will have 12 contracts outstanding at any given point in time.
Value Date/Final Settlement Date: The last business day of the month will be te
rmed the Value date / Final Settlement date of each contract. The last business
day would be taken to the same as that for Inter-bank Settlements in Mumbai. The
rules for Inter-bank Settlements, including those for ‘known holidays’ and ‘sub
sequently declared holiday’ would be those as laid down by Foreign Exchange Deal
ers’ Association of India (FEDAI). Expiry date: It is the date specified in the
futures contract. This is the last day on which the contract will be traded, at
the end of which it will cease to exist. The last trading day will be two busine
ss days prior to the Value date / Final Settlement Date. Contract size: The amou
nt of asset that has to be delivered under one contract. Also called as lot size
. In the case of USD/INR it is USD 1000. Basis: In the context of financial futu
res, basis can be defined as the futures price minus the spot price. There will
be a different basis for each delivery month for each contract. In a normal mark
et, basis will be positive. This reflects that futures prices normally exceed sp
ot prices. Cost of carry: The relationship between futures prices and spot price
s can be summarized in terms of what is known as the cost of carry. This measure
s (in commodity markets) the storage cost plus the interest that is paid to fina
nce or ‘carry’ the asset till delivery less the income earned on the asset. For
equity derivatives carry cost is the rate of interest. Initial margin: The amoun
t that must be deposited in the margin account at the time a futures contract is
first entered into is known as initial margin. Marking-to-market: In the future
s market, at the end of each trading day, the margin account is adjusted to refl
ect the investor s gain or loss depending upon the futures closing price. This i
s called marking-to-market.
•
•
• •
•
• •
3.3
RATIONALE BEHIND CURRENCY FUTURES
Futures markets were designed to address certain problems that exist in forward
markets. A futures contract is an agreement between two parties to buy or sell a
n asset at a certain time in the future at a certain price. But unlike forward c
ontracts, the futures contracts are standardized and exchange traded. To facilit
ate liquidity in the futures contracts, the exchange specifies certain standard
features of the contract. A futures contract is standardized contract with stand
ard underlying instrument, a standard quantity of the underlying instrument that
can be delivered, (or which can be used for reference purposes in settlement) a
nd a standard timing of such settlement. A futures contract may be offset prior
to maturity by entering into an equal and opposite transaction.
20
The standardized items in a futures contract are: • Quantity of the underlying •
The date and the month of delivery • The units of price quotation and minimum p
rice change • Location of settlement The rationale for introducing currency futu
res in the Indian context has been outlined in the Report of the Internal Workin
g Group on Currency Futures (Reserve Bank of India, April 2008) as follows; “The
rationale for establishing the currency futures market is manifold. Both reside
nts and non-residents purchase domestic currency assets. If the exchange rate re
mains unchanged from the time of purchase of the asset to its sale, no gains and
losses are made out of currency exposures. But if domestic currency depreciates
(appreciates) against the foreign currency, the exposure would result in gain (
loss) for residents purchasing foreign assets and loss (gain) for non residents
purchasing domestic assets. In this backdrop, unpredicted movements in exchange
rates expose investors to currency risks. Currency futures enable them to hedge
these risks. Nominal exchange rates are often random walks with or without drift
, while real exchange rates over long run are mean reverting. As such, it is pos
sible that over a long – run, the incentive to hedge currency risk may not be la
rge. However, financial planning horizon is much smaller than the long-run, whic
h is typically inter-generational in the context of exchange rates. Per se, ther
e is a strong need to hedge currency risk and this need has grown manifold with
fast growth in cross-border trade and investments flows. The argument for hedgin
g currency risks appear to be natural in case of assets, and applies equally to
trade in goods and services, which results in income flows with leads and lags a
nd get converted into different currencies at the market rates. Empirically, cha
nges in exchange rate are found to have very low correlations with foreign equit
y and bond returns. This in theory should lower portfolio risk. Therefore, somet
imes argument is advanced against the need for hedging currency risks. But there
is strong empirical evidence to suggest that hedging reduces the volatility of
returns and indeed considering the episodic nature of currency returns, there ar
e strong arguments to use instruments to hedge currency risks. Currency risks co
uld be hedged mainly through forwards, futures, swaps and options. Each of these
instruments has its role in managing the currency risk. The main advantage of c
urrency futures over its closest substitute product, viz. forwards which are tra
ded over the counter lies in price transparency, elimination of counterparty cre
dit risk and greater reach in terms of easy accessibility to all. Currency futur
es are expected to bring about better price discovery and also possibly lower tr
ansaction costs. Apart from pure hedgers, currency futures also invite arbitrage
urs, speculators and those traders who may take a bet on exchange rate movements
without an underlying or an economic exposure as a motivation for trading. From
an economy-wide perspective, currency futures contribute to hedging of risks an
d help traders and investors in undertaking their economic activity. There is a
large body of empirical evidence which suggests that exchange rate volatility ha
s an adverse impact on foreign trade. Since there are first order gains from tra
de which contribute to output growth and consumer welfare, currency futures can
potentially have an important impact on real economy. Gains from international r
isk sharing through trade in assets could be of relatively smaller magnitude tha
n gains from trade. However, in a dynamic setting these investments could still
significantly impact capital formation in an economy and as such currency future
s could be seen as a facilitator in promoting investment and aggregate demand in
the economy, thus promoting growth”.
21
The Chicago Mercantile Exchange (CME) created FX futures, the first ever financi
al futures contracts, in 1972. The contracts were created under the guidance and
leadership of Leo Melamed, CME Chairman Emeritus. The FX contract capitalized o
n the U.S. abandonment of the Bretton Woods agreement, which had fixed world exc
hange rates to a gold standard after World War II. The abandonment of the Bretto
n Woods agreement resulted in currency values being allowed to float, increasing
the risk of doing business. By creating another type of market in which futures
could be traded, CME currency futures extended the reach of risk management bey
ond commodities, which were the main derivative contracts traded at CME until th
en. The concept of currency futures at CME was revolutionary, and gained credibi
lity through endorsement of Nobel-prize-winning economist Milton Friedman. Today
, CME offers 41 individual FX futures and 31 options contracts on 19 currencies,
all of which trade electronically on the exchange’s CME Globex platform. It is
the largest regulated marketplace for FX trading. Traders of CME FX futures are
a diverse group that includes multinational corporations, hedge funds, commercia
l banks, investment banks, financial managers, commodity trading advisors (CTAs)
, proprietary trading firms, currency overlay managers and individual investors.
They trade in order to transact business, hedge against unfavourable changes in
currency rates, or to speculate on rate fluctuations. Box 3.1: Emergence and gr
owth of FX futures
3.4
DISTINCTION BETWEEN FUTURES AND FORWARD CONTRACTS
Forward contracts are often confused with futures contracts. The confusion is pr
imarily because both serve essentially the same economic functions of allocating
risk in the probability of future price uncertainty. However futures have some
distinct advantages over forward contracts as they eliminate counterparty risk a
nd offer more liquidity and price transparency. However, it should be noted that
forwards enjoy the benefit of being customized to meet specific client requirem
ents. The advantages and limitations of futures contracts are as follows; Advant
ages of Futures: Transparency and efficient price discovery. The market brings t
ogether divergent categories of buyers and sellers. Elimination of Counterparty
credit risk. Access to all types of market participants. (Currently, in the Fore
ign Exchange OTC markets one side of the transaction has to compulsorily be an A
uthorized Dealer – i.e. Bank). Standardized products. Transparent trading platfo
rm.
Limitations of Futures: The benefit of standardization which often leads to impr
oving liquidity in futures, works against this product when a client needs to he
dge a specific amount to a date for which there is no standard contract While ma
rgining and daily settlement is a prudent risk management policy, some clients m
ay prefer not to incur this cost in favor of OTC forwards, where collateral is u
sually not demanded
-
22
3.5
INTEREST RATE PARITY AND PRICING OF CURRENCY FUTURES
For currencies which are fully convertible, the rate of exchange for any date ot
her than spot, is a function of spot and the relative interest rates in each cur
rency. The assumption is that, any funds held will be invested in a time deposit
of that currency. Hence, the forward rate is the rate which neutralizes the eff
ect of differences in the interest rates in both the currencies. In the context
of currencies, like USD/INR which are not fully convertible, forwards and future
s prices can be influenced by several factors including regulations that are in
place at any given point in time. The forward rate is a function of the spot rat
e and the interest rate differential between the two currencies, adjusted for ti
me. A futures contract is a standardized forward contract traded through an exch
ange to eliminate counterparty risk.
In order to derive the forward rate from the spot rate, there are three commonly
used formulae which give similar results, viz.
a. Term : Base Formula b. Spot-Forward r& p Formula c. Continuous Compounding Fo
rmula
a. Term : Base Formula Forward Rate = Spot + Points
Points = Spot 1 + terms i * days basis 1 + base i * days basis
_1
Where: i = rate of interest basis = day count basis (Most currencies use a 360-d
ay basis, except the pound sterling and a few others, which use a 365-day year.)
b. Spot-Forward r& p Formula
The spot exchange rate is S0. This quote is in USD per INR. The US risk-free int
erest rate is p, and the holding period is T. You take S0(1+ p)-T INR and buy (1
+ p)-T dollars. Simultaneously, you sell one future contract expiring at time T.
The future exchange rate is F0, which is also in INR per dollar. You take your
(1+ p)-T dollars and invest them in US T-bills that have a return of p.
When the forward contract expires, you will have 1 dollar. This is because your
(1+ ρ)-T dolla
s will have g
own by the facto
(1+ p)T the
efo
e (1+ p)-T (1+ p)
T = 1. You
fo
wa
d cont
act obligates you to delive
the dolla
, fo

23
which you
eceive F(0,T) INR. In effect, you have invested S0(1+ p)-T and
eceiv
ed F(0,T) INR. Since the t
ansaction is
iskless, you

etu
n should be the INR

ate,
; the
efo
e:

F(0,T) = S0(1+
) T/ (1+p) T

C. Continuous Compounding Fo
mula
F(0,T) = S0e(
-p)T
Illust
ation: Conside
the following example f
om an Indian pe
spective. On Janu
a
y 31 of a pa
ticula
yea
, the spot USD/INR
ate was 43.50. The US inte
est
a
te was 3 pe
cent, while the Indian inte
est
ate was 6 pe
cent. The time to expi

ation was 90/360 = 0.25. This can be solved using th
ee diffe
ent fo
mulae as i
llust
ated below:
(a) Te
ms:Base Fo
mula
(b) Spot Fo
wa
d
& p (c) Continuous Fo
mula Compounding Fo
mula F(0,T) = S0(1+

) (1+p) T
_1
T/
Fo
wa
d Rate = Spot + Points
Points = Spot 1 + te
ms i * days basis 1 + base i * days basis
F(0,T) = S0e(
-p)T
Points = 43.5 {[(1+.06*.25)/(1+.03*.25)]-1} = 0.3238 Fo
wa
d Rate = 43.5 + (.323
8) = 43.8238
F = 43.5 * [(1+.06)^.25] F = 43.5 * e [(.06-.03) * / [(1+.03)^.25] .25]
Ans: 43.8238
Ans: 43.8133
Ans: 43.8275
The te
m ‘e’ is a well-known mathematical exp
ession to simplify a la
ge
exp
es
sion: (1+
/∞)∞ which signifies continuous compounding on a given inte
est
ate.
The best app
oximation of e is 2.71828183.
24
As can be noticed f
om the above table, the th
ee fo
mulae give
esults which a

e simila
but not identical. Any of these fo
mulae can be used fo
decision maki
ng. Howeve
, f
om a t
ading pe
spective, g
eate
levels of accu
acy may be desi

ed. Hence, t
ade
s p
efe
the Continuous Compounding fo
mula.
25
CHAPTER 4 STRATEGIES USING CURRENCY FUTURES
4.1 SPECULATION IN FUTURES MARKETS
Speculato
s play a vital
ole in the futu
es ma
kets. Futu
es a
e designed p
ima

ily to assist hedge
s in managing thei
exposu
e to p
ice
isk; howeve
, this w
ould not be possible without the pa
ticipation of speculato
s. Speculato
s, o
t

ade
s, assume the p
ice
isk that hedge
s attempt to lay off in the ma
kets. In
othe
wo
ds, hedge
s often depend on speculato
s to take the othe
side of thei

t
ades ( i.e. act as counte
pa
ty) and to add depth and liquidity to the ma
k
ets that a
e vital fo
the functioning of a futu
es ma
ket. The speculato
s the

efo
e have a big hand in making the ma
ket. Speculation is not simila
to manipu
lation. A manipulato
t
ies to push p
ices in the
eve
se di
ection of the ma
ke
t equilib
ium while the speculato
fo
ecasts the movement in p
ices and this eff
o
t eventually b
ings the p
ices close
to the ma
ket equilib
ium. If the specul
ato
s do not adhe
e to the
elevant fundamental facto
s of the spot ma
ket, they
would not su
vive since thei
co

elation with the unde
lying spot ma
ket would
be nonexistent.
4.2
LONG POSITION IN FUTURES
Long position in a cu

ency futu
es cont
act without any exposu
e in the cash ma

ket is called a speculative position. Long position in futu
es fo
speculative
pu
pose means buying futu
es cont
act in anticipation of st
engthening of the ex
change
ate (which actually means buy the base cu

ency (USD) and sell the te
ms
cu

ency (INR) and you want the base cu

ency to
ise in value and then you wou
ld sell it back at a highe
p
ice). If the exchange
ate st
engthens befo
e the
expi
y of the cont
act then the t
ade
makes a p
ofit on squa
ing off the positi
on, and if the exchange
ate weakens then the t
ade
makes a loss.
Payoff – Long Position in Futu
es Long Futu
e Payoff
P
ofit
P
ofit
0
Time
Loss
Loss
The g
aph above depicts the pay-off of a long position in a futu
e cont
act, whi
ch does demonst
ate that the pay-off of a t
ade
is a linea
de
ivative, that is
, he makes unlimited p
ofit if the ma
ket moves as pe
his di
ectional view, and
if the ma
ket goes against, he has equal
isk of making unlimited losses if he
doesn’t choose to exit out his position.
27
Hypothetical Example – Long positions in futu
es On May 1, 2008, an active t
ade

in the cu

ency futu
es ma
ket expects INR will dep
eciate against USD caused
by India’s sha
ply
ising impo
t bill and poo
FII equity flows. On the basis of
his view about the USD/INR movement, he buys 1 USD/INR August cont
act at the p

evailing
ate of Rs. 40.5800. He decides to hold the cont
act till expi
y and d
u
ing the holding pe
iod USD/INR futu
es actually moves as pe
his anticipation
and the RBI Refe
ence
ate inc
eases to USD/INR 42.46 on May 30, 2008. He squa
e
s off his position and books a p
ofit of Rs. 1880 (42.4600x1000 - 40.5800x1000)
on 1 cont
act of USD/INR futu
es cont
act.
USDINR (May 1 - May 30, 2008) 43
Position Squa
edoff USDINR@42.46
USDINR
42
Long Position Initiated USDINR@40.58 USD St
engthen by 1.88.
41
40
May 1, ‘08
Time
May 30, ‘08
Obse
vation: The t
ade
has effectively analysed the ma
ket conditions and has t
aken a
ight call by going long on futu
es and thus has made a gain of Rs. 1,880
.
4.3
SHORT POSITION IN FUTURES
Sho
t position in a cu

ency futu
es cont
act without any exposu
e in the cash m
a
ket is called a speculative t
ansaction. Sho
t position in futu
es fo
specula
tive pu
poses means selling a futu
es cont
act in anticipation of decline in the
exchange
ate (which actually means sell the base cu

ency (USD) and buy the te

ms cu

ency (INR) and you want the base cu

ency to fall in value and then you
would buy it back at a lowe
p
ice). If the exchange
ate weakens befo
e the exp
i
y of the cont
act, then the t
ade
makes a p
ofit on squa
ing off the position
, and if the exchange
ate st
engthens then the t
ade
makes loss. The g
aph abo
ve depicts the pay-off of a sho
t position in a futu
e cont
act which does exhib
it that the pay-off of a sho
t t
ade
is a linea
de
ivative, that is, he makes
unlimited p
ofit if the ma
ket moves as pe
his di
ectional view and if the ma
k
et goes against his view he has equal
isk of making unlimited loss if he doesn’
t choose to exit out his position.
28
Example – Sho
t positions in futu
es On August 1, 2008, an active t
ade
in the
cu

ency futu
es ma
ket expects INR will app
eciate against USD, caused by softe
ning of c
ude oil p
ices in the inte
national ma
ket and hence imp
oving India’s
t
ade balance. On the basis of his view about the USD/INR movement, he sells 1
USD/INR August cont
act at the p
evailing
ate of Rs. 42.3600. On August 6, 2008
, USD/INR August futu
es cont
act actually moves as pe
his anticipation and dec
lines to 41.9975. He decides to squa
e off his position and ea
ns a p
ofit of Rs
. 362.50 (42.3600x1000 – 41.9975x1000) on squa
ing off the sho
t position of 1 U
SD/INR August futu
es cont
act. Obse
vation: The t
ade
has effectively analysed
the ma
ket conditions and has taken a
ight call by going sho
t on futu
es and
thus has made a gain of Rs. 362.50 pe
cont
act with small investment (a ma
gin
of 3%, which comes to Rs. 1270.80) in a span of 6 days.
4.4
HEDGING USING CURRENCY FUTURES
Hedging: Hedging means taking a position in the futu
e ma
ket that is opposite t
o a position in the physical ma
ket with a view to
educe o
limit
isk associat
ed with unp
edictable changes in exchange
ate. A hedge
has an Ove
all Po
tfoli
o (OP) composed of (at least) 2 positions: 1. Unde
lying position 2. Hedging pos
ition with negative co

elation with unde
lying position Value of OP = Unde
lyin
g position + Hedging position; and in case of a Pe
fect hedge, the Value of the
OP is insensitive to exchange
ate (FX) changes. Types of FX Hedge
s using Futu

es Long hedge: • Unde
lying position: sho
t in the fo
eign cu

ency • Hedging po
sition: long in cu

ency futu
es Sho
t hedge: • Unde
lying position: long in the
fo
eign cu

ency • Hedging position: sho
t in cu

ency futu
es The p
ope
size
of the Hedging position
• •
Basic App
oach: Equal hedge Mode
n App
oach: Optimal hedge
Equal hedge: In an Equal Hedge, the total value of the futu
es cont
acts involve
d is the same as the value of the spot ma
ket position. As an example, a US impo

te
who has an exposu
e of £ 1 million will go long on 16 cont
acts assuming a
face value of £62,500 pe
cont
act. The
efo
e in an equal hedge: Size of Unde
ly
ing position = Size of Hedging position. Optimal Hedge: An optimal hedge is one
whe
e the changes in the spot p
ices a
e negatively co

elated with the changes
in the futu
es p
ices and pe
fectly offset each othe
. This can gene
ally be des
c
ibed as an equal hedge, except when the spot-futu
e basis
elationship changes
. An Optimal Hedge is a hedging st
ategy which yields the highest level of utili
ty to the hedge
.
29
Co
po
ate Hedging Befo
e the int
oduction of cu

ency futu
es, a co
po
ate hedge

had only Ove
-the-Counte
(OTC) ma
ket as a platfo
m to hedge his cu

ency exp
osu
e; howeve
now he has an additional platfo
m whe
e he can compa
e between th
e two platfo
ms and acco
dingly decide whethe
he will hedge his exposu
e in the
OTC ma
ket o
on an exchange o
he will like to hedge his exposu
es pa
tially o
n both the platfo
ms. Example 1: Long Futu
es Hedge Exposed to the Risk of St
en
gthening USD Unhedged Exposu
e: Let’s say on Janua
y 1, 2008, an Indian impo
te

ente
s into a cont
act to impo
t 1,000 ba

els of oil with payment to be made i
n US Dolla
(USD) on July 1, 2008. The p
ice of each ba

el of oil has been fixe
d at USD 110/ba

el at the p
evailing exchange
ate of 1 USD = INR 39.41; the co
st of one ba

el of oil in INR wo
ks out to be Rs. 4335.10 (110 x 39.41). The im
po
te
has a
isk that the USD may st
engthen ove
the next six months causing t
he oil to cost mo
e in INR; howeve
, he decides not to hedge his position. On Ju
ly 1, 2008, the INR actually dep
eciates and now the exchange
ate stands at 1 U
SD = INR 43.23. In dolla
te
ms he has fixed his p
ice, that is USD 110/ba

el,
howeve
, to make payment in USD he has to conve
t the INR into USD on the given
date and now the exchange
ate stands at 1USD = INR43.23. The
efo
e, to make pay
ment fo
one dolla
, he has to shell out Rs. 43.23. Hence the same ba

el of oil
which was costing Rs. 4335.10 on Janua
y 1, 2008 will now cost him Rs. 4755.30,
which means 1 ba

el of oil ended up costing Rs. 4755.30 - Rs. 4335.10 = Rs. 42
0.20 mo
e and hence the 1000 ba

els of oil has become dea
e
by INR 4,20,200.
USDINR (Janua
y 1, 2008 to July 1, 2008)
43
Date of Payment USDINR @ 43.23
42
USDINR
USD app
eciated by Rs. 3.82 (Cu

ency Risk)
41 Exposu
e inititaion date USDINR @ 39.41 40
39
Jan 1’08
Time
July 1’08
When INR weakens, he makes a loss, and when INR st
engthens, he makes a p
ofit.
As the impo
te
cannot be su
e of futu
e exchange
ate developments, he has an e
nti
ely speculative position in the cash ma
ket, which can affect the value of h
is ope
ating cash flows, income statement, and competitive position, hence ma
ke
t sha
e and stock p
ice. Hedged: Let’s p
esume the same Indian Impo
te
p
e-empt
ed that the
e is good p
obability that INR will weaken against the USD given the
cu

ent mac
o economic fundamentals of inc
easing Cu

ent Account deficit and F
II outflows and decides to hedge his exposu
e on an exchange platfo
m using cu


ency futu
es. Since he is conce
ned that the value of USD will
ise he decides g
o long on cu

ency futu
es, it means he pu
chases a USD/INR futu
es cont
act. Th
is p
otects the impo
te
because st
engthening of USD would lead to
30
p
ofit in the long futu
es position, which would effectively ensu
e that his los
s in the physical ma
ket would be mitigated. The following figu
e and Exhibit ex
plain the mechanics of hedging using cu

ency futu
es.
• •
Is sho
t on USD 110000 in the spot ma
ket Is long (buys) 110 USD/INR futu
es con
t
acts
OIL IMPORTER
• •
Buys back (sells) USD/INR futu
es cont
acts to squa
e off t
ansaction Buys USD t
o meet impo
t
equi
ement in the spot ma
ket
Obse
vation: Following a 9.7%
ise in the spot p
ice fo
USD, the US dolla
s a
e
pu
chased at the new, highe
spot p
ice, but p
ofits on the hedge foste
an eff
ective exchange
ate equal to the o
iginal hedge p
ice.
31
Example 2: Sho
t Futu
es Hedge Exposed to the Risk of Weakening USD Unhedged Exp
osu
e: Let’s say on Ma
ch 1, 2008, an Indian
efine
ente
s into a cont
act to e
xpo
t 1000 ba

els of oil with payment to be
eceived in US Dolla
(USD) on June
1, 2008. The p
ice of each ba

el of oil has been fixed at USD 80/ba

el at the
p
evailing exchange
ate of 1 USD = INR 44.05; the p
ice of one ba

el of oil i
n INR wo
ks out to be is Rs. 3524 (80 x 44.05). The
efine
has a
isk that the
INR may st
engthen ove
the next th
ee months causing the oil to cost less in IN
R; howeve
he decides not to hedge his position. On June 1, 2008, the INR actual
ly app
eciates against the USD and now the exchange
ate stands at 1 USD = INR 4
0.30. In dolla
te
ms he has fixed his p
ice, that is USD 80/ba

el; howeve
, th
e dolla
that he
eceives has to be conve
ted in INR on the given date and the e
xchange
ate stands at 1USD = INR40.30. The
efo
e, eve
y dolla
that he
eceives
is wo
th Rs. 40.30 as against Rs. 44.05. Hence the same ba

el of oil that init
ially would have ga
ne
ed him Rs. 3524 (80 x 44.05) will now
ealize Rs. 3224, w
hich means 1 ba

el of oil ended up selling Rs. 3524 – Rs. 3224 = Rs. 300 less a
nd hence the 1000 ba

els of oil has become cheape
by INR 3,00,000.
USDINR (Ma
1 - June 1, 2008) 45 Exposu
e inititaion date USDINR @ 44.05
44
USDINR
43
42
USD dep
eciated by Rs. 3.75 (Cu

ency Risk) Date of Payment USDINR @ 40.30
41
40
Ma
1, ‘08
Time
June 1, ‘08
When INR st
engthens, he makes a loss and when INR weakens, he makes a p
ofit. A
s the
efine
cannot be su
e of futu
e exchange
ate developments, he has an ent
i
ely speculative position in the cash ma
ket, which can affect the value of his
ope
ating cash flows, income statement, and competitive position, hence ma
ket
sha
e and stock p
ice. Hedged: Let’s p
esume the same Indian
efine
p
e-empted
that the
e is good p
obability that INR will st
engthen against the USD given th
e cu

ent mac
oeconomic fundamentals of
educing fiscal deficit, stable cu

ent
account deficit and st
ong FII inflows and decides to hedge his exposu
e on an e
xchange platfo
m using cu

ency futu
es. Since he is conce
ned that the value of
USD will fall he decides go sho
t on cu

ency futu
es, it means he sells a USD/
INR futu
e cont
act. This p
otects the impo
te
because weakening of USD would l
ead to p
ofit in the sho
t futu
es position, which would effectively ensu
e that
his loss in the physical ma
ket would be mitigated. The following figu
e and ex
hibit explain the mechanics of hedging using cu

ency futu
es.
32
• •
Is long on USD 80000 in the Spot ma
ket Is sho
t (sells) 80 USD/INR futu
es cont

acts

OIL REFINER
• •
Buys back USD/INR futu
es cont
acts to squa
e off t
ansaction Buys USD to meet i
mpo
t
equi
ement in the spot ma
ket
Obse
vation: Following an 8.51% fall in the spot p
ice fo
USD, the US dolla
s a

e sold at the new, lowe
spot p
ice; but p
ofits on the hedge foste
an effecti
ve exchange
ate equal to the o
iginal hedge p
ice.
33
Example 3 (Va
iation of Example 1): Long Futu
es Hedge Exposed to the Risk of Co
nt
act Expi
y and Liquidation on the Same Day
Initiation of hedge T
ansaction date Spot value date Futu
es delive
y date Spot
p
ice($/FX) Futu
es p
ice Results INR paid fo
USD 110000 on June 30: INR 43.72
x 110000 = INR 4809200 Hedge
esult: USD 110000 x (Rs. 43.72 - 39.90) = INR 4202
00 Effective exchange
ate = (INR 4809200 - INR 420200)/110000 = 39.90 1-Jan 3-J
an 17-Jun 39.41 39.90 Liquidation of hedge 28-Jun 30-Jun 30-Jun 43.72 43.72
Obse
vation: The size of the exposu
e is USD 110000 and the desi
ed value date i
s p
ecisely the same as the futu
es delive
y date (June 30). Following a 9.5%
i
se in the spot p
ice fo
USD against INR, the US dolla
s a
e pu
chased at the ne
w, highe
spot p
ice; but p
ofits on the hedge foste
an effective exchange
ate
equal to the o
iginal futu
es p
ice because on the date of expi
y the spot p
ic
e and the futu
e p
ice tend to conve
ge. Example 4: Retail Hedging – Long Futu
e
s Hedge Exposed to the Risk of a st
onge
USD On 1st Ma
ch 2008, a student decid
es to en
oll fo
CMT-USA Octobe
2008 exam fo
which he needs to make a payment
of USD 1,000 on 15th Septembe
, 2008. On 1st Ma
ch, 2008 USD/INR
ate of 40.26,
the p
ice of en
olment in INR wo
ks out to be Rs. 40,260. The student has the
i
sk that the USD may st
engthen ove
the next six months causing the en
olment to
cost mo
e in INR hence decides to hedge his exposu
e on an exchange platfo
m us
ing cu

ency futu
es. Since he is conce
ned that the value of USD will
ise, he
decides go long on cu

ency futu
es; it means he pu
chases a USD/INR futu
es con
t
act. This p
otects the student because st
engthening of USD would lead to p
of
it in the long futu
es position, which would effectively ensu
e that his loss in
the physical ma
ket would be mitigated. The following figu
e and Exhibit explai
n the mechanics of hedging using cu

ency futu
es.
34
Obse
vation: Following a 14.25%
ise in the spot p
ice fo
USD (against INR), th
e US dolla
s a
e bought at the new, highe
spot p
ice; but p
ofits on the hedge
foste
an effective exchange
ate equal to the o
iginal hedge p
ice. Example 5:
Retail Hedging – Remove Fo
ex Risk while Investing Ab
oad Let’s say when USD/INR
at 44.20, an active stock ma
ket investo
decides to invest USD 200,000 fo
a p
e
iod of six months in the S&P 500 Index with a pe
spective that the ma
ket will
g
ow and his investment will fetch him a decent
etu
n. In Indian te
ms, the in
vestment is about Rs. 8,840,000. Let’s say that afte
six months, as pe
his ant
icipation, the ma
ket whe
ein he has invested has app
eciated by 10% and now his
investment of USD 200,000 stands at USD 220,000. Having ea
ned a decent
etu
n
the investo
decides to squa
e off all his positions and b
ing back his p
oceeds
to India. The cu

ent USD/INR exchange
ate stands at 40.75 and his investment
of USD 220,000 in Indian te
m stands at Rs. 8,965,000. Thus fetching him a meage


etu
n of 1.41% as compa
ed to
etu
n of 10% in USD, this is because du
ing th
e same pe
iod USD has dep
eciated by 7.81% against the INR and the
efo
e the poo


etu
n. Consequently, even afte
gauging the ove
seas stock ma
ket movement co


ectly he is not able to ea
n the desi
ed ove
seas
etu
n because he was not ab
le to captu
e and manage his cu

ency exposu
e. Let’s p
esume the same Indian in
vesto
p
e-empted that the
e is good p
obability that the USD will weaken given
the then ma
ket fundamentals and has decided to hedge his exposu
e on an exchang
e platfo
m using cu

ency futu
es. Since he was conce
ned that the value of USD
will fall he decides go sho
t on cu

ency futu
es, it means he sells a USD/INR f
utu
es cont
act. This p
otects the investo
because weakening of USD would lead
to p
ofit in
35
the sho
t futu
es position, which would effectively ensu
e that his loss in the
investment ab
oad would be mitigated. The following figu
e and Exhibit explain t
he mechanics of hedging using cu

ency futu
es.
Date
Spot Ma
ket Futu
es Ma
ket The cu

ent exchange
ate is INR 44.20 pe
USD, USDIN
R cont
act is at INR 44.50. P
ice pe
cont
act is INR 44,500 (44.50*1000). The t
he
efo
e the cu

ent investment of USD 200000 app
opa
iate numbe
of cont
act he
should sell is 8840000/44500 = 199. Sell 199 Cont
acts fo
in INR is Rs. 884000
0. 8855500.
Leg I
The spot
ate is 40.75. Receive 220000 USD fo
his Buy back 199 cont
act at the
p
evailing
ate of Leg II investmen. Revenues in Rupees: 220000(40.75) = INR 896
5000 Analysis: The investment ended up ga
ne
ing INR 9724000 - INR 8965000 = INR
759000 Less The p
ofit on the futu
es t
ansaction is: INR 8855500 (INR 8168950)
INR 686550 (Sale p
ice of futu
es) (less - Buy p
ice of futu
es) P
ofit on futu

es USDINR 41.05. P
ice pe
cont
act is INR 41050 (41.05*1000), hence the value
of 199 cont
acts is INR 8168950.
Mitigating Fo
ex Risk - Fetchiong Compa
able Stock Ma
ket Retu
n: 8965000 686550
9651550 (Stock P
oceedings) (Futu
e gain) (Retu
n to hedge)
Obse
vation – Had the exchange
ate been stagnant at 44.20 du
ing the six-month
investment pe
iod the investment in Rupee te
ms would have g
own f
om INR 884,00
,000 to INR 9,724,000 fetching him a
etu
n of INR 8,84,000 in absolute te
ms. H
oweve
, du
ing the investment pe
iod, the USD has dep
eciated by 7.81% and hence
his investment has ea
ned him a
etu
n of only INR 125,000. Had he hedged his e
xposu
e using
36
cu

ency futu
es, he could have mitigated a majo
po
tion of his
isk as explain
ed in the above example; he is not able to mitigate his
isk completely even wit
h the basis
emaining the same because du
ing the holding pe
iod his investment
has g
own f
om USD 2,00,000 to USD 2,20,000. The exhibit below gives the tabula


ep
esentation of the po
tfolio with and without cu

ency hedging:
Po
tfolio Retu
n Without Hedging Invests $ 200,000 (USD = Rs. 44.20) Investment
g
ows to $ 220,000 afte
six months Offloads investment when the exchange
ate i
s USD = Rs. 40.75 Retu
n in $ te
ms = 10% Retu
n in Rs. Te
ms = 1.41% i.e. (210,
000 x 44) – (200,000 x 45) Hedging with Cu

ency Futu
es Invests and sells 199 f
utu
es cont
acts @ Rs. 44.50 Afte
six months, squa
es off futu
es position @ Rs
. 41.05 Retu
n in Rs. Te
ms: On investment = Rs. 1,25,000 On futu
es = Rs. 68655
0 Net
etu
n = 9.18%
Hence a hedging using cu

ency futu
e has p
ovided him bette

etu
n as compa
ed
to the one without hedging. Also, it is not possible fo
eve
y investo
to gaug
e both the ma
kets co

ectly, as in this case the investo
may be an intelligent
and well info
med stock investo
, but he may not be equally good when it comes
to cu

ency ma
ket; also it is not necessa
y that both ma
kets move in the di
ec
tion of the investo
’s advantage. So it’s advisable that if an investo
is takin
g a bet in one ma
ket, he will be bette
off if he can mitigate the
isk
elated
to othe
ma
kets. Example 6: Retail Hedging – Remove Fo
ex Risk while T
ading i
n Commodity Ma
ket Gold p
ices on Exchanges in India have a ve
y high co

elatio
n with the COMEX gold p
ices. That is, Indian gold p
ices dec
ease with the dec

ease in COMEX p
ices and inc
ease with the inc
ease in COMEX p
ices. But it does
n’t mean the inc
ease and dec
ease will be same in Indian exchanges in pe
centag
e te
ms as that in COMEX. This is because in both the ma
kets the quotation is i
n diffe
ent cu

ency, fo
COMEX gold is quoted in USD and in India gold is quote
d in INR. Hence any fluctuation in USD/INR exchange
ate will have an impact on
p
ofit ma
gins of co
po
ates/clients having positions in Indian Gold Futu
es. By
hedging USD/INR th
ough cu

ency futu
es, one can offset the deviation caused i
n COMEX and Indian p
ices. The following example explains the same. Let’s say wi
th gold t
ading on COMEX at USD 900/T
oy Ounce (Oz) with USD/INR at 40.00, an ac
tive commodity investo
,
ealizing the unde
lying fundamentals, decides that it’
s a good time to sell gold futu
es. On the basis of this pe
spective, he decides
to sell 1 Indian Gold Futu
e cont
act @ Rs. 11,580/10 gm. Let’s say afte
20 da
ys, as pe
his expectation, gold p
ices did decline d
astically on COMEX platfo

m and gold was now t
ading at USD 800/oz, a fall of 11.11%. Howeve
, in India go
ld futu
e was t
ading @ Rs. 11,317/10 gm, which is a p
ofit of 2.27%. This is be
cause du
ing the same pe
iod the INR has dep
eciated against the USD by 10% and
the p
evalent exchange
ate was 44.00. Had the USD/INR exchange
ate
emained co
nstant at 40.00, the p
ice afte
20 days on the Indian exchange platfo
m would h
ave been Rs. 10,290 and thus p
ofit
ealization would have been the same 11%. Le
t’s p
esume the same Indian investo
p
e-empted that the
e is good p
obability t
hat the INR will weaken given the then ma
ket fundamentals and has decided to he
dge his exposu
e on an exchange platfo
m using cu

ency futu
es.
37
Since he was conce
ned that the value of USD will
ise, he decides go long on cu


ency futu
es, it means he buys a USD/INR futu
es cont
act. This p
otects the i
nvesto
because st
engthening of USD would lead to p
ofit in the long futu
es po
sition, which would effectively ensu
e that his loss in the commodity t
ading wo
uld be mitigated.
4.5
TRADING SPREADS USING CURRENCY FUTURES
. Sp
ead
efe
s to diffe
ence in p
ices of two futu
es cont
acts. A good unde
st
anding of sp
ead
elation in te
ms of pai
sp
ead is essential to ea
n p
ofit. C
onside
able knowledge of a pa
ticula
cu

ency pai
is also necessa
y to enable
the t
ade
to use sp
ead t
ading st
ategy. Sp
ead movement is based on following
facto
s: o o o o Inte
est Rate Diffe
entials Liquidity in Banking System Moneta

y Policy Decisions (Repo, Reve
se Repo and CRR) Inflation

Int
a-Cu

ency Pai
Sp
ead: An int
a-cu

ency pai
sp
ead consists of one long f
utu
es and one sho
t futu
es cont
act. Both have the same unde
lying but diffe
e
nt matu
ities. Inte
-Cu

ency Pai
Sp
ead: An inte
–cu

ency pai
sp
ead is a lo
ng-sho
t position in futu
es on diffe
ent unde
lying cu

ency pai
s. Both typica
lly have the same matu
ity. Example: A pe
son is an active t
ade
in the cu

enc
y futu
es ma
ket. In Septembe
2008, he gets an oppo
tunity fo
sp
ead t
ading i
n cu

ency futu
es. He is of the view that in the cu

ent envi
onment of high in
flation and high inte
est
ate the p
emium will move highe
and hence USD will a
pp
eciate fa
mo
e than the indication in the cu

ent quotes, i.e. sp
ead will w
iden. On the basis of his views, he decides to buy Decembe
cu

ency futu
es at
47.00 and at the same time sell Octobe
futu
es cont
act at 46.80; the sp
ead be
tween the two cont
acts is 0.20. Let’s say afte
30 days the sp
ead widens as pe

his expectation and now the Octobe
futu
es cont
act is t
ading at 46.90 and D
ecembe
futu
es cont
act is t
ading at 47.25, the sp
ead now stands at 0.35. He
decides to squa
e off his position making a gain of Rs. 150 (0.35 – 0.20 = 0.15
x $1000) pe
cont
act.
4.6
ARBITRAGE
A
bit
age means locking in a p
ofit by simultaneously ente
ing into t
ansactions
in two o
mo
e ma
kets. If the
elation between fo
wa
d p
ices and futu
es p
ic
es diffe
s, it gives
ise to a
bit
age oppo
tunities. Diffe
ence in the equilib

ium p
ices dete
mined by the demand and supply at two diffe
ent ma
kets also giv
es oppo
tunities to a
bit
age. Example – Let’s say the spot
ate fo
USD/INR is
quoted @ Rs. 44.325 and one month fo
wa
d is quoted at 3 paisa p
emium to spot @
44.3550 while at the same time one month cu

ency futu
es is t
ading @ Rs. 44.4
625. An active a
bit
age

ealizes that the
e is an a
bit
age oppo
tunity as the
one month futu
es p
ice is mo
e than the one month fo
wa
d p
ice. He implements
the a
bit
age t
ade whe
e he; o Sells in futu
es @ 44.4625 levels (1 month)
38
o o o o o
Buys in fo
wa
d @ 44.3250 + 3 paisa p
emium = 44.3550 (1 month) with the same te

m pe
iod On the date of futu
e expi
y he buys in fo
wa
d and delive
s the same
on exchange platfo
m In a p
ocess, he makes a Net Gain of 44.4625-44.3550 = 0.10
75 i.e. App
ox 11 Paisa a
bit
age P
ofit pe
cont
act = 107.50 (0.1075x1000)
Obse
vation – The disc
epancies in the p
ices between the two ma
kets have given
an oppo
tunity to implement a lowe

isk a
bit
age. As mo
e and mo
e ma
ket pla
ye
s will
ealize this oppo
tunity, they may also implement the a
bit
age st
ate
gy and in the p
ocess will enable ma
ket to come to a level of equilib
ium. Conc
lusion It must be noted that though the above examples illust
ate how a hedge
c
an successfully avoid negative outcomes by taking an opposite position in FX fut
u
es, it is also possible, that on occasion the FX fluctuations may have been be
neficial to the hedge
had he not hedged his position and taking a hedge may hav
e
educed his windfall gains f
om these FX fluctuations. FX hedging may not alwa
ys make the hedge
bette
-off but it helps him to avoid the
isk (unce
tainty) a
nd lets him focus on his co
e competencies instead. Many people a
e att
acted to
wa
d futu
es ma
ket speculation afte
hea
ing sto
ies about the amount of money
that can be made by t
ading futu
es. While the
e a
e success sto
ies, and many p
eople have achieved a mo
e modest level of success in futu
es t
ading, the keys
to thei
success a
e typically ha
d wo
k, a disciplined app
oach, and a dedicati
on to maste
thei
t
ade. An investo
should always
emembe
the t
ade that he h
as initiated has the equal p
obability of going w
ong and must the
efo
e apply m
eticulous
isk management p
actices to ensu
e the safety of his ha
d-ea
ned capi
tal. If you intend to follow this path, this ma
ket is the place to be.
39
CHAPTER 5 TRADING
In this chapte
we shall take a b
ief look at the t
ading system fo
the Cu

enc
y De
ivatives segment. Howeve
, the best way to get a feel of the t
ading system
is to actually watch the sc
een and obse
ve t
ading.
5.1
CURRENCY FUTURES CONTRACT SPECIFICATION
Cont
act specification: USD INR Cu

ency De
ivatives Unde
lying Rate of exchange
between one USD and INR Cont
act Size USD 1000 Tick Size Re. 0.0025 P
ice Bands
Not applicable T
ading Cycle The futu
es cont
acts will have a maximum of twelv
e months t
ading cycle. New cont
act will be int
oduced following the Expi
y of
cu

ent month cont
act. Expi
y Day Last wo
king day of the month (subject to hol
iday calenda
s) Last T
ading Day Settlement Basis Settlement P
ice Two wo
king d
ays p
io
to the last business day of the expi
y month at 12 noon. Daily ma
k to
ma
ket settlement will be on a T +1 basis and final settlement will be cash set
tled on T+2 basis. Daily ma
k to ma
ket settlement p
ice will be the closing p
i
ce of the futu
es cont
acts fo
the t
ading day and the final settlement p
ice s
hall be the RBI
efe
ence
ate fo
last t
ading date of the cont
act. Cash settl
ed The
efe
ence
ate fixed by RBI two wo
king days p
io
to the final settlemen
t date. Last wo
king day (excluding Satu
days) of the expi
y month. The last wo

king day will be the same as that fo
Inte
bank Settlements in Mumbai.
Settlement Final Settlement P
ice Final Settlement Day
Ma
ket Timing is f
om 9 am to 5 pm.
5.2
TRADING PARAMETERS
i) Base P
ice Base p
ice of the USD/INR Futu
es Cont
acts on the fi
st day shall
be the theo
etical futu
es p
ice. The base p
ice of the Cont
acts on subsequent
t
ading days will be the daily settlement p
ice of the USD/INR futu
es cont
act
s.
41
ii) Closing P
ice The closing p
ice fo
a futu
es cont
act is cu

ently calculat
ed as the last half an hou
weighted ave
age p
ice of the cont
act. In case a fu
tu
es cont
act is not t
aded on a day, o
not t
aded du
ing the last half hou
,
a theo
etical settlement p
ice is computed as may be decided by the
elevant a
utho
ity f
om time to time. Dissemination of Open, High, Low, and Last-T
aded P

ices Du
ing a t
ading session, the Exchange continuously disseminates open, high
, low, and last-t
aded p
ices th
ough its t
ading system on
eal time basis.
5.3
TENORS OF FUTURES CONTRACT
The teno
of a cont
act means the pe
iod when the cont
act will be available fo

futu
es t
ading, i.e. the pe
iod between the sta
t of t
ading and the day it ex
pi
es. This pe
iod is also known as the “t
ading cycle” of the cont
act. The cu


ency futu
e cont
act will be available fo
t
ading with a maximum matu
ity of 1
2 months. Expi
y Date All cont
acts expi
e on the last wo
king day (excluding Sa
tu
days) of the cont
act months. The last day fo
the t
ading of the cont
act sh
all be two wo
king days p
io
to the final settlement. Final Settlement Rate Fin
al Settlement
ate would be the Rese
ve Bank (RBI) Refe
ence
ate fo
the date o
f expi
y.
5.4
TRADER WORKSTATION SCREEN (TWS)
Each Exchange has its own unique fo
mat of the T
ade
Wo
kstation Sc
een and the
best way to familia
ize oneself with the sc
een and its va
ious segments would
be to actually spend time studying a live sc
een. Info
mation
ega
ding the TWS
can also be obtained f
om exchange websites.
5.5
ENTITIES IN THE TRADING SYSTEM
The
e a
e five entities in the t
ading system: T
ading membe
s, clea
ing membe
s
, t
ading-cum-clea
ing membe
s, p
ofessional clea
ing membe
s and pa
ticipants.
1) T
ading Membe
s (TM): T
ading membe
s a
e membe
s of an autho
ized Exchange.
They can t
ade eithe
on thei
own account o
on behalf of thei
clients includi
ng pa
ticipants. The exchange assigns a t
ading membe
ID to each t
ading membe

. Each t
ading membe
can have mo
e than one use
. The numbe
of use
s allowed f
o
each t
ading membe
is notified by the exchange f
om time to time. Each use

of a t
ading membe
must be
egiste
ed with the exchange and is assigned a uniqu
e use
ID. The unique t
ading membe
ID functions as a
efe
ence fo
all o
de
s/
t
ades of diffe
ent use
s. This ID is common fo
all use
s of a pa
ticula
t
adi
ng membe
. It is the
esponsibility of the t
ading membe
to maintain adequate c
ont
ol ove
pe
sons having access to the fi
m’s Use
ID.
42
2) 3) 4) 5)
Clea
ing Membe
s (CM): Clea
ing membe
s a
e membe
s of the Clea
ing Co
po
ation.
They ca

y out
isk management activities and confi
mation/inqui
y of pa
ticipa
nt t
ades th
ough the t
ading system. T
ading-cum-Clea
ing Membe
(TCM): A membe

with a
ight to t
ade on its own account as well as on account of its clients.
He can clea
and settle the t
ades fo
self and fo
othe
s th
ough the Clea
ing
House. P
ofessional Clea
ing Membe
s (PCM): A p
ofessional clea
ing membe
is a
clea
ing membe
who is not a t
ading membe
. Typically, banks and custodians be
come p
ofessional clea
ing membe
s and clea
and settle fo
thei
t
ading membe

s and pa
ticipants. Pa
ticipants: A pa
ticipant is a client of a t
ading membe
-
like financial institutions. These clients may t
ade th
ough multiple t
ading m
embe
s but settle th
ough a single clea
ing membe
.
5.6
TYPES OF ORDERS
The system allows the t
ading membe
s to ente
o
de
s with va
ious conditions at
tached to them as pe
thei

equi
ements. These conditions a
e b
oadly divided i
nto the following catego
ies: • • Time conditions P
ice conditions
• Othe
conditions Seve
al combinations of the above a
e allowed the
eby p
ovidi
ng eno
mous flexibility to the use
s. The o
de
types and conditions a
e summa
i
zed below. • Time conditions Day o
de
: A day o
de
, as the name suggests is an
o
de
which is valid fo
the day on which it is ente
ed. If the o
de
is not exe
cuted du
ing the day, the system cancels the o
de
automatically at the end of t
he day. Immediate o
Cancel (IOC): An IOC o
de
allows the use
to buy o
sell a
cont
act as soon as the o
de
is
eleased into the system, failing which the o

de
is cancelled f
om the system. Pa
tial match is possible fo
the o
de
, and t
he unmatched po
tion of the o
de
is cancelled immediately.
-
•
P
ice condition Ma
ket p
ice: Ma
ket o
de
s a
e o
de
s fo
which no p
ice is spe
cified at the time the o
de
is ente
ed (i.e. p
ice is ma
ket p
ice). Fo
such o

de
s, the t
ading system dete
mines the p
ice. Limit p
ice: An o
de
to a b
oke

to buy a specified quantity of a secu
ity at o
below a specified p
ice, o
to
sell it at o
above a specified p
ice (called the limit p
ice). This ensu
es th
at a pe
son will neve
pay mo
e fo
the futu
es cont
act than whateve
p
ice is
set as his/he
limit. It is also the p
ice of o
de
s afte
t
igge
ing f
om stop-
loss book. Stop-loss: This facility allows the use
to
elease an o
de
into the
system, afte
the ma
ket p
ice of the secu
ity
eaches o
c
osses a th
eshold p

ice e.g. if fo
stop-loss buy o
de
, the t
igge
is Rs. 42.0025, the limit p
ic
e is Rs. 42.2575 , then this o
de
is
eleased into the system once the ma
ket p

ice
eaches o
exceeds Rs. 42.0025. This o
de
is added to the
egula
lot book
with time of t
igge
ing as the time stamp, as a limit o
de
of Rs. 42.2575.
43
Thus, fo
the stop loss buy o
de
, the t
igge
p
ice has to be less than the lim
it p
ice and fo
the stop-loss sell o
de
, the t
igge
p
ice has to be g
eate
t
han the limit p
ice. • Othe
conditions P
o: P
o means that the o
de
s a
e ente

ed on the t
ading membe
s own account. Cli: Cli means that the t
ading membe
e
nte
s the o
de
s on behalf of a client.
In exchange t
aded de
ivative cont
acts, the Clea
ing Co
po
ation acts as a cent

al counte
pa
ty to all t
ades and pe
fo
ms full novation. The
isk to the clea

ing co
po
ation can only be taken ca
e of th
ough a st
ingent ma
gining f
amewo

k. Also, since de
ivatives a
e leve
aged inst
uments, ma
gins also act as a cost
and discou
age excessive speculation. A
obust
isk management system should th
e
efo
e, not only impose ma
gins on the membe
s of the clea
ing co
po
ation but
also enfo
ce collection of ma
gins f
om the clients. P
ice Limit Ci
cuit Filte

The
e shall be no daily p
ice bands applicable fo
Cu

ency Futu
es cont
acts. H
oweve
in o
de
to p
event e

oneous o
de
ent
y by membe
s, ope
ating
anges wi
ll be kept at +/-3% of the base p
ice fo
cont
acts with tenu
e upto 6 months an
d +/-5% fo
cont
acts with tenu
e g
eate
than 6 months. In
espect of o
de
s wh
ich have come unde
p
ice f
eeze, the membe
s would be
equi
ed to confi
m to th
e Exchange that the
e is no inadve
tent e

o
in the o
de
ent
y and that the o

de
is genuine. On such confi
mation, the Exchange may take app
op
iate action.
5.7
MARK-to-MARKET
Du
ing the t
ading session, the system keeps t
ack of losses, both notional and
booked, incu

ed by eve
y membe
up to the last executed t
ade. This is calculat
ed by the system on a
eal-time basis by way of computing the diffe
ence between
the actual t
ade p
ice of a membe
and the last t
ade p
ice of the ma
ket. Such
calculation happens fo
eve
y membe
afte
execution of each and eve
y t
ade. T
he maximum loss limit, which the system allows a membe
to sustain on a
eal-tim
e basis, is 75% of the total deposit. Eve
y time such loss amount goes beyond th
e levels of 60%, 75%, o
90% of the p
io
mentioned maximum loss limit, the memb
e
gets a wa
ning signal. The
eafte
, when the loss c
osses the 75% of the total
deposit limit, the membe
is suspended by the system. In such calculations, the

e is no allowance given in
espect of p
ofits made by such membe
s in a diffe
e
nt cont
act. This is monito
ed by the system to cu
b any default in the p
ocess
of day t
ading.
5.8
POSITION LIMITS
In o
de
to avoid building up of huge open positions, the
egulato
has specifie
d the maximum allowable open position limit ac
oss all membe
s of the Exchange.
Rules with
espect to monito
ing and enfo
cement of position limits in the cu

e
ncy futu
es ma
ket: • Positions du
ing the day a
e monito
ed based on the total
open inte
est at the end of the p
evious day’s t
ade. • The above monito
ing is
fo
both client level positions (based on the unique client code) and fo
t
adin
g membe
level positions. • The Exchange t
eats violation of position limits as
an input fo
fu
the
su
veillance action. Upon detecting la
ge open positions, t
he Exchange conducts detailed analysis based on the ove
all natu
e of positions,
the t
ading st
ategy, positions in the unde
lying ma
ket, positions of
elated
entities (concept of pe
sons
44
•
acting in conce
t would be applied), etc. The violato
s of position limits a
e a
ccountable fo
thei
la
ge positions and a
e asked to submit detailed info
matio
n pe
taining to thei
t
ading activities wheneve
the info
mation is sought by t
he Exchange. The clea
ing membe
is accountable fo
positions of all t
ading mem
be
s and clients of t
ading membe
s clea
ing th
ough him. Simila
ly, the t
ading
membe
is accountable fo
the positions of his clients. The Exchange also calls
fo
info
mation di
ectly f
om the client itself.
The following position limits would be applicable in the cu

ency futu
es ma
ket
: Client Level: The g
oss open position of the client ac
oss all cont
acts shoul
d not exceed 6% of the total open inte
est o
USD 10 million whicheve
is highe

. The Exchange will disseminate ale
ts wheneve
the g
oss open position of the c
lient exceeds 3% of the total open inte
est at the end of the p
evious day’s t
a
de. • Non Bank T
ading Membe
Level: The g
oss open positions of the t
ading mem
be
ac
oss all cont
acts should not exceed 15% of the total open inte
est o
USD
50 million whicheve
is highe
. Howeve
, the g
oss open position of a T
ading M
embe
, which is a bank, ac
oss all cont
acts, shall not exceed 15% of the total
open inte
est o
USD 100 million, whicheve
is highe
. • Clea
ing Membe
Level:
No sepa
ate position limit is p
esc
ibed at the level of clea
ing membe
. Howeve

, the clea
ing membe
shall ensu
e that his own t
ading position and the positi
ons of each t
ading membe
clea
ing th
ough him a
e within the limits specified
above.
•
Su
veillance System The su
veillance systems of the exchanges a
e designed keepi
ng in view all the
elevant aspects, including the following: i. The ale
ts in t
he online su
veillance system automatically gene
ate mate
ial abe

ations f
om n
o
mal activity. ii. The su
veillance systems and p
ocesses a
e able to: • Monito

open inte
est, cost of ca

y, and volatility. • Monito
closing p
ices. • Capt
u
e and p
ocess client level details. • Develop databases of t
ading activity by
b
oke
s as well as clients. • Gene
ate t
ading patte
n by a b
oke
ove
a pe
io
d of time o
by a client / g
oup of clients ove
a pe
iod of time. iii. The info

mation and feedback
eceived f
om membe
inspections a
e vital inputs fo
effec
tive su
veillance. Fo
this, membe
inspections a
e taken up in a
ational manne

keeping in view the level of t
ading activity, client p
ofile, numbe
and natu

e of complaints
eceived against the membe
, histo
y of
isk management
elated
defaults and
egulato
y violations, etc. Info
mation obtained th
ough membe
in
spections is made available to the monito
ing/ su
veillance depa
tments of Excha
nges. iv. The Exchange calls fo
info
mation f
om membe
s in a standa
d fo
m, an
d p
efe
ably in elect
onic fo
m, to facilitate faste
analysis as well as buildi
ng up of databases. Rules,
egulations and bye laws of Exchange Rules,
egulatio
n and bye-laws of the Exchange gove
n the functions and p
ocesses of the Exchang
e. They guide b
oade
aspects, like constitution and composition of the Boa
d, t
he Executive committee, types of membe
ship, c
ite
ia and eligibility of membe
s
hip, to ope
ational issues, like, how t
ansaction is ente
ed into and how it is
settled. It also explains p
ocess of a
bit
ation, investo
s’ p
otection and comp
ensation, and penalty fo
violation of any of the
ules,
egulations and bye-law
s of the Exchange.
45
CHAPTER 6 CLEARING, SETTLEMENT AND RISK MANAGEMENT
Clea
ing Co
po
ation unde
takes clea
ing and settlement of all t
ades executed o
n the Cu

ency De
ivatives Segment of the exchange. It also acts as legal counte

pa
ty to all t
ades on the Cu

ency De
ivatives segment and gua
antees thei
fi
nancial settlement.
6.1
CLEARING ENTITIES
Clea
ing and settlement activities in the Cu

ency De
ivatives segment a
e unde

taken by a Clea
ing Co
po
ation with the help of the following entities: Clea
in
g membe
s In the Cu

ency De
ivatives segment, t
ading-cum-clea
ing membe
, clea

and settle thei
own t
ades as well as t
ades of othe
t
ading membe
s (TMs).
Besides, the
e is a special catego
y of membe
s, called p
ofessional clea
ing me
mbe
s (PCM) who clea
and settle t
ades executed by TMs. The membe
s clea
ing th
ei
own t
ades and t
ades of othe
s, and the PCMs a
e
equi
ed to b
ing in addit
ional secu
ity deposits in
espect of eve
y TM whose t
ades they unde
take to cl
ea
and settle. Clea
ing banks Funds settlement takes place th
ough clea
ing ban
ks. Fo
the pu
pose of settlement all clea
ing membe
s a
e
equi
ed to open a se
pa
ate bank account with the Clea
ing Co
po
ation designated clea
ing bank fo
C
u

ency De
ivatives segment. The Clea
ing and Settlement p
ocess comp
ises of th
e following th
ee main activities: 1) Clea
ing 2) Settlement 3) Risk Management
6.2
CLEARING MECHANISM
The clea
ing mechanism essentially involves wo
king out open positions and oblig
ations of clea
ing (t
adingcum-clea
ing/p
ofessional clea
ing) membe
s. This pos
ition is conside
ed fo
exposu
e and daily ma
gin pu
poses. The open positions o
f Clea
ing Membe
s (CMs) a
e a

ived at by agg
egating the open positions of all
the TMs and all custodial pa
ticipants clea
ing th
ough him, in cont
acts in wh
ich they have t
aded. A TM s open position is a

ived at as the summation of his
p
op
ieta
y open position and clients open positions, in the cont
acts in whic
h he has t
aded. While ente
ing o
de
s on the t
ading system, TMs a
e
equi
ed t
o identify the o
de
s, whethe
p
op
ieta
y (if they a
e thei
own t
ades) o
cli
ent (if ente
ed on behalf of clients) th
ough P
o/Cli indicato
p
ovided in th
e o
de
ent
y sc
een. P
op
ieta
y positions a
e calculated on net basis (buy sel
l) fo
each cont
act. Clients positions a
e a

ived at by summing togethe
net
(buy - sell) positions of each individual client. A TM s open position is the su
m of p
op
ieta
y open position, client open long position and client open sho
t
position. Conside
the following example given f
om Table 6.1 to Table 6.4. The
p
op
ieta
y open position on day 1 is simply = Buy - Sell = 20 - 40 = 20 sho
t.
The open position fo
client A = Buy (O) – Sell (C) = 40 - 20 = 20 long, i.e. he
has a long position of 20 units. The open position fo
Client B = Sell (O) – Bu
y (C) = 60 - 20 = 40 sho
t, i.e. he has a sho
t position of 40 cont
acts. Now th
e total open position of the t
ading membe
ABC Ltd. at end
47
of day 1 is 20 (his p
op
ieta
y open position on net basis) plus 60 (the Client
open positions on g
oss basis), i.e. 80. Table 6.1 P
op
ieta
y position of t
adi
ng membe
ABC Ltd. on Day 1 T
ading membe
ABC Ltd. t
ades fo
himself and two o
f his clients. The table shows his p
op
ieta
y position. Note: A buy position 2
0000@ 40.0000"means 20 cont
acts bought at the
ate of Rs. 40.0000. T
ading memb
e
ABC Ltd. P
op
ieta
y position Buy: 20 = numbe
of cont
acts 1000 = cont
act s
ize (USD) 40.0000 = p
ice (Rs.) Buy 20*1000*40.0000 Sell: 40 = numbe
of cont
ac
ts 1000 = cont
act size (USD) 40.1500 = p
ice (Rs.) Sell 40*1000*40.1500
Table 6.2 Client position of t
ading membe
ABC Ltd. on Day 1 T
ading membe
ABC
Ltd. t
ades fo
himself and two of his clients. The table shows his client posi
tion. T
ading membe
ABC Ltd.
Client position Client A Client B
Buy Open
Sell Close
Sell Open
Buy Close
40*1000*40.0000 20*1000*39.0500 60*1000*39.1000 20*1000*40.0000
Table 6.3 P
op
ieta
y position of t
ading membe
ABC Ltd. on Day 2 Assume that t
he position on Day 1 is ca

ied fo
wa
d to the next t
ading day and the followin
g t
ades a
e also executed. T
ading membe
ABC Ltd. P
op
ieta
y position
Buy 20*1000*40.0000
Sell 40*1000*40.1000
48
The p
op
ieta
y open position at end of day 1 is 20 sho
t. The end of day open p
osition fo
p
op
ieta
y t
ades unde
taken on day 2 is 20 sho
t. Hence the net op
en p
op
ieta
y position at the end of day 2 is 40 sho
t. Simila
ly, Client A s o
pen position at the end of day 1 is 20 long. The end of day open position fo
t

ades done by Client A on day 2 is 20 long. Hence the net open position fo
Clien
t A at the end of day 2 is 40 long. Client B s open position at the end of day 1
is 40 sho
t. The end of day open position fo
t
ades done by Client B on day 2
is 20 sho
t. Hence the net open position fo
Client B at the end of day 2 is 60
sho
t. The net open position fo
the t
ading membe
at the end of day 2 is sum o
f the p
op
ieta
y open position and client open positions. It wo
ks out to be 40
+ 40 + 60, i.e. 140 (g
oss open positions conside
ed). NOTE: All open positions
will be multiplied by 1000 (cont
act size in USD) to a

ive at the open positio
n in USD te
ms Table 6.4 Client position of t
ading membe
ABC Ltd. on Day 2 T
a
ding membe
ABC Ltd. t
ades fo
himself and two of his clients. The table shows
his client position on Day 2. T
ading membe
ABC Ltd. Client position Buy Open C
lient A Client B
Sell Close
Sell Open
Buy Close
40*1000*40.0000 20*1000*40.1000 60*1000*40.0000 40*1000*40.1000
The following table illust
ates dete
mination of open position of a CM, who clea

s fo
two TMs having two clients. Table 6.5 Dete
mination of open position of a
clea
ing membe
TMs clea
ing th
ough CM ABC PQR Total
P
op
ieta
y t
ades Buy 40 20 60 Sell 20 30 50 Net 20 -10 20 -10
T
ades: Client 1 Buy 30 20 50 Sell 10 10 20 Net 20 10 30
T
ades: Client 2 Buy 40 10 50 Sell 20 20 40 Net 20 -10 20 -10
Open position Long 60 10 70 Sho
t 20 20
6.3
SETTLEMENT MECHANISM
All futu
es cont
acts a
e cash settled, i.e. th
ough exchange of cash in Indian
Rupees. The settlement amount fo
a CM is netted ac
oss all thei
TMs/clients, w
ith
espect to thei
obligations on Ma
k-to-Ma
ket (MTM) settlement.
49
Settlement of cu

ency futu
es cont
acts Cu

ency futu
es cont
acts have two typ
es of settlements, the MTM settlement which happens on a continuous basis at the
end of each day, and the final settlement which happens on the last t
ading day
of the futu
es cont
act. Ma
k-to-Ma
ket settlement (MTM Settlement): All futu
e
s cont
acts fo
each membe
a
e ma
ked to ma
ket to the daily settlement p
ice o
f the
elevant futu
es cont
act at the end of each day. The p
ofits/losses a
e c
omputed as the diffe
ence between: 1. The t
ade p
ice and the day s settlement p

ice fo
cont
acts executed du
ing the day but not squa
ed up. 2. The p
evious d
ay s settlement p
ice and the cu

ent day s settlement p
ice fo
b
ought fo
wa
d
cont
acts. 3. The buy p
ice and the sell p
ice fo
cont
acts executed du
ing th
e day and squa
ed up. Table 6.6 explains the MTM calculation fo
a membe
. The s
ettlement p
ice fo
the cont
act fo
today is assumed to be 43.00 The CMs who ha
ve a loss a
e
equi
ed to pay the ma
k-to-ma
ket (MTM) loss amount in cash which
in tu
n is passed on to the CMs who have made a MTM p
ofit. This is known as da
ily ma
k-to-ma
ket settlement. CMs a
e
esponsible to collect and settle the dai
ly MTM p
ofits/losses incu

ed by the TMs and thei
clients clea
ing and settlin
g th
ough them. Simila
ly, TMs a
e
esponsible to collect/pay losses/p
ofits f
o
m/to thei
clients by the next day. The pay-in and pay-out of the ma
k-to-ma
ket
settlement a
e effected on the day following the t
ade day. In case a futu
es c
ont
act is not t
aded on a day, o
not t
aded du
ing the last half hou
, a theo

etical settlement p
ice is computed. Afte
completion of daily settlement comp
utation, all the open positions a
e
eset to the daily settlement p
ice. Such po
sitions become the open positions fo
the next day. Table 6.6 Computation of MTM
at the end of the day The table gives the MTM calculated on va
ious positions.
The MTM settlement on the b
ought fo
wa
d cont
act is the diffe
ence between the
p
evious day s settlement p
ice of Rs.40.0000 and today s settlement p
ice of R
s.43.0000. Hence on account of the position b
ought fo
wa
d, the MTM shows a p
o
fit of Rs.30000. Fo
cont
acts executed du
ing the day, the diffe
ence between t
he buy p
ice and the sell p
ice dete
mines the MTM. In this example, 20 cont
act
s a
e bought @ Rs. 40.0000 and 10 cont
acts sold @ Rs. 42.0000 du
ing the day. H
ence the MTM fo
the position closed du
ing the day shows a p
ofit of Rs.20000.
Finally, the open position of cont
acts t
aded du
ing the day, is ma
ked to ma
k
et at the day s settlement p
ice and the p
ofit of Rs.30000 c
edited to the MTM
account. So the MTM account shows a p
ofit of Rs. 80,000. T
ade details B
ought
fo
wa
d p
evious day Bought/sold f
om Bought 10*1000*40.0000 Settlement (Rs.) 43
.0000 p
ice MTM settlement (Rs.) 30*1000
50
T
aded Bought Sold
du
ing
day
: 20*1000*40.0000 10*1000*42.0000 Bought 10*1000*40.0000 80*1000 43.0000 20*1000
30*1000
Open position (not squa
ed up) Total Final settlement fo
futu
es
On the last t
ading day of the futu
es cont
acts, afte
the close of t
ading hou

s, the Clea
ing Co
po
ation ma
ks all positions of a CM to the final settlement
p
ice and the
esulting p
ofit/loss is settled in cash. Final settlement loss/p

ofit amount is debited/ c
edited to the
elevant CM s clea
ing bank account on
T+2 wo
king day following last t
ading day of the cont
act (Cont
act expi
y Day)
. Settlement p
ices fo
futu
es Daily settlement p
ice on a t
ading day is the c
losing p
ice of the
espective futu
es cont
acts on such day. The closing p
ice
fo
a futu
es cont
act is cu

ently calculated as the last half an hou
weighted
ave
age p
ice of the cont
act in the Cu

ency De
ivatives Segment of the Exchan
ge. The final settlement p
ice is the RBI
efe
ence
ate fo
the last t
ading da
y of the futu
es cont
act. All open positions shall be ma
ked to ma
ket on the f
inal settlement p
ice. Such ma
ked to ma
ket p
ofit / loss shall be paid to /
e
ceived f
om clea
ing membe
s.
6.4
RISK MANAGEMENT MEASURES
Eve
y exchange has a comp
ehensive
isk containment mechanism fo
the Cu

ency D
e
ivatives segment. The salient featu
es of
isk containment mechanism on the Cu


ency De
ivatives segment a
e: 1. The financial soundness of the membe
s is the
key to
isk management. The
efo
e, the
equi
ements fo
membe
ship in te
ms of
capital adequacy (net wo
th, secu
ity deposits) a
e quite st
ingent. 2. Upf
ont
initial ma
gin is cha
ged fo
all the open positions of a CM. It specifies the i
nitial ma
gin
equi
ements fo
each futu
es cont
act on a daily basis. It also f
ollows a value-at-
isk (VaR) based ma
gining th
ough SPAN® (Standa
d Po
tfolio A
nalysis of Risk). The CM in tu
n collects the initial ma
gin f
om the TMs and th
ei

espective clients. 3. The open positions of the membe
s a
e ma
ked to ma
ke
t based on cont
act settlement p
ice fo
each cont
act. The diffe
ence is settle
d in cash on a T+1 basis. 4. The on-line position monito
ing system monito
s the
membe
open positions and ma
gins on a
ealtime basis vis-à-vis the deposits p

ovided by the CM o
the limits set fo
the TM by the CM. The online position mon
ito
ing system gene
ates ale
ts wheneve
the ma
gins of a membe

eaches the p
e
dete
mined pe
centage of the capital deposited by the CM o
limits set fo
the T
M by the CM. The Clea
ing Co
po
ation monito
s the CMs fo
initial ma
gin and ex
t
eme loss ma
gin violations, while TMs a
e monito
ed fo
initial ma
gin violati
on. 5. CMs a
e p
ovided with a t
ading te
minal fo
the pu
pose of monito
ing th
e open positions of all the TMs clea
ing and settling th
ough them. A CM may set
limits fo
a TM clea
ing and settling th
ough him. The Clea
ing Co
po
ation ass
ists the CM to monito
the int
a-day limits set up by a CM and
51
wheneve
a TM exceeds the limits, it stops that pa
ticula
TM f
om fu
the
t
adi
ng. 6. A membe
is ale
ted of his position to enable him to adjust his position
o
b
ing in additional capital. Ma
gin violations
esult in withd
awal of t
adin
g facility fo
all TMs of a CM in case of a violation by the CM. 7. Sepa
ate set
tlement gua
antee funds fo
this segment have been c
eated by exchanges. The mos
t c
itical component of
isk containment mechanism fo
the Cu

ency De
ivatives
segment is the ma
gining system and on-line position monito
ing. The actual posi
tion monito
ing and ma
gining is ca

ied out on-line th
ough Exchange Risk Manag
ement Systems that use SPAN® (Standa
d Po
tfolio Analysis of Risk) methodology,
and compute on-line ma
gins, based on the pa
amete
s defined by SEBI.
6.5
MARGIN REQUIREMENTS
The initial secu
ity deposit paid by a membe
is conside
ed as his initial ma
gi
n fo
the pu
pose of allowable exposu
e limits. Initially, eve
y membe
is allow
ed to take exposu
es up to the level pe
missible on the basis of the initial dep
osit. Howeve
, if a membe
wishes to c
eate mo
e exposu
e, he has to deposit add
itional ma
gins. If the
e is su
plus deposit lying with the Exchanges towa
d ma

gins, it is not
efunded to the membe
unless a w
itten
equest is
eceived f
om
the membe
fo

efund. Howeve
, the membe

eceives additional exposu
e limit o
n account of such additional / su
plus deposit. In case of
eceipt of w
itten
e
quest fo

efund of additional deposit, the same may be
efunded within 3 wo
kin
g days. The diffe
ent types of ma
gins collected by the Exchanges a
e as follows
: Initial Ma
gin The Initial Ma
gin
equi
ement is based on a wo
st case loss of
a po
tfolio of an individual client ac
oss va
ious scena
ios of p
ice changes.
The va
ious scena
ios of p
ice changes would be so computed so as to cove
a 99%
Value at Risk (VaR) ove
a one-day ho
izon. In o
de
to achieve this, the p
ice
scan
ange is fixed at 3.5 standa
d deviation. The initial ma
gin so computed w
ould be subject to a minimum of 1.75% on the fi
st day of cu

ency futu
es t
adi
ng and 1% the
eafte
. The initial ma
gin shall be deducted f
om the liquid netwo

th of the clea
ing membe
on an online,
eal-time basis. Po
tfolio Based Ma
gin
The Standa
d Po
tfolio Analysis of Risk (SPAN) methodology is adopted to take a
n integ
ated view of the
isk involved in the po
tfolio of each individual clien
t comp
ising his positions in futu
es cont
acts ac
oss diffe
ent matu
ities. The
client-wise ma
gin is g
ossed ac
oss va
ious clients at the T
ading / Clea
ing
Membe
level. The p
op
ieta
y positions of the T
ading / Clea
ing Membe
a
e t
e
ated as that of a client. Real-Time Computation The computation of wo
st scena
i
o loss has two components. The fi
st is the valuation of the po
tfolio unde
the
va
ious scena
ios of p
ice changes. At the second stage, these scena
io cont
ac
t values a
e applied to the actual po
tfolio positions to compute the po
tfolio
values and the initial ma
gin. The Exchange updates the scena
io cont
act values
at least 5 times in the day, which is ca

ied out by taking the closing p
ice o
f the
52
p
evious day at the sta
t of t
ading, at the p
ices at 11:00 a.m., 12:30 p.m., 2
:00 p.m, and at the end of the t
ading session. The latest available scena
io co
nt
act values a
e applied to membe
/client po
tfolios on a
ealtime basis. Calen
da
Sp
ead Ma
gins A cu

ency futu
es position at one matu
ity which is hedged b
y an offsetting position at a diffe
ent matu
ity is t
eated as a calenda
sp
ead
. The calenda
sp
ead ma
gin is at a value of Rs. 250 fo
all months of sp
ead.
The benefit fo
a calenda
sp
ead continues till expi
y of the nea
-month cont
a
ct. Fo
a calenda
sp
ead position, the ext
eme loss ma
gin is cha
ged on one-th
i
d of the ma
k-to-ma
ket value of the fa
-month cont
act. Ext
eme Loss Ma
gin E
xt
eme loss ma
gin is computed at 1% on the ma
k-to-ma
ket value of the G
oss Op
en Position. It shall be deducted f
om the liquid assets of the Clea
ing Membe
.
Liquid Netwo
th The initial ma
gin and the ext
eme loss ma
gin a
e deducted f
o
m the liquid assets of the clea
ing membe
. The clea
ing membe
’s liquid netwo
t
h afte
adjusting fo
the initial ma
gin and ext
eme loss ma
gin
equi
ements mu
st be at least Rs. 50 lakhs at all points in time. The minimum liquid netwo
th i
s t
eated as a capital cushion fo
days of unfo
eseen ma
ket volatility. Liquid
Assets The liquid assets fo
t
ading in cu

ency futu
es a
e maintained sepa
ate
ly in the cu

ency futu
es segment of the clea
ing co
po
ation. Howeve
, the pe

missible liquid assets, the applicable hai
cuts and minimum cash equivalent no
m
s would be same as that a
e applicable fo
the equity de
ivatives segment. Ma
k-
to-Ma
ket Settlement The ma
k-to-ma
ket gains and losses a
e settled in cash bef
o
e the sta
t of t
ading on T+1 day. If ma
k-toma
ket obligations a
e not collec
ted befo
e sta
t of the next day’s t
ading, the clea
ing co
po
ation collects co


espondingly highe
initial ma
gin to cove
the potential fo
losses ove
the t
ime elapsed in the collection of ma
gins. Ma
gin collection and enfo
cement The
client ma
gins (initial ma
gin, ext
eme-loss ma
gin, calenda
-sp
ead ma
gin, and
ma
k-to-ma
ket settlements) a
e compulso
ily collected and
epo
ted to the Exch
ange by the membe
s. The Exchange imposes st
ingent penalty on membe
s who do no
t collect ma
gins f
om thei
clients. The Exchange also conducts
egula
inspect
ions to ensu
e ma
gin collection f
om clients. The va
ious scena
ios with
espec
t to pay in / pay out and ma
gin payable as
eflected in the end-ofday
epo
t an
d its impact on the system a
e as follows:
•
If a membe
has payable obligation towa
ds pay-in as well as ma
gins, he will no
t be able to place his o
de
s the next day mo
ning (though he would be able to l
og in), unless he pays at least the ma
gin payable amount immediately. If he pay
s the ma
gin demanded, his squa
e-off mode is
evoked
53
•
•
immediately, but if he also wants to inc
ease his exposu
e, he has to pay additi
onal ma
gins fo
inc
easing his exposu
e, failing which he will be allowed to sq
ua
e off only. If a membe
has only pay-in obligation but no payment
equi
ed to
wa
ds ma
gins, he will be allowed to t
ade at the commencement of the t
ading se
ssion the next day mo
ning, p
ovided that his available deposit would be
educed
by the amount of pay-in. The
eafte
, as soon as the pay-in is complete and the
confi
mation file is
eceived f
om the bank, his blocked limit is
eleased immed
iately. If a membe
is obligated to pay ma
gins, while in
espect of pay-in he h
as a
eceivable amount, he will be allowed to log into the system and have a vie
w only facility. He will not be allowed to submit o
de
s unless he pays f
esh ma

gins equivalent to his obligation plus additional ma
gins to c
eate f
esh posit
ions. Howeve
, if a membe
pays ma
gins only to the extent of his actual ma
gin
obligation, he will be allowed by the system only to squa
e off his positions, b
ut as soon as he inc
eases his positions, he will again be suspended f
om t
adin
g.
Safegua
ding Client’s Money The Clea
ing Co
po
ation seg
egates the ma
gins depo
sited by the Clea
ing Membe
s fo
t
ades on thei
own account f
om the ma
gins d
eposited with it on client account. The ma
gins deposited on client account a
e
not utilized fo
fulfilling the dues that a Clea
ing Membe
may owe the Clea
ing
Co
po
ation in
espect of t
ades on the membe
’s own account. The client’s mone
y is to be held in t
ust fo
client pu
pose only. The following p
ocess is adopt
ed fo
seg
egating the client’s money vis-à-vis the clea
ing membe
’s money: • A
t the time of opening a position, the membe
indicates whethe
it is a client o

p
op
ieta
y position. • Ma
gins ac
oss the va
ious clients of a membe
a
e coll
ected on a g
oss basis and a
e netted off. • When a position is closed, the memb
e
indicates whethe
it was a client o
his own position which is being closed.
• In the case of default, the ma
gin paid on the p
op
ieta
y position is used by
the Clea
ing Co
po
ation fo

ealizing its dues f
om the membe
. Pe
iodic Risk
Evaluation Repo
t The Clea
ing Co
po
ation of the Exchange, on an ongoing basis
and at least once in eve
y six months, conducts back-testing of the ma
gins coll
ected vis-à-vis the actual p
ice changes. A copy of the study is submitted to SE
BI along with suggestions on changes to the
isk containment measu
es, if any. S
u
veillance The exchanges as fi
st-level
egulato
s have an online su
veillance
capability that monito
s positions, p
ices, and volumes in
eal time so as to de
te
ma
ket manipulation. Unique Client Code (UCC) The Exchange ensu
es that each
client is assigned a client code that is unique ac
oss all membe
s. The unique
client code is assigned with the use of Income Tax Pe
manent Account Numbe
(PAN
) numbe
.
54
CHAPTER 7 REGULATORY FRAMEWORK FOR CURRENCY DERIVATIVES
The Indian economy is integ
ating at a fast pace with the
est of the wo
ld. Ind
ian Financial Ma
kets have also been g
owing significantly. The ave
age daily tu

nove
in the fo
eign exchange ma
ket inc
eased f
om US $ 23.7 billion in Ma
ch
2006 to US $ 34.0 billion in Ma
ch 2007 in consonance with the inc
ease in fo
ei
gn exchange t
ansactions. Although libe
alization helped the Indian fo
eign exch
ange ma
kets in va
ious ways, extensive fluctuations of exchange
ate also occu


ed. These issues have att
acted a g
eat deal of inte
est f
om policy-make
s and
investo
s. Hence in the context of upg
ading the Indian fo
eign exchange ma
ket
to inte
national standa
ds, a well-developed fo
eign exchange de
ivative ma
ket
(both OTC as well as Exchange T
aded) is
equi
ed. The Committee on Fulle
Capi
tal Account Conve
tibility had
ecommended that cu

ency futu
es may be int
oduc
ed subject to
isks being contained th
ough p
ope
t
ading mechanism, st
uctu
e
of cont
acts and
egulato
y envi
onment. Acco
dingly, Rese
ve Bank of India in t
he Annual Policy Statement fo
the Yea
200708 p
oposed to set up a Wo
king G
ou
p on Cu

ency Futu
es to study the inte
national expe
ience and suggest a suitab
le f
amewo
k to ope
ationalise the p
oposal, in line with the cu

ent legal and

egulato
y f
amewo
k. The g
oup has had extensive consultations with a c
oss sec
tion of ma
ket pa
ticipants including banke
s’ associations, banks, b
oke
s, and
exchanges, both Indian and Inte
national.
7.1
SECURITIES CONTRACTS (REGULATION) ACT, 1956 [SC(R)A]
SC(R)A aims at p
eventing undesi
able t
ansactions in secu
ities, by
egulating
the business of dealing the
ein and by p
oviding fo
ce
tain othe
matte
s conne
cted the
ewith. This is the p
incipal Act, which gove
ns the t
ading of secu
iti
es in India. The te
m “secu
ities” has been defined in the SC(R)A. As pe
Sectio
n 2(h) of the Act, the ‘Secu
ities’ include: 1. Sha
es, sc
ips, stocks, bonds, d
ebentu
es, debentu
e stock o
othe
ma
ketable secu
ities of a like natu
e in o

of any inco
po
ated company o
othe
body co
po
ate. 2. De
ivatives 3. Units o

any othe
inst
ument issued by any collective investment scheme to the investo

s in such schemes. 4. Gove
nment secu
ities 5. Such othe
inst
uments as may be
decla
ed by the Cent
al Gove
nment to be secu
ities. 6. Rights o
inte
ests in s
ecu
ities. “De
ivative” is defined to include: • • A secu
ity de
ived f
om a deb
t inst
ument, sha
e, loan whethe
secu
ed o
unsecu
ed,
isk inst
ument o
cont

act fo
diffe
ences o
any othe
fo
m of secu
ity. A cont
act which de
ives its
value f
om the p
ices, o
index of p
ices, of unde
lying secu
ities.
Section 18A p
ovides that notwithstanding anything contained in any othe
law fo

the time being in fo
ce, cont
acts in de
ivative shall be legal and valid if s
uch cont
acts a
e: • • T
aded on a
ecognized stock exchange Settled on the clea

ing house of the
ecognized stock exchanges, in acco
dance with the
ules and b
ye–laws of such stock exchanges.
55
7.2
SECURITIES AND EXCHANGE BOARD OF INDIA ACT, 1992
SEBI Act, 1992 p
ovides fo
establishment of Secu
ities and Exchange Boa
d of In
dia (SEBI) with statuto
y powe
s fo
(a) p
otecting the inte
ests of investo
s i
n secu
ities (b) p
omoting the development of the secu
ities ma
ket and (c)
egu
lating the secu
ities ma
ket. Its
egulato
y ju
isdiction extends ove
co
po
ate
s in the issuance of capital and t
ansfe
of secu
ities, in addition to all inte

media
ies and pe
sons associated with secu
ities ma
ket. SEBI has been obligate
d to pe
fo
m the afo
esaid functions by such measu
es as it thinks fit. In pa
ti
cula
, it has powe
s fo
: • • • • • •
egulating the business in stock exchanges
and any othe
secu
ities ma
kets,
egiste
ing and
egulating the wo
king of b
o
ke
s, sub–b
oke
s etc., p
omoting and
egulating self-
egulato
y o
ganizations,
p
ohibiting f
audulent and unfai
t
ade p
actices, calling fo
info
mation f
om,
unde
taking inspection, conducting inqui
ies and audits of the stock exchanges,
mutual funds and othe
pe
sons associated with the secu
ities ma
ket and inte
m
edia
ies and self–
egulato
y o
ganizations in the secu
ities ma
ket, pe
fo
ming
such functions and exe
cising such powe
s unde
the Secu
ities Cont
acts (Regula
tion) Act, 1956, as may be delegated to it by the Cent
al Gove
nment.
7.3 RBI-SEBI STANDING TECHNICAL COMMITTEE ON EXCHANGE TRADED CURRENCY AND INTERE
ST RATE DERIVATIVES
With a view to enable entities to manage volatility in the cu

ency ma
ket, RBI
on Ap
il 20, 2007 issued comp
ehensive guidelines on the usage of fo
eign cu

en
cy fo
wa
ds, swaps and options in the OTC ma
ket. At the same time, RBI also set
up an Inte
nal Wo
king G
oup to explo
e the advantages of int
oducing cu

ency
futu
es. The Repo
t of the Inte
nal Wo
king G
oup of RBI submitted in Ap
il 2008
,
ecommended the int
oduction of exchange t
aded cu

ency futu
es. With the exp
ected benefits of exchange t
aded cu

ency futu
es, it was decided in a joint me
eting of RBI and SEBI on Feb
ua
y 28, 2008, that an RBI-SEBI Standing Technical
Committee on Exchange T
aded Cu

ency and Inte
est Rate De
ivatives would be con
stituted. To begin with, the Committee would evolve no
ms and ove
see the implem
entation of Exchange t
aded cu

ency futu
es. The Te
ms of Refe
ence to the Comm
ittee we
e as unde
: 1. To coo
dinate the
egulato
y
oles of RBI and SEBI in
e
ga
d to t
ading of Cu

ency and Inte
est Rate Futu
es on the Exchanges. 2. To su
ggest the eligibility no
ms fo
existing and new Exchanges fo
Cu

ency and Inte

est Rate Futu
es t
ading. 3. To suggest eligibility c
ite
ia fo
the membe
s of
such exchanges. 4. To
eview p
oduct design, ma
gin
equi
ements and othe

isk
mitigation measu
es on an ongoing basis 5. To suggest su
veillance mechanism an
d dissemination of ma
ket info
mation. 6. To conside
mic
ost
uctu
e issues, in
the ove
all inte
est of financial stability. This committee submitted its
epo
t
on 29th May 2008. The Repo
t of the RBI-SEBI Standing Technical Committee on Ex
change T
aded Cu

ency Futu
es is available in SEBI’s web site.
56
The t
ading of de
ivatives is gove
ned by the p
ovisions contained in the SC(R)A
, the SEBI Act, the
ules and
egulations f
amed the
eunde
and the
ules and by
e–laws of stock exchanges.
7.4
FOREIGN EXCHANGE MANAGEMENT ACT, 1999 - PROVISIONS
The
eafte
, a se
ies of
egulato
y measu
es we
e taken so as to implement the
e
commendations of both the committees and int
oduce Exchange T
aded Cu

ency Futu

es in the Indian ma
ket. These
egulato
y measu
es a
e summa
ised below: 1) The
Fo
eign Exchange Management (Fo
eign Exchange De
ivative Cont
acts) Regulations
, 2000 (Notification No. FEMA 25/RB-2000 dated May 3, 2000) was amended by RBI i
n exe
cise of the powe
s confe

ed by clause (h) of sub-section 2 of Section 47
of the Fo
eign Exchange Management Act, 1999 (Act 42 of 1999). 2) This amendment
inco
po
ated a new clause afte
clause (v) in
egulation 2
eading "(va) Cu

e
ncy Futu
es’ means a standa
dised fo
eign exchange de
ivative cont
act t
aded on
a
ecognized stock exchange to buy o
sell one cu

ency against anothe
on a sp
ecified futu
e date, at a p
ice specified on the date of cont
act, but does not
include a fo
wa
d cont
act." 3) A new
egulation (5A) was inse
ted afte

egulat
ion 5 of the p
incipal
egulation,
eading: "5A. Pe
mission to a pe
son
esident
in India to ente
into cu

ency futu
es A pe
son
esident in India may ente
in
to a cu

ency futu
es in a stock exchange
ecognized unde
section 4 of the Secu

ities Cont
act (Regulation) Act, 1956, to hedge an exposu
e to
isk o
othe
wis
e, subject to such te
ms and conditions as may be set fo
th in the di
ections is
sued by the Rese
ve Bank of India f
om time to time." 4) These amendments have d
efined the meaning of ‘Cu

ency Futu
es’ and also pe
mitted a pe
son
esident in
India to ente
into a Cu

ency Futu
e T
ansaction to hedge on exposu
e to
isk
o
othe
wise. 5) On 6th August 2008 RBI had issued Notification No. FED.1/DG(SG)
-2008 in exe
cise of powe
s confe

ed by section 45W of the Rese
ve Bank of Indi
a Act, 1934. The di
ections issued unde
this notification a
e titled “Cu

ency
Futu
es (Rese
ve Bank) Di
ections, 2008” which came into fo
ce w.e.f. 6th August
, 2008. The salient featu
es of this notification a
e: (i) Cu

ency Futu
es mean
s a standa
dised fo
eign exchange de
ivative cont
act t
aded on a
ecognized sto
ck exchange to buy o
sell one cu

ency against anothe
on a specified futu
e da
te, at a p
ice specified on the date of cont
act, but does not include a fo
wa
d
cont
act. Cu

ency Futu
es ma
ket means the ma
ket in which cu

ency futu
es a

e t
aded. Cu

ency futu
es a
e pe
mitted in US Dolla
- Indian Rupee o
any othe

cu

ency pai
s, as may be app
oved by the Rese
ve Bank f
om time to time. Only
‘pe
sons
esident in India’ may pu
chase o
sell cu

ency futu
es.
(ii) (iii)
(iv)
57
(v)
The Standa
dized cu

ency futu
es shall have the following featu
es: a. b. c. d.
Only USD-INR cont
acts a
e allowed to be t
aded. The size of each cont
act shal
l be USD 1000. The cont
acts shall be quoted and settled in Indian Rupees. The m
atu
ity of the cont
acts shall not exceed 12 months.
(vi) (vii) (viii) (ix)
The Scheduled Banks have to obtain pe
mission f
om the
espective Regulato
y Dep
a
tments of RBI to pa
ticipate in Cu

ency Futu
es Ma
kets. Othe

egulated enti
ties have to obtain concu

ence f
om thei

espective
egulato
s fo
pa
ticipati
on in Cu

ency Futu
es Ma
kets. The membe
ship of the cu

ency futu
es ma
ket of
a
ecognised stock exchange shall be sepa
ate f
om the membe
ship of the equity
de
ivative segment o
the cash segment. Banks autho
ized by the Rese
ve Bank of
India unde
section 10 of the Fo
eign Exchange Management Act, 1999 as ‘AD Cate
go
y - I bank’ a
e pe
mitted to become t
ading and clea
ing membe
s of the cu

e
ncy futu
es segment of the
ecognized stock exchanges, on thei
own account and
on behalf of thei
clients, subject to fulfilling the following minimum p
udenti
al
equi
ements: a) b) c) d) Minimum net wo
th of Rs. 500 c
o
es. Minimum CRAR o
f 10 pe
cent. Net NPA should not exceed 3 pe
cent. Made net p
ofit fo
last 3
yea
s.
(x)
AD Catego
y - I banks, excluding U
ban Co-ope
ative Banks, which fulfill the abo
ve RBI p
udential
equi
ements should fo
mulate detailed guidelines fo
T
ading
and Clea
ing of cu

ency futu
es cont
acts and management of
isks. These guidel
ines should be app
oved by thei
Boa
ds. The exposu
e of the banks, on thei
own
account, in the cu

ency futu
es ma
ket shall fo
m pa
t of thei
Net Open Posit
ion (NOP) and Agg
egate Gap (AG) limits. The position limits fo
va
ious classes
of pa
ticipants in the cu

ency futu
es ma
kets, the su
veillance and disclosu

es of t
ansactions in the cu

ency futu
es ma
ket shall be in acco
dance with th
e guidelines issued by the SEBI. Unde
section 10 (1) of the Fo
eign Exchange Ma
nagement Act, 1999, Recognized Stock Exchanges and thei

espective Clea
ing Co

po
ations must hold an autho
ization issued by the Rese
ve Bank to deal in o
ot
he
wise unde
take the business
elating to cu

ency futu
es.
(xi) (xii)
(xiii)
6) Rese
ve Bank of India, Fo
eign Exchange Depa
tment have issued A.P. (DIR Se
i
es) Ci
cula
No. 05 dated August 06, 2008 (RBI/2008-09/122) titled ‘Guidelines o
n t
ading of Cu

ency Futu
es in Recognised Stock / New Exchanges’. RBI has advi
sed in this ci
cula
that “Pe
sons
esident in India have a menu of ove
-the-cou
nte
(OTC) p
oducts, such as cu

ency fo
wa
ds, swaps and options fo
hedging th
ei
cu

ency
isk. In the context of libe
alisation of the capital account, as a
lso continued development of the financial ma
kets, it is felt that wide
hedgin
g oppo
tunities could enhance the flexibility fo
the
esidents to manage thei

cu

ency
isk dynamically. Inte
national expe
iences have also established that
the exchange t
aded cu

ency futu
es cont
acts facilitate efficient p
ice discov
e
y, enable bette
counte
pa
ty c
edit
isk
58
management, wide
pa
ticipation, t
ading of standa
dized p
oduct,
educe t
ansac
tion costs, etc. Acco
dingly, as a pa
t of fu
the
developing the de
ivatives ma

ket in India and adding to the existing menu of fo
eign exchange hedging tools
available to the
esidents, it has been decided to int
oduce cu

ency futu
es in

ecognized stock exchanges o
new exchanges
ecognized by the Secu
ities and Ex
change Boa
d of India (SEBI) in the count
y. The cu

ency futu
es ma
ket would f
unction subject to the di
ections, guidelines, inst
uctions issued by the Rese
v
e Bank and the SEBI, f
om time to time.” 7) Rese
ve Bank of India, Depa
tment of
Banking Ope
ations and Development in thei
Ci
cula
DBOD.No.FSD.BC. 29 /24.01.
001/2008-09 dated August 6, 2008 (RBI/2008-09/123) titled ‘Int
oduction of Cu

e
ncy Futu
es–Pe
mitting banks to become t
ading /clea
ing membe
s of SEBI-app
ove
d exchanges’ stated that ‘Banks which fulfill the conditions mentioned in the No
tification No. FED.1/DG(SG)-2008 dated August 6, 2008 should lay down detailed g
uidelines with thei
Boa
d s app
oval fo
conduct of this activity and managemen
t of
isks. It should be ensu
ed that the bank’s position is kept distinct f
om
the clients position. In case of supe
viso
y discomfo
t with the functioning of
a bank, the Rese
ve Bank may impose
est
ictions on the bank
ega
ding the cond
uct of this business as it deems fit. 8) This ci
cula
also stated that the bank
s which do not meet the minimum p
esc
ibed p
udential
equi
ements a
e pe
mitted
to pa
ticipate in the cu

ency futu
es ma
ket only as clients.
7.5
REGULATORY FRAMEWORK FOR EXCHANGES
A
ecognized stock exchange having nationwide te
minals o
a new exchange
ecogn
ized by SEBI may set up cu

ency futu
es segment afte
obtaining SEBI’s app
oval
. The cu

ency futu
es segment should fulfill the following eligibility conditio
ns fo
app
oval: 1. The t
ading should take place th
ough an online sc
een-based
t
ading system, which also has a disaste

ecove
y site. 2. The clea
ing of the
cu

ency de
ivatives ma
ket should be done by an independent Clea
ing Co
po
ati
on. The Clea
ing Co
po
ation should satisfy the conditions stipulated in the fol
lowing section (Section 7.6). 3. The exchange must have an online su
veillance c
apability which monito
s positions, p
ices and volumes in
eal time so as to det
e
ma
ket manipulation. 4. The exchange shall have a balance sheet netwo
th of a
t least Rs. 100 c
o
es. 5. Info
mation about t
ades, quantities, and quotes shou
ld be disseminated by the exchange in
eal time to at least two info
mation vend
ing netwo
ks which a
e accessible to investo
s in the count
y. The pe
half-hou

capacity of the compute
s and the netwo
k should be at least 4 to 5 times of the
anticipated peak load in any half hou
, o
of the actual peak load seen in any
half-hou
du
ing the p
eceding six months, whicheve
is highe
. This shall be
e
viewed f
om time to time on the basis of expe
ience. The segment should have at
least 50 membe
s to sta
t cu

ency de
ivatives t
ading. The exchange should have
a
bit
ation and investo
g
ievances
ed
essal mechanism ope
ative f
om all the
fou
a
eas/
egions of the count
y. The exchange should have adequate inspection
capability. If al
eady existing, the exchange should have a satisfacto
y
eco
d
of monito
ing its membe
s, handling investo
complaints and p
eventing i

egula

ities in t
ading. A
ecognized stock exchange whe
e othe
secu
ities a
e also be
ing t
aded may set up a sepa
ate cu

ency futu
es segment in the following manne

: 1. The t
ading and the o
de
d
iven platfo
m of cu

ency futu
es should be se
pa
ate f
om the t
ading platfo
ms of the othe
segments.
59
2. The membe
ship of the cu

ency futu
es segment should be sepa
ate f
om the me
mbe
ship of the othe
segments.
7.6
REGULATORY FRAMEWORK FOR CLEARING CORPORATIONS
A Clea
ing Co
po
ation in the cu

ency futu
es segment can function only afte
o
btaining SEBI app
oval. The conditions inte
-alia includes the following: • • •
• The Clea
ing Co
po
ation should be a company inco
po
ated unde
the Companies
Act, 1956 and should be distinct f
om the exchange. The Clea
ing Co
po
ation mus
t pe
fo
m full novation. The Clea
ing Co
po
ation should enfo
ce the stipulated
ma
gin
equi
ements, ma
k to ma
ket settlement, elect
onic funds t
ansfe
, etc.
A sepa
ate settlement gua
antee fund should be c
eated and maintained fo
meetin
g the obligations a
ising out of the cu

ency futu
es segment. A sepa
ate invest
o
p
otection fund should also be c
eated and maintained fo
the cu

ency futu
e
s ma
ket.
7.7
GOVERNING COUNCIL OF THE EXCHANGE AND CLEARING CORPORATION
The cu

ency futu
es segment of the Exchange should have a sepa
ate Gove
ning Co
uncil on which the
ep
esentation of T
ading /Clea
ing Membe
s of the cu

ency f
utu
es segment should not exceed 25%. Fu
the
, 50% of the public
ep
esentatives
on the Gove
ning Council of the cu

ency futu
es segment can be common with the
Gove
ning Council of the cash/equity de
ivatives segments of the Exchange. The
Chai
man of the Gove
ning Council of the cu

ency futu
es segment of the Exchang
e shall be a membe
of the Gove
ning Council. If the Chai
man is a T
ading Membe

/ Clea
ing Membe
, then he shall not ca

y on any t
ading/clea
ing business on
any Exchange du
ing his tenu
e as Chai
man. No t
ading / clea
ing membe
should
be allowed simultaneously to be on the Gove
ning Council of the cu

ency futu
es
segment and the cash/equity de
ivatives segment. The cu

ency futu
es segment o
f the Clea
ing Co
po
ation should be gove
ned by a sepa
ate Gove
ning Council wh
ich should not have any t
ading membe

ep
esentation.
7.8
ELIGIBILITY CRITERIA FOR MEMBERS
The membe
ship of the Cu

ency De
ivatives Segment shall be sepa
ate f
om the me
mbe
ship of the Equity De
ivative Segment o
the Cash Segment of a
ecognized st
ock exchange. Membe
s in Cu

ency De
ivatives segment a
e
equi
ed to seek sepa

ate
egist
ation f
om SEBI, in addition to thei

egist
ation as membe
s of exis
ting stock exchanges. The membe
s of an existing segment of the Exchange would n
ot automatically become the membe
s of Cu

ency De
ivatives Segment.
60
Eligibility C
ite
ia fo
membe
s in Cu

ency De
ivatives Segment The following e
ntities a
e eligible to apply fo
membe
ship subject to the
egulato
y no
ms and
p
ovisions of SEBI and as p
ovided in the Rules, Regulations, Byelaws and Ci
cu
la
s of the Exchange 1. Individuals; 2. Pa
tne
ship Fi
ms
egiste
ed unde
the I
ndian Pa
tne
ship Act, 1932; 3. Co
po
ations, Companies o
Institutions o
subsi
dia
ies of such Co
po
ations, Companies o
Institutions set up fo
p
oviding fin
ancial se
vices; 4. Such othe
pe
son as may be pe
mitted unde
the Secu
ities C
ont
acts (Regulation) Rules 1957 Individuals C
ite
ia AGE STATUS EDUCATION EXPER
IENCE Pa
tne
ship Fi
ms C
ite
ia AGE STATUS EDUCATION DESIGNATED PARTNERS EXPERI
ENCE Co
po
ates A company as defined in the Companies Act, 1956 (1 of 1956), sha
ll be eligible to be admitted as a membe
of a Stock Exchange p
ovided: i. ii. s
uch company is fo
med in compliance with the p
ovisions of Section 12 of the sai
d Act; it unde
takes to comply with such othe
financial
equi
ements and no
ms
as may be specified by the Secu
ities and Exchange Boa
d of India fo
the
egist

ation of such company unde
sub-section (1) of section 12 of the Secu
ities and
Exchange Boa
d of India Act, 1992 (15 of 1992); the di
ecto
s of such company a

e not disqualified fo
being membe
s of a stock exchange unde
clause (1) of
u
le 8 [except sub-clauses (b) and (f) the
eof] o
clause (3) of
ule 8 [except su
b-clauses (a) and (f) the
eof] of the Secu
ities Cont
acts (Regulation) Rules, 1
957 and the di
ecto
s of the company had not Minimum age : 21 yea
s Maximum age
: 60 yea
s Indian Citizen At least a g
aduate o
equivalent qualification Should
have a minimum expe
ience in as p
esc
ibed by Secu
ities and Exchange Boa
d of
India
Minimum age : 21 yea
s (applicable fo
pa
tne
s) Registe
ed Pa
tne
ship fi
m und
e
Indian Pa
tne
ship Act, 1932 Pa
tne
s should be at least a g
aduate o
equiva
lent qualification Should have a minimum expe
ience in as p
esc
ibed by Secu
iti
es and Exchange Boa
d of India
iii.
61
held the offices of the di
ecto
s in any company which had been a membe
of the
stock exchange and had been decla
ed defaulte
o
expelled by the stock exchange
. C
ite
ia AGE STATUS EDUCATION
Minimum age : 21 yea
s (applicable fo
di
ecto
s) Co
po
ate
egiste
ed unde
The
Companies Act, 1956 (Indian) Two Di
ecto
s (Designated di
ecto
s) should be at
least g
aduate o
equivalent qualification
DESIGNATED Should have a minimum expe
ience in as p
esc
ibed by Secu
ities and E
xchange DIRECTORS Boa
d of India EXPERIENCE MINIMUM PAID UP As stipulated by the
Exchange EQUITY CAPITAL P
ofessional Clea
ing Membe
The following pe
sons a
e
eligible to become PCMs fo
Cu

ency Futu
es De
ivatives p
ovided they fulfill t
he p
esc
ibed c
ite
ia: 1. SEBI Registe
ed Custodians; and 2. Banks Banks Banks
autho
ized by the Rese
ve Bank of India unde
section 10 of the Fo
eign Exchange
Management Act, 1999 as ‘AD Catego
y - I bank’ a
e pe
mitted to become t
ading
and clea
ing membe
s of the cu

ency futu
es ma
ket of the
ecognized stock exch
anges, on thei
own account and on behalf of thei
clients, subject to fulfillin
g the following minimum p
udential
equi
ements: a) Minimum net wo
th of Rs. 500
c
o
es. b) Minimum CRAR of 10 pe
cent. c) Net NPA should not exceed 3 pe
cent
. d) Made net p
ofit fo
last 3 yea
s. The AD Catego
y - I banks which fulfill t
he p
udential
equi
ements a
e
equi
ed to lay down detailed guidelines with the
app
oval of thei
Boa
ds fo
t
ading and clea
ing in cu

ency futu
es cont
acts
and management of
isks. AD Catego
y - I banks which do not meet the above mini
mum p
udential
equi
ements and AD Catego
y - I banks which a
e U
ban Co-ope
ati
ve banks o
State Co-ope
ative banks can pa
ticipate in the cu

ency futu
es ma

ket only as clients, subject to app
oval f
om the
espective
egulato
y Depa
tme
nts of the Rese
ve Bank. Othe
applicable eligibility c
ite
ia 1. Whe
e the appl
icant is a pa
tne
ship fi
m/co
po
ate entity, the applicant shall identify a Dom
inant P
omote
G
oup as pe
the no
ms of the Exchange at the time of making the
application. Any change in the
62
sha
eholding of the company including that of the said Dominant P
omote
G
oup o

thei
sha
eholding inte
est shall be effected only with the p
io
pe
mission o
f the Exchange/SEBI. 2. The applicant has to ensu
e that at any point of time th
ey would ensu
e that at least individual/one pa
tne
/one designated di
ecto
/com
pliance office
would have a valid ce
tification as pe
the
equi
ements of the
Exchange. The above no
m would be a continued admittance no
m fo
membe
ship of
the Exchange. 3. An applicant must be in a position to pay the membe
ship and ot
he
fees, deposits etc, as applicable at the time of admission within th
ee mont
hs of intimation to him of admission as a T
ading Membe
o
as pe
the time sche
dule specified by the Exchange. 4. The t
ading membe
s and sales pe
sons in the
cu

ency futu
es ma
ket must have passed a ce
tification p
og
amme which is cons
ide
ed adequate by SEBI. The app
oved use
s and sales pe
sonnel of the t
ading m
embe
should have passed the ce
tification p
og
amme. 5. At p
esent, FIIs and NR
Is would not be pe
mitted to pa
ticipate in cu

ency futu
es ma
ket. 6. St
ict e
nfo
cement of “Know You
Custome
” (KYC)
ule is
equi
ed. The
efo
e eve
y clien
t shall be
egiste
ed with the membe
. The membe
s a
e also
equi
ed to make the
i
clients awa
e of the
isks involved in de
ivatives t
ading by issuing to the
client the Risk Disclosu
e Document and obtain a copy of the same duly acknowled
ged by the client. The membe
s shall ente
into a membe
constituent ag
eement a
s stipulated. 7. The Exchange may specify such standa
ds fo
investo
se
vice an
d inf
ast
uctu
e with
ega
d to any catego
y of applicants as it may deem necess
a
y, f
om time to time. Who cannot become a membe
? No entity shall be admitted
as a membe
/pa
tne
o
di
ecto
of the membe
if a. It has been adjudged bank
up
t o
a
eceive
o
de
in bank
uptcy has been made against him o
he has been p
o
ved to be insolvent even though he has obtained his final discha
ge; b. it has c
ompounded with his c
edito
s fo
less than full discha
ge of debts; c. it has be
en convicted of an offence involving a f
aud o
dishonesty;
d. it is engaged as a p
incipal o
employee in any business othe
than that of S
ecu
ities, except as a b
oke
o
agent not involving any pe
sonal financial liab
ility o
fo
p
oviding me
chant banking, unde
w
iting o
co
po
ate o
investment
adviso
y se
vices, unless he unde
takes to seve
e its connections with such bus
iness on admission, if admitted; e. it has been at any time expelled o
decla
ed
a defaulte
by any othe
Stock Exchange o
he has been deba

ed f
om t
ading in
secu
ities by an Regulato
y Autho
ities like SEBI, RBI etc; f. it incu
s such d
isqualification unde
the p
ovisions of the Secu
ities Cont
act (Regulations) Ac
t, 1956 o
Rules made the
e-unde
so as to disentitle such pe
sons f
om seeking
membe
ship of a stock exchange;
g. it incu
s such disqualification consequent to which the Exchange dete
mines i
t to be not in public inte
est to admit him as a membe
on the Exchange, p
ovide
d that in case of
egiste
ed fi
ms, body co
po
ates and companies, the condition
f
om (will apply to all pa
tne
s in case of pa
tne
ship fi
ms, all di
ecto
s in
case of companies) the Exchange may f
om time to time modify
63
/ expand the scope of activities that could be conside
ed as
elevant expe
ience
fo
the above pu
pose. Fu
the
, the Exchange
ese
ves the
ight to accept o

e
ject any application o
amend the te
ms and conditions without assigning any
ea
son whatsoeve
. Fo
ms of collate
als acceptable by the Clea
ing Co
po
ation Memb
e
s have to fulfill ce
tain
equi
ements and p
ovide collate
al deposits to the
Clea
ing Co
po
ation. All collate
al deposits a
e seg
egated into cash component
and non-cash component. Cash component means cash, bank gua
antee, fixed deposi
t
eceipts, T
easu
y bills and dated gove
nment secu
ities. Non-cash component m
ean all othe
fo
ms of collate
al like app
oved demat secu
ities.
Requi
ements to become autho
ized / app
oved use
T
ading membe
s and pa
ticipan
ts a
e entitled to appoint, with the app
oval of the Cu

ency De
ivatives segmen
t of the exchange, autho
ized pe
sons and app
oved use
s to ope
ate the t
ading
wo
kstation(s). These autho
ized use
s can be individuals,
egiste
ed pa
tne
shi
p fi
ms o
co
po
ate bodies. These Autho
ized Pe
sons cannot collect any commiss
ion o
any amount di
ectly f
om the clients they int
oduce to the t
ading membe

who appointed him. Howeve
they can
eceive a commission o
any such amount f
o
m the t
ading membe
who appointed them as p
ovided unde

egulation.
64
CHAPTER 8 ACCOUNTING AND TAXATION
8.1 ACCOUNTING
The Institute of Cha
te
ed Accountants of India (ICAI) has issued guidance notes
on accounting of index futu
es cont
acts f
om the view point of pa
ties who ent
e
into such futu
es cont
acts as buye
s o
selle
s. Fo
othe
pa
ties involved
in the t
ading p
ocess, like b
oke
s, t
ading membe
s, clea
ing membe
s and clea

ing co
po
ations, a t
ade in cu

ency de
ivatives is simila
to a t
ade in, say
sha
es, and does not pose any peculia
accounting p
oblems. It is not clea
, as
of now, whethe
any sepa
ate guidance notes would be issued fo
cu

ency de
iva
tives. If issued, pa
ticipants will have to conside
such guidance shall p
evail
. Hence in this section, just as a pa
allel on the lines of guidelines fo
equit
y de
ivatives, we shall la
gely focus on the accounting t
eatment of cu

ency fu
tu
es in the books of the client. But befo
e we do so, a quick
e-look at some o
f the te
ms used. 1. Clea
ing co
po
ation/house: Clea
ing co
po
ation/house mean
s a clea
ing co
po
ation/house app
oved by SEBI fo
clea
ing and settlement of t

ades on the cu

ency de
ivatives exchange/segment. 2. Clea
ing membe
: Clea
ing
membe
means a membe
of the clea
ing co
po
ation and includes all catego
ies o
f clea
ing membe
s as may be admitted as such by the clea
ing co
po
ation to the
cu

ency segment. 3. Client: A client means a pe
son, on whose inst
uctions and
on whose account, the t
ading membe
ente
s into any cont
act fo
the pu
chase
o
sale of any cont
act o
does any act in
elation the
eto. 4. Cont
act month:
Cont
act month means the month in which the exchange/clea
ing co
po
ation
ules

equi
e a cont
act to be finally settled. 5. Daily settlement p
ice: Daily settl
ement p
ice is the closing p
ice of the cu

ency futu
es cont
act fo
the day o

such othe
p
ice as may be decided by the clea
ing house f
om time to time. 6.
Cu

ency De
ivatives exchange/segment: Cu

ency De
ivative exchange means an exc
hange app
oved by SEBI as a cu

ency de
ivative exchange. Cu

ency De
ivative se
gment means segment of an existing exchange app
oved by SEBI as cu

ency de
ivat
ive segment. 7. Final settlement p
ice: The final settlement p
ice is the closin
g p
ice of the cu

ency futu
es cont
act on the last t
ading day of the cont
act
o
such othe
p
ice as may be specified by the clea
ing co
po
ation, f
om time
to time. 8. Long position: Long position in a cu

ency futu
es cont
act means ou
tstanding pu
chase obligations in
espect of the cu

ency futu
es cont
act at an
y point of time. 9. Open position: Open position means the total numbe
of cu

e
ncy futu
es cont
acts that have not yet been offset and closed by an opposite po
sition. 10. Settlement date: Settlement date means the date on which the settlem
ent of outstanding obligations in a cu

ency futu
es cont
act a
e
equi
ed to be
settled as p
ovided in the Bye-Laws of the Cu

ency De
ivatives exchange/segmen
t. 11. Sho
t position: Sho
t position in a cu

ency futu
es cont
act means outst
anding sell obligations in
65

espect of a cu

ency futu
es cont
act at any point of time. 12. T
ading membe
:
T
ading membe
means a Membe
of the Cu

ency De
ivatives exchange/segment and

egiste
ed with SEBI. Accounting at the inception of a cont
act Eve
y client is

equi
ed to pay to the t
ading membe
/clea
ing membe
, the initial ma
gin dete
m
ined by the clea
ing co
po
ation as pe
the bye-laws/
egulations of the exchange
fo
ente
ing into cu

ency futu
es cont
acts. Such initial ma
gin paid/payable
should be debited to “Initial ma
gin - cu

ency futu
es account”. Additional ma

gins, if any, should also be accounted fo
in the same manne
. It may be mention
ed that at the time when the cont
act is ente
ed into fo
pu
chase/sale of cu

e
ncy futu
es, no ent
y is passed fo

eco
ding the cont
act because no payment is
made at that time except fo
the initial ma
gin. At the balance sheet date, the
balance in the ‘Initial ma
gin - cu

ency futu
es account’ should be shown sepa

ately unde
the head ‘cu

ent assets’. In those cases whe
e any amount has been
paid in excess of the initial/additional ma
gin, the excess should be disclosed
sepa
ately as a deposit unde
the head ‘cu

ent assets’. In cases whe
e instead
of paying initial ma
gin in cash, the client p
ovides bank gua
antees o
lodges
secu
ities with the membe
, a disclosu
e should be made in the notes to the fin
ancial statements of the client. Accounting at the time of daily settlement This
involves the accounting of payment/
eceipt of ma
k-to-ma
ket ma
gin money. Paym
ents made o

eceived on account of daily settlement by the client would be c
ed
ited/debited to the bank account and the co

esponding debit o
c
edit fo
the s
ame should be made to an account titled as “Ma
k-to-ma
ket ma
gin cu

ency futu

es account”. Some times the client may deposit a lump sum amount with the b
oke

/t
ading membe
in
espect of ma
k-toma
ket ma
gin money instead of
eceiving/pa
ying ma
k-to-ma
ket ma
gin money on daily basis. The amount so paid is in the na
tu
e of a deposit and should be debited to an app
op
iate account, say, “Deposit
fo
ma
k-toma
ket ma
gin account”. The amount of “ma
k-to-ma
ket ma
gin”
eceiv
ed/paid f
om such account should be c
edited/debited to “Ma
k-to-ma
ket ma
gin –
cu

ency futu
es account” with a co

esponding debit/c
edit to “Deposit fo
ma

k-to-ma
ket ma
gin account”. At the yea
-end, any balance in the “Deposit fo
ma

k-to-ma
ket ma
gin account” should be shown as a deposit unde
the head “cu

en
t assets”. Accounting fo
open positions Position left open on the balance sheet
date must be accounted fo
. Debit/c
edit balance in the “ma
k-to-ma
ket ma
gin
- cu

ency futu
es account”, maintained on global basis,
ep
esents the net amou
nt paid/
eceived on the basis of movement in the p
ices of cu

ency futu
es till
the balance sheet date. Keeping in view ‘p
udence’ as a conside
ation fo
p
epa

ation of financial statements, p
ovision fo
anticipated loss, which may be equ
ivalent to the net payment made to the b
oke
(
ep
esented by the debit balance
in the “ma
k-to-ma
ket ma
gin cu

ency futu
es account”) should be c
eated by de
biting the p
ofit and loss account. Net amount
eceived (
ep
esented by c
edit b
alance in the “ma
k-to-ma
ket ma
gin - cu

ency futu
es account”) being anticipa
ted p
ofit should be igno
ed and no c
edit fo
the same should be taken in the p

ofit and loss account. The debit balance in the said “ma
k-to-ma
ket ma
gin - c
u

ency futu
es account”, i.e., net payment made to the b
oke
, may be shown und
e
the head “cu

ent assets, loans and advances” in the balance sheet and the p

ovision c
eated the
e-against should be shown as a deduction the
ef
om. On the o
the
hand, the c
edit balance in the said account, i.e., the net amount
eceived
f
om the b
oke
, should be shown as a cu

ent liability unde
the head “cu

ent
liabilities and p
ovisions in the balance sheet”. Accounting at the time of fin
al settlement
66
This involves accounting at the time of final settlement o
squa
ing-up of the c
ont
act. At the expi
y of a se
ies of cu

ency futu
es, the p
ofit/loss, on fina
l settlement of the cont
acts in the se
ies, should be calculated as the diffe
e
nce between final settlement p
ice and cont
act p
ices of all the cont
acts in t
he se
ies. The p
ofit/loss, so computed, should be
ecognized in the p
ofit and
loss account by co

esponding debit/c
edit to “ma
k-to-ma
ket ma
gin - cu

ency
futu
es account”. Howeve
, whe
e a balance exists in the p
ovision account c
eat
ed fo
anticipated loss, any loss a
ising on such settlement should be fi
st cha

ged to such p
ovision account, to the extent of the balance available in the p

ovision account, and the balance of loss, if any, should be cha
ged to the p
ofi
t and loss account. Same accounting t
eatment should be made when a cont
act is
squa
ed-up by ente
ing into a
eve
se cont
act. It appea
s that, at p
esent, it
is not feasible to identify the cu

ency futu
es cont
acts. Acco
dingly, if mo
e
than one cont
act in
espect of the se
ies of cu

ency futu
es cont
acts to whi
ch the squa
ed-up cont
act pe
tains is outstanding at the time of the squa
ing o
f the cont
act, the cont
act p
ice of the cont
act so squa
ed-up should be dete

mined using Fi
st-In, Fi
st-Out (FIFO) method fo
calculating p
ofit/loss on squ
a
ing-up. On the settlement of a cu

ency futu
es cont
act, the initial ma
gin p
aid in
espect of the cont
act is
eleased, which should be c
edited to “Initial
ma
gin - cu

ency futu
es account”, and a co

esponding debit should be given t
o the bank account o
the deposit account (whe
e the amount is not
eceived). Ac
counting in case of a default When a client defaults in making payment in
espec
t of a daily settlement, the cont
act is closed out. The amount not paid by the
Client is adjusted against the initial ma
gin. In the books of the Client, the a
mount so adjusted should be debited to “ma
k-to-ma
ket - cu

ency futu
es accoun
t” with a co

esponding c
edit to “Initial ma
gin - cu

ency futu
es account”. T
he amount of initial ma
gin on the cont
act, in excess of the amount adjusted ag
ainst the ma
k-to-ma
ket ma
gin not paid, will be
eleased. The accounting t
eat
ment in this
ega
d will be the same as explained above. In case, the amount to
be paid on daily settlement exceeds the initial ma
gin the excess is a liability
and should be shown as such unde
the head ‘cu

ent liabilities and p
ovisions’
, if it continues to exist on the balance sheet date. The amount of p
ofit o
lo
ss on the cont
act so closed out should be calculated and
ecognized in the p
of
it and loss account in the manne
dealt with above. Disclosu
e
equi
ements The
amount of bank gua
antee and book value as also the ma
ket value of secu
ities l
odged should be disclosed in
espect of cont
acts having open positions at the y
ea
end, whe
e initial ma
gin money has been paid by way of bank gua
antee and/o

lodging of secu
ities. Total numbe
of cont
acts ente
ed and g
oss numbe
of u
nits of cu

ency futu
es t
aded (sepa
ately fo
buy/sell) should be disclosed in

espect of each se
ies of cu

ency futu
es. The numbe
of cu

ency futu
es cont

acts having open position, numbe
of units of cu

ency futu
es pe
taining to th
ose cont
acts and the daily settlement p
ice as of the balance sheet date should
be disclosed sepa
ately fo
long and sho
t positions, in
espect of each se
ies
of cu

ency futu
es.
67
8.2
TAXATION OF DERIVATIVE TRANSACTION IN SECURITIES
Taxation of P
ofit/Loss on de
ivative t
ansaction in secu
ities P
io
to Financi
al Yea
2005–06, t
ansaction in de
ivatives we
e conside
ed as speculative t
ans
actions fo
the pu
pose of dete
mination of tax liability unde
the Income-tax A
ct. This is in view of section 43(5) of the Incometax Act which defined speculat
ive t
ansaction as a t
ansaction in which a cont
act fo
pu
chase o
sale of any
commodity, including stocks and sha
es, is pe
iodically o
ultimately settled o
the
wise than by the actual delive
y o
t
ansfe
of the commodity o
sc
ips. How
eve
, such t
ansactions ente
ed into by hedge
s and stock exchange membe
s in co
u
se of jobbing o
a
bit
age activity we
e specifically excluded f
om the pu
vie
w of definition of speculative t
ansaction. In view of the above p
ovisions, mos
t of the t
ansactions ente
ed into in de
ivatives by investo
s and speculato
s w
e
e conside
ed as speculative t
ansactions. The tax p
ovisions p
ovided fo
diff
e
ential t
eatment with
espect to set off and ca

y fo
wa
d of loss on such t
a
nsactions. Loss on de
ivative t
ansactions could be set off only against othe
s
peculative income and the same could not be set off against any othe
income. Th
is
esulted in payment of highe
taxes by an assesse. Finance Act, 2005 has amen
ded section 43(5) so as to exclude t
ansactions in de
ivatives ca

ied out in a
“
ecognized stock exchange” fo
this pu
pose. This implies that income o
loss o
n de
ivative t
ansactions which a
e ca

ied out in a “
ecognized stock exchange”
is not taxed as speculative income o
loss. Thus, loss on de
ivative t
ansactio
ns can be set off against any othe
income du
ing the yea
. In case the same can
not be set off, it can be ca

ied fo
wa
d to subsequent assessment yea
and set
off against any othe
income of the subsequent yea
. Such losses can be ca

ied
fo
wa
d fo
a pe
iod of 8 assessment yea
s. It may also be noted that secu
ities
t
ansaction tax paid on such t
ansactions is eligible as deduction unde
Income
-tax Act, 1961.
68
CHAPTER 9 CODES OF CONDUCT AND INVESTOR PROTECTION MEASURES
9.1 ADHERENCE TO SEBI CODES OF CONDUCT FOR BROKERS/ SUB-BROKERS
All t
ading membe
s must at all times adhe
e to the Code of Conduct as specified
by the Secu
ities and Exchange Boa
d of India (Stock B
oke
s and Sub-B
oke
s) R
egulations, 1992. CODE OF CONDUCT FOR BROKERS A
egiste
ed b
oke
must at all ti
mes abide by the Code of Conduct as given below: I. Gene
al a) Integ
ity: A b
ok
e
should maintain high standa
ds of integ
ity, p
omptitude and fai
ness in the
conduct of all his business. b) Exe
cise of Due Skill and Ca
e: A b
oke
should
act with due skill, ca
e and diligence in the conduct of all his business. c) Ma
nipulation: A b
oke
should not indulge in manipulative, f
audulent o
deceptive
t
ansactions o
schemes o
sp
ead
umou
s with a view to disto
ting ma
ket equi
lib
ium o
making pe
sonal gains. d) Malp
actices: A b
oke
should not c
eate fa
lse ma
ket eithe
singly o
in conce
t with othe
s o
indulge in any act det
ime
ntal to the investo
s’ inte
est o
which leads to inte
fe
ence with the fai
and
smooth functioning of the ma
ket. A b
oke
should not involve himself in excess
ive speculative business in the ma
ket beyond
easonable levels. e) Compliance w
ith Statuto
y Requi
ements: A b
oke
should abide by all the p
ovisions of the A
ct and the
ules,
egulations issued by the Gove
nment, SEBI and the stock excha
nges f
om time to time as may be applicable to him. II. Duty to the client a) Ex
ecution of O
de
s: A b
oke
, in his dealings with the clients and the gene
al pu
blic, should faithfully execute the o
de
s fo
buying and selling of secu
ities
at the best available ma
ket p
ice. A b
oke
should p
omptly info
m his client a
bout the execution o
non-execution of an o
de
. b) Issue of Cont
act Note: A b

oke
should issue without delay to his client o
client of sub-b
oke
a cont
act
note fo
all t
ansactions in the fo
m specified by the exchanges. c) B
each of
T
ust: A b
oke
should not disclose o
discuss with any othe
pe
son o
make imp

ope
use of the details of pe
sonal investments and othe
info
mation of a conf
idential natu
e of the client which he comes to know in his business
elationshi
p. d) Business and Commission: (i) A b
oke
should not encou
age sales o
pu
cha
ses of secu
ities with the sole object of gene
ating b
oke
age o
commission.
69
(ii) A b
oke
should not fu
nish false o
misleading quotations o
give any othe

false o
misleading advice o
info
mation to the clients with a view of induci
ng him to do business and enabling himself to ea
n b
oke
age o
commission the
e
by. e) Business of Defaulting Clients: A b
oke
should not deal o
t
ansact busi
ness knowingly, di
ectly o
indi
ectly o
execute an o
de
fo
a client who has
failed to ca

y out his commitments in
elation to secu
ities with anothe
b
oke

. f) Fai
ness to Clients: A b
oke
, when dealing with a client, should disclose
whethe
he is acting as a p
incipal o
as an agent and should ensu
e at the sam
e time that no conflict of inte
est a
ises between him and the client. In the ev
ent of a conflict of inte
est, he should info
m the client acco
dingly and shoul
d not seek to gain a di
ect o
indi
ect pe
sonal advantage f
om the situation an
d should not conside
client’s inte
est infe
io
to his own. g) Investment Advic
e: A b
oke
should not make a
ecommendation to any client who might be expected
to
ely the
eon to acqui
e, dispose of,
etain any secu
ities unless he has
ea
sonable g
ounds fo
believing that the
ecommendation is suitable fo
such a cli
ent upon the basis of the facts, if disclosed by such a client as to his own sec
u
ity holdings, financial situation and objectives of such investment. The b
oke

should seek such info
mation f
om clients, whe
eve
he feels it is app
op
iate
to do so. h) Investment Advice in publicly accessible media: (i) A b
oke
o
an
y of his employees should not
ende
, di
ectly o
indi
ectly, any investment adv
ice about any secu
ity in the publicly accessible media, whethe

eal-time o
no
n
eal-time; unless a disclosu
e of his inte
est including thei
long o
sho
t p
osition in the said secu
ity has been made, while
ende
ing such advice. (ii) In
case, an employee of the b
oke
is
ende
ing such advice, he should also disclo
se the inte
est of his dependent family membe
s and the employe
including thei

long o
sho
t position in the said secu
ity, while
ende
ing such advice. (iii)
Competence of B
oke
: A b
oke
should have adequately t
ained staff and a

ange
ments to
ende
fai
, p
ompt and competent se
vices to his clients. III. B
oke
s
vis-à-vis othe
b
oke
s (a) P
otection of Clients Inte
ests: A b
oke
should ex
tend fullest coope
ation to othe
b
oke
s in p
otecting the inte
ests of his cli
ents. (b) T
ansactions with B
oke
s: A b
oke
should ca

y out his t
ansactions
with othe
b
oke
s and should comply with his obligations in completing the sett
lement of t
ansactions with them. (c) Adve
tisement and Publicity: A b
oke
shou
ld not adve
tise his business publicly unless pe
mitted by the exchange. (d) Ind
ucement of Clients: A b
oke
should not
eso
t to unfai
means of inducing clien
ts f
om othe
b
oke
s. (e) False o
Misleading Retu
ns: A b
oke
should not negl
ect o
fail o

efuse to submit the
equi
ed
etu
ns and not make any false o
m
isleading statement on any
etu
ns
equi
ed to be submitted to the Boa
d and the
exchange.
70
CODE OF CONDUCT FOR SUB-BROKERS The sub-b
oke
at all times abides by the Code o
f Conduct as given he
eunde
:
I. Gene
al
(a) Integ
ity: A sub-b
oke
should maintain high standa
ds of integ
ity, p
ompti
tude and fai
ness in the conduct of his business. (b) Exe
cise of Due Skill and
Ca
e: A sub-b
oke
should act with due skill, ca
e and diligence in the conduct
of his business.
II. Duty to the Client
1. Execution of O
de
s: (a) A sub-b
oke
, in his dealings with the clients and t
he gene
al public, should faithfully execute the o
de
s fo
buying and selling o
f secu
ities at the best available ma
ket p
ice. A sub-b
oke
should p
omptly in
fo
m his client about the execution o
non-execution of an o
de
. 2. Issue of Pu

chase o
Sale Notes: (a) A sub-b
oke
should issue p
omptly to his clients pu
c
hase o
sale notes fo
all the t
ansactions ente
ed into by him with his clients
. (b) A sub-b
oke
should not match the pu
chase and sale o
de
s of his clients
and each such o
de
must inva
iably be
outed th
ough a membe
-b
oke
of the sto
ck exchange with whom he is affiliated. 3. B
each of T
ust: A sub-b
oke
should
not disclose o
discuss with any othe
pe
son o
make imp
ope
use of the detail
s of pe
sonal investments and othe
info
mation of a confidential natu
e of the
client which he comes to know in his business
elationship. 4. Business and Comm
ission: (a) A sub-b
oke
should not encou
age sales o
pu
chases of secu
ities w
ith the sole object of gene
ating b
oke
age o
commission. (b) A sub-b
oke
shou
ld not fu
nish false o
misleading quotations o
give any othe
false o
mislead
ing advice o
info
mation to the clients with a view to induce him to do busines
s and enabling himself to ea
n b
oke
age o
commission the
eby. 5. Business of D
efaulting Clients: A sub-b
oke
should not deal o
t
ansact business knowingly,
di
ectly o
indi
ectly o
execute an o
de
fo
a client who has failed to ca

y
out his commitments and is in default with anothe
b
oke
o
sub-b
oke
. 6. Fai

ness to Clients: A sub-b
oke
, when dealing with a client, should disclose that
he is acting as an agent ensu
ing at the same time, that no conflict of inte
est
a
ises between him and the client. In the event of a conflict of inte
est, he s
hould info
m the client acco
dingly and should not seek to gain a di
ect o
indi

ect pe
sonal advantage f
om the situation and should not conside
clients’ inte

est infe
io
to his own. 7. Investment Advice: A sub-b
oke
should not make a

ecommendation to any client who might be expected to
ely the
eon to acqui
e, di
spose of,
etain any secu
ities unless he has
easonable g
ounds fo
believing t
hat
71
the
ecommendation is suitable fo
such a client upon the basis of the facts, if
disclosed by such a client as to his own secu
ity holdings, financial situation
and objectives of such investment. The sub-b
oke
should seek such info
mation
f
om clients, whe
eve
they feel it is app
op
iate to do so. 8. Investment Advic
e in publicly accessible media: (a) A sub-b
oke
o
any of his employees should
not
ende
, di
ectly and indi
ectly any investment advice about any secu
ity in
the publicly accessible media, whethe

eal-time o
non-
eal-time, unless a disc
losu
e of his inte
est including his long o
sho
t position in the said secu
ity
has been made, while
ende
ing such advice. (b) In case, an employee of the sub
-b
oke
is
ende
ing such advice, he should also disclose the inte
est of his de
pendent family membe
s and the employe
including thei
long o
sho
t position i
n the said secu
ity, while
ende
ing such advice. 9. Competence of Sub-b
oke
: A
sub-b
oke
should have adequately t
ained staff and a

angements to
ende
fai

, p
ompt and competent se
vices to his clients and continuous compliance with th
e
egulato
y system.
III. Sub-B
oke
s vis-à-vis B
oke
s
(a) P
otection of Clients Inte
ests: A sub-b
oke
should extend fullest coope
at
ion to his b
oke
in p
otecting the inte
ests of thei
clients. (b) T
ansactions
with B
oke
s: A sub-b
oke
should not fail to ca

y out his b
oking t
ansaction
s with his b
oke
no
should he fail to meet his business liabilities o
show ne
gligence in completing the settlement of t
ansactions with them. (c) Ag
eement b
etween sub-b
oke
, client of the sub-b
oke
and main b
oke
: A sub-b
oke
should
ente
into a t
ipa
tite ag
eement with his client and with the main b
oke
spec
ifying the scope of
ights and obligations of the b
oke
, sub-b
oke
and such cl
ient of the sub-b
oke
. (d) Adve
tisement and Publicity: A sub-b
oke
should not
adve
tise his business publicly unless pe
mitted by the exchanges. (e) Induceme
nt of Clients: A sub-b
oke
should not
eso
t to unfai
means of inducing client
s f
om othe
b
oke
s.
IV. Sub-b
oke
s vis-a-vis Regulato
y Autho
ities
(a) Gene
al Conduct: A sub-b
oke
should not indulge in dishonou
able, disg
acef
ul o
diso
de
ly o
imp
ope
conduct on the exchange no
shall he willfully obst

uct the business of the exchange. He should comply with the
ules, byelaws and

egulations of the stock exchange. (b) Failu
e to give Info
mation: A sub-b
oke

should not neglect o
fail o

efuse to submit to SEBI o
the exchange with whi
ch he is
egiste
ed, such books, special
etu
ns, co

espondence, documents, and
pape
s o
any pa
t the
eof as may be
equi
ed. (c) False o
Misleading Retu
ns:
A sub-b
oke
should not neglect o
fail o

efuse to submit the
equi
ed
etu
n
s and not make any false o
misleading statement on any
etu
ns
equi
ed to be s
ubmitted to SEBI o
the exchanges. (d) Manipulation: A sub-b
oke
should not ind
ulge in manipulative, f
audulent o
deceptive t
ansactions o
schemes o
sp
ead

umou
s with a view to disto
ting ma
ket equilib
ium o
making pe
sonal gains.

72
(e) Malp
actices: A sub-b
oke
should not c
eate false ma
ket eithe
singly o
i
n conce
t with othe
s o
indulge in any act det
imental to the public inte
est o

which leads to inte
fe
ence with the fai
and smooth function of the ma
ket me
chanism of the stock exchanges. A sub-b
oke
should not involve himself in exces
sive speculative business in the ma
ket.
9.2
ADHERENCE TO CODES OF CONDUCT SPECIFIC TO ETCF SEGMENT
Exchange
egulations specify codes of conduct
elated to the ETCF segment. All t

ading membe
s must comply with these. These a
e detailed below. GENERAL PRINCIP
LES (a) A T
ading Membe
shall make adequate disclosu
es of
elevant mate
ial in
fo
mation in his dealings with his clients. (b) No T
ading Membe
o
pe
son asso
ciated with the T
ading Membe
shall gua
antee a client against a loss in any t

ansactions effected by the T
ading Membe
fo
such client. (c) P
ofessionalism:
A T
ading Membe
in the conduct of his business shall obse
ve high standa
ds of
comme
cial honou
of just and equitable p
inciples of t
ade. (d) Adhe
ence to T

ading P
actices: T
ading Membe
s shall adhe
e to the Rules, Regulations and Bye
- laws of the Exchanges and shall comply with such ope
ational pa
amete
s,
ulin
gs, notices, guidelines and inst
uctions of the Relevant Autho
ity as may be app
licable f
om time to time. (e) Honesty and Fai
ness: In conducting his business
activities, a T
ading Membe
shall act honestly and fai
ly, in the best inte
est
s of his constituents. (f) Capabilities: A T
ading Membe
shall have and employ
effectively the
esou
ces and p
ocedu
es which a
e needed fo
the p
ope
pe
fo
m
ance of his business activities. TRADING PRINCIPLES (a) T
ading Membe
s/Pa
ticip
ants shall ensu
e that the fiducia
y and othe
obligations imposed on them and t
hei
staff by the va
ious statuto
y acts,
ules and
egulations is complied with
. (b) T
ading Membe
s/Pa
ticipants shall ensu
e – (i) that any employee who comm
its the T
ading Membe
s o
Pa
ticipants to a t
ansaction has the necessa
y autho

ity to do so. (ii) that employees a
e adequately t
ained in ope
ating in the
e
levant ma
ket segment in which they deal, a
e awa
e of thei
own, and thei
o
ga
nization’s
esponsibilities as well as the
elevant statuto
y acts gove
ning the
T
ading Membe
, the Rules, Regulations and Bye-laws of the Cu

ency De
ivatives
Segments of the Exchanges including any additions o
amendments the
eof. (c) A
T
ading Membe
shall be
esponsible fo
all the actions including t
ades o
igina
ting th
ough o
with the use of all following va
iables - T
ading Membe
Id and
Use
Id, at that point of time. Howeve
if the T
ading Membe
satisfies the Cu


ency De
ivatives Segment of the Exchanges that the action(s) and/o
t
ade(s) too
k place due to f
aud o
mis
ep
esentation by any othe
pe
son othe
than his aut
ho
ized pe
son(s) and that the action(s) and/o
t
ades did not o
iginate f
om an
y of his app
oved wo
kstations, the Cu

ency De
ivatives
73
Segment of the Exchanges may issue such di
ections as they conside
s just and
e
asonable. The di
ections may include
efe

ing the matte
to a
bit
ation and/o

annulment of t
ade(s) so affected. (d) When ente
ing into t
ansactions on behalf
of constituents, the T
ading Membe
s shall ensu
e that they abide by the Code o
f Conduct and
egulations. (e) No T
ading Membe
o
pe
son associated with a T
a
ding Membe
shall make imp
ope
use of constituent’s secu
ities/positions in de

ivatives cont
acts o
funds. (f) No T
ading Membe
shall publish and ci
culate o

cause to be published o
ci
culated, any notice, ci
cula
, adve
tisement, news
pape
a
ticle, investment se
vice o
communication of any kind which pu
po
ts to

epo
t any t
ansaction as a pu
chase o
sale of any de
ivatives cont
acts unles
s such T
ading Membe
can establish if called fo
, that such t
ansaction was a b
onafide pu
chase o
sale of such cont
act; o
which pu
po
ts to quote the pu
cha
se/sale p
ice fo
any de
ivatives cont
act unless such T
ading Membe
can establ
ish if called fo
that such quotation
ep
esents a bonafide o
de
of such de
iva
tives cont
act. (g) When ente
ing into o
a

anging a t
ansaction, T
ading Membe

s must ensu
e that at all times g
eat ca
e is taken not to mis
ep
esent in any
way, the natu
e of t
ansaction. (h) No T
ading Membe
shall exe
cise any disc
et
iona
y powe
in a constituent’s account unless such constituent has given p
io

w
itten autho
isation to a stated individual o
individuals and the account has
been accepted by the T
ading Membe
, as evidenced in w
iting by the T
ading Memb
e
. (i) A T
ading Membe
shall not act as a p
incipal o
ente
into any ag
eemen
t o
a

angement with a constituent o
constituent’s agents, employees o
any ot
he
pe
son connected to the constituent, employee o
agency, whe
eby special o

unusual
ates a
e given with an intent to give special o
unusual advantage to s
uch constituent fo
the pu
pose of secu
ing his business. (j) The T
ading Membe

shall not disclose the name and beneficial identity of a constituent to any pe

son except to the Cu

ency De
ivatives Segment of the Exchanges as and when
equ
i
ed by it. (k) The facility of placing o
de
s on ‘P
o-account’ th
ough t
ading
te
minals shall be availed by the T
ading Membe
s only at one location of the T

ading Membe
s as specified /
equi
ed by the T
ading Membe
s. Any t
ading te
min
al located at a place othe
than the above location shall have a facility to pla
ce o
de
only fo
and on behalf of a Constituent by ente
ing client code details
as
equi
ed/specified by the Exchange / SEBI. In case any T
ading Membe

equi

es the facility of using ‘P
o-account’ th
ough t
ading te
minals f
om mo
e than
one location, such T
ading Membe
shall
equest the Exchange stating the
eason
fo
using the ‘P
o-account’ at multiple locations and the Exchange may, on a cas
e to case basis afte
due diligence, conside
extending the facility of allowing
use of ‘P
o-account’ f
om mo
e than one location. GENERAL GUIDELINES A T
ading
Membe
shall desist f
om the following t
ading p
actices while conducting busine
ss on the Cu

ency De
ivatives Segment of the Exchanges. (a) Shielding o
Assist
ing: No T
ading Membe
shall shield o
assist o
omit to
epo
t any othe
T
adin
g Membe
whom he has known to have committed a b
each o
evasion of any Rules, B
ye-Laws o
Regulations of the Cu

ency De
ivatives Segment of the Exchanges o
o
f any
esolution, o
de
, notice o
di
ection the
eunde
of the Gove
ning Boa
d o

the Managing Di
ecto
o
of any committee o
office
of the Cu

ency De
ivativ
es Segment of the Exchanges autho
ised in that behalf.
74
(b) Suspended de
ivatives cont
acts Except with the pe
mission of the Cu

ency D
e
ivatives Segment of the Exchanges, business shall not be t
ansacted by the T
a
ding Membe
in de
ivatives cont
acts which have been suspended f
om official quo
tation. (c) Misleading T
ansactions A T
ading Membe
shall not (i) make bids and
/o
offe
s fo
de
ivatives cont
acts with an intention of c
eating a false o
mi
sleading appea
ance with
espect to the ma
ket fo
, o
the p
ice of any de
ivati
ves cont
acts, (ii) make a t
ansaction o
give an o
de
fo
the pu
chase o
sale
of de
ivatives cont
acts, the execution of which would involve no change of ben
eficial owne
ship, unless the T
ading Membe
had no knowledge that the t
ansacti
on would not involve a change in the beneficial owne
ship of de
ivatives cont
ac
ts. (d) Use of info
mation obtained in Fiducia
y Capacity A T
ading Membe
who i
n the capacity of paying agent, t
ansfe
agent, t
ustee, o
in any othe
simila

capacity, has
eceived info
mation as to the pu
chase/sale of de
ivatives cont

acts, shall unde
no ci
cumstance make use of such info
mation fo
the pu
pose o
f soliciting pu
chases/sales except at the
equest and on behalf of the issue
,
if any.
9.3
GRIEVANCE REDRESSAL MECHANISM FOR INVESTORS
Each Exchange has a p
ocess fo
G
ievance Red
essal. The gene
al featu
es of the
se p
ocesses a
e mentioned below. Investo
G
ievance Resolution Mechanism (again
st t
ading membe
s) All exchanges have a dedicated depa
tment to handle g
ievanc
es of investo
s against the T
ading Membe
s and Issue
s. Gene
ally these depa
tm
ents ope
ate f
om all offices of the exchange so as to p
ovide easy access to in
vesto
s. All exchanges also have supe
vision mechanisms fo
the functioning of t
his depa
tment/ cell. These include the Investo
Se
vice Committees (ISC) consis
ting of Exchange officials and independent expe
ts whose nomination is app
oved
by Secu
ities and Exchange Boa
d of India. SEBI also monito
s exchange pe
fo
man
ce
elated to investo
g
ievance
ed
essal. P
ocess Receipt of complaints The in
vesto
is
equi
ed to submit his complaint in the p
esc
ibed complaint fo
m agai
nst the t
ading membe
p
oviding the details as specified in the inst
uctions an
nexed to the complaint
egist
ation fo
m along with suppo
ting documents substan
tiating his claim. On
eceipt of the complaint, exchanges sc
utinize the natu
e
of complaint and adequacy of documents submitted along with the complaint. If al
l the
elevant documents a
e submitted, the complaint is
eco
ded, a complaint n
umbe
is assigned and an acknowledgement towa
ds
eceipt of complaint is sent to
the investo
. If the documents a
e inadequate, the investo
is advised to set

ight the deficiencies in the documents.
75
Red
essal of complaints Gene
ally, exchanges initially t
y to
esolve the compla
int by following up with the membe
and the complainant. The issues
aised by th
e complainant a
e analyzed and the complaint is taken up the conce
ned t
ading m
embe
fo

esolution /
esponse within the set timef
ame. Subsequently, the
esp
onse
eceived f
om the t
ading membe
is
eviewed. • • • If the T
ading Membe
h
as ag
eed with the contents of the complaint, he is advised to settle the matte

immediately and confi
m If the T
ading Membe
states that he has al
eady settle
d the complaint, p
oof of settlement is solicited and c
oss confi
mation is obta
ined f
om the investo
If the T
ading Membe

aises issues f
om his side, the co
mments a
e analyzed and fo
wa
ded to the investo
fo
his views and comments. If
diffe
ences pe
sist the Exchange holds meeting with the pa
ties at the Exchange
p
emises fo
expeditious
esolution of the complaints. Incase diffe
ences still
pe
sist the investo
is info
med that he may opt fo
A
bit
ation p
oceedings. I
f the T
ading Membe
has justifiable
easons fo
his actions which a
e within th
e
egulato
y f
amewo
k, the investo
is enlightened on the co

ect position on t
he matte
.
•
Natu
e of Complaints Exchanges p
ovide assistance if the complaints fall within
the pu
view of the Exchange and a
e
elated to t
ades that a
e executed on the E
xchange Platfo
m. These may be of the following types: • • Non-Receipt of Co
po

ate Benefit (Dividend/Inte
est/Bonus etc.) Complaints against t
ading membe
s on
account of the following :
◊ ◊ ◊ ◊ ◊ ◊ ◊ ◊ ◊
Non-receipt of funds / securities Non- receipt of documents such as member clien
t agreement, contract notes, settlement of accounts, order trade log etc. Non-Re
ceipt of Funds / Securities kept as margin Trades executed without adequate marg
ins Delay /non – receipt of funds Squaring up of positions without consent Unaut
horized transaction in the account Excess Brokerage charged by Trading Member /
Sub-broker Unauthorized transfer of funds from commodities account to other acco
unts etc.
•
Complaints in cases where the member has surrendered his membership and the comp
lainant has approached the Exchange before expiry of the time mentioned in the p
ublic notice
Exchanges may not take up the following types of complaints a. Complaints in res
pect of transactions which are already subject matter of Arbitration proceedings
, b. Complaints involving payment of funds and transfer of securities to entitie
s other than Trading Member,
76
c.
Claims for mental agony/harassment and expenses incurred for pursuing the matter
with the ISC,
d. Claims for notional loss, opportunity loss for the disputed period or trade,
e. Complaints pertaining to trades not executed on the Exchange by the complaina
nt, f. Claims of sub-broker/authorized persons for private commercial dealings w
ith the trading member,
g. Claims relating to transactions which are in the nature of loan or financing
which are not within the framework defined by the Exchange. Arbitration SEBI has
instructed the exchange to have arbitration committees so that differences, dis
putes and claims between trading members and investors can be settled effectivel
y and in a short time. Arbitration is also governed by Exchange Bye-laws. Arbitr
ation is a quasi judicial process of settlement of disputes between Trading Memb
ers, Investors, Subbrokers & Clearing Members and between Investors and Issuers
(Listed Companies). Generally the application for arbitration has to be filed at
the Arbitration Centres established by the exchanges. The parties to arbitratio
n are required to select the arbitrator from the panel of arbitrators provided b
y the Exchange. The arbitrator conducts the arbitration proceeding and passes th
e award normally within a period of three months from the date of initial hearin
g. The arbitration award is binding on both the parties. However, the aggrieved
party, within fifteen days of the receipt of the award from the arbitrator, can
file an appeal to the arbitration tribunal for re-hearing the whole case. On rec
eipt of the appeal, the Exchange appoints an Appellate Bench consisting of five
arbitrators who rehear the case and then give the decision. The judgment of the
Bench is by a ‘majority’ and is binding on both the parties. The final award of
the Bench is enforceable as if it were the decree of the Court. Any party who is
dissatisfied with the Appellate Bench Award may challenge the same only in a Co
urt of Law.
77
APPENDIX A
SAFEGUARDS FOR INVESTORS
Investors must understand the process that is required to be followed while
 tran
sacting on exchanges. Investors must also be aware of their rights vis- -vis tra
ding members. The following section contains some of these processes that must b
e understood before trading in the securities market. 1. Selecting a Broker/ Sub
- Broker Investors must deal only with a SEBI registered Broker / Sub - broker
after due diligence. Details of the registered brokers can be obtained from the
Exchange websites. 2. Entering into an Agreement with the Trading member (broker
)/ Sub-broker Investors must: • • • • • Fill in a Client registration form with
the Broker / Sub - broker Enter into Broker / Sub - broker - Client Agreement. T
his agreement is mandatory for all investors for registering as a client of a Tr
ading Member. Ensure the following before entering into an agreement: Carefully
read and understand the terms and conditions of the agreement before executing t
he same on a valid stamp paper of the requisite value. Agreement must be signed
on all the pages by the Client and the Member or their representative who has th
e authority to sign the agreement. Agreement has also to be signed by the witnes
ses by giving their names and addresses. Investors must note that Regulatory Aut
horities have not stipulated for execution of any document other than Broker/ Su
b - Broker / Client Agreement.
•
3. Transacting Investors must:
• •
Specify to the Broker / Sub - broker, the exchange through which the trade is to
be executed and maintain separate account for each exchange. Obtain a valid Con
tract Note from the Broker / Sub-broker within 24 hours of the execution of the
trade. Contract note is a confirmation of trade(s) done on a particular day for
and on behalf of a client in the prescribed format. It establishes a legally enf
orceable relationship between the Trading Member and his Client in respect of se
ttlement of trades executed on the exchange as stated in the Contract Note. Cont
ract Notes are made in duplicate, and the Trading Member and Client, both are pr
ovided one copy each. The Client is expected to sign on the duplicate copy of th
e Contract Note, confirming receipt of the original. The following are the presc
ribed types of contract notes.
79
◊
Contract Note - Form A - Contract Note issued where Member is acting for const
ituents as brokers/ agents. Contract Note - Form B - Contract Note issued by M
embers dealing with constituents as principals.
◊
•
Ensure that the Contract Note:
◊ ◊
Contains SEBI registration number of the Trading Member/ Sub – broker. Contains
details of trade such as, Order number, trade number, trade time, quantity, pric
e, brokerage, settlement number, and details of other levies. Shows trade price
separately from the brokerage charged. Shows brokerage within SEBI stipulated li
mits. As stipulated by SEBI, the maximum brokerage that can be charged is 2.5% o
f the contract price. This maximum brokerage is inclusive of the brokerage charg
ed by the sub-broker (Sub-brokerage cannot exceed 1.5% of the contract price). A
dditional charges that a Trading Member can charge include Service Tax on the br
okerage, any penalties arising on behalf of client and Securities Transaction Ta
x (STT). The brokerage, service tax and STT are indicated separately in the Cont
ract Note. Contains signature of authorised representative of the broker. Contai
ns arbitration clause stating jurisdiction of relevant courts.
◊ ◊
◊ ◊ ◊
4. Settlement Investors must:
• •
Ensure delivery of securities/ payment of money to the broker immediately upon g
etting the Contract Note for sale / purchase but in any case, before the prescri
bed pay-in-day. Give the Depository Participant (DP), Delivery out instruction
s to transfer the same from the beneficiary account to the pool account of broke
r through whom shares and securities have been sold, so as to deliver securities
from ‘demat’ account. The instructions must contain: details of the pool a/c of
broker to which the shares are to be transferred, details of security, quantity
etc. As per the requirement of depositories the Delivery out Instruction shou
ld be given at least 48 hours prior to the cut-off time for the prescribed secur
ities ‘pay-in’.
•
Give the Depository Participant (DP) ‘Delivery in instructions to accept shares
in beneficiary account from the pool account of broker through whom shares have
been purchased, so as to receive shares in the demat account. Ensure that the m
embers pay the money or securities to the investor within 24 hours of the payout
.
•
80
GENERAL DO S AND DON’TS FOR INVESTORS Investors must follow some Do’s and Don’ts
while transacting in the securities market. Given below are some general Do’s a
nd Don’ts for investors: Do’s Investors must:
• •
Always deal with the market intermediaries registered with SEBI / stock exchange
s. Carry out due diligence before registering as client with any intermediary. C
arefully read and understand the contents stated in the Risk Disclosure Document
, which forms part of the investor registration requirement for dealing through
brokers. Collect photocopies of all documents executed for registration as a cli
ent, immediately on its execution. Ensure that the documents or forms for regist
ration as Client are fully filled in. Give clear and unambiguous instructions to
their broker / agent / depository participant. Always insist on contract notes
from their brokers/sub-brokers. In case of doubt in respect of the transactions,
verify the genuineness of the same from the exchange. Always settle the dues th
rough the normal banking channels with the market intermediaries. Adopt trading
/ investment strategies commensurate with their risk-bearing capacity as all inv
estments carry some risk, the degree of which varies according to the investment
strategy adopted. Be cautious about securities which show a sudden spurt in pri
ce or trading activity, especially low price stocks. Remember that there are no
guaranteed returns on investment in the stock market. Read the terms and conditi
ons and understand the risk factors associated with the commodity market investm
ent Always keep copies of all investment documentation (e.g. application forms,
acknowledgements slips, contract notes). Send important documents by a reliable
mode (preferably through registered post) to ensure delivery. Ensure that they h
ave money and will be able to pay, before you buy. Ensure that they hold securit
ies and will be able to deliver, before they sell. Follow up diligently and prom
ptly e.g. If the required documentation is not received within a reasonable time
, investors must contact the concerned person at the Trading Member immediately.
• • • • • •
• • • • • • • •
81
Don’ts Investors must not: • • • • • • • • • • • • • • Deal with unregistered br
okers / sub - brokers, or other unregistered intermediaries. Execute any documen
ts with any intermediary without fully understanding its terms and conditions. L
eave the custody of their Demat Transaction slip book in the hands of any interm
ediary. Make any payments in cash Accept unsigned/ duplicate or incomplete contr
act notes Deal based on rumours or tips . Get swayed by promises of high return
s. Fall prey to promises of guaranteed returns. Get misled by guarantees of repa
yment of their investments through post-dated cheques. Get carried away by lurin
g advertisements of any nature in print and electronic media. Blindly follow med
ia reports on corporate developments, as some of these could be misleading. Blin
dly imitate investment decisions of others who may have profited from their inve
stment decisions. Forgo obtaining all documents of transactions, in good faith e
ven from people whom they ‘know’. Delay approaching concerned authorities in cas
e of a dispute. Written complaints must be filed with the Exchange as soon as po
ssible.
82
APPENDIX B
SAMPLE QUESTIONS
1) The market where currencies are traded is known as the ______. (a) Equity Mar
ket (b) Bond Market (c) Fixed Income Market (d) Foreign Exchange Market 2) The U
SD/CAD (US – Canadian Dollars) currency pair settles in _____ basis. (a) T+1 (b)
T+2 (c) T+3 (d) T+4 3) A derivatives contract cannot exist without an ________.
(a) Exchange (b) Underlying, be it equity, interest rate etc. (c) Increase in v
olatility (d) Increase in arbitrage 4) The first participants who traded in deri
vatives where those exposed to __________. (a) Exchange rate risk (b) Interest R
ate risk (c) Equity price risk (d) Commodity price risk 5) OTC Derivatives stand
for ________. (a) Over the Counter Derivatives (b) Outstanding Transaction Cred
it Derivatives (c) Options Trade Credit Derivatives (d) Commodity price risks 6)
There are no formal rules or mechanisms for ensuring market stability and integ
rity, and for safeguarding the collective interests of market participants. Whic
h type of Derivatives contracts are being referred to here? (a) Over the Counter
Derivatives (b) Exchange traded derivatives (c) Stock Futures (d) Commodity der
ivatives 7) In a currency pair, term currency is in the: (a) Numerator (b) Denom
inator
83
8) Bids and offers are for the: (a) Counter Currency (b) Term Currency (c) Base
Currency (d) All the above 9) A quotation for “dollar-rupee” means the dollar is
the: (a) Counter Currency (b) Term Currency (c) Base Currency (d) All the above
10) For most currencies, bid and offer quotes are presented to the fourth decim
al place usually called a: (a) Value (b) Quotes (c) Unit (d) Pip 11) The forward
rate for any two currencies is generally a function of their spot rate and: (a)
Trade Difference (b) Difference in the exchange rate (c) Interest rate differen
tial between them (d) Both B and C 12) The underlying for the currency futures c
ontract that is presently permitted is: (a) USD/INR (b) Euro/Dollar (c) Dollar/Y
en (d) Euro/INR 13) Closing price of USD/INR futures contract at the end of an a
ctive trading session will be calculated based on the: (a) Weighted average of t
he last 30 trades done in the last 60 minutes (b) Weighted average of the last 5
trades done in the last 60 minutes (c) Weighted average of all the trades done
in the last 30 minutes (d) Simple average of the last 30 trades done in the last
30 minutes 14) In Exchange-traded currency futures contracts, who acts as a cen
tral counterparty to all trades? (a) Government (b) Regulator (c) Market Maker (
d) Clearing House
84
15) If the numbers of trades during the last 30 minutes are less than 5, then th
e closing price is based on the: (a) Weighted average price of the last 5 trades
executed during the day. (b) Weighted average price of the last 10 trades execu
ted during the day. (c) Weighted average price of the last 15 trades executed du
ring the day. (d) Weighted average price of the last 25 trades executed during t
he day. 16) If the numbers of trades during the day are less than 5, then the cl
osing price is taken as the: (a) Weighted average price of the last 3 trades exe
cuted during the day. (b) Weighted average price of the last 4 trades executed d
uring the day. (c) Weighted average price of the last 2 trades executed during t
he day. (d) Weighted average of all trades executed during the day
17) Exchanges in India trade in Currency Options. True or False? (a) True (b) Fa
lse
18) (a) (b) (c) (d)
Arbitragers take advantage of ____ in the markets? Hedgers Volatility Mispricing
Speculators
19) On 15th January Mr. Arvind Sethi bought a January USD/INR futures contract w
hich cost him Rs.43,000. Each USD/INR futures contract is for delivery of USD100
0. The RBI reference rate for final settlement was fixed as 43.10. How much prof
it/loss did he make? (a) (+) Rs. 1000 (b) (+) Rs. 100 (c) (-) Rs.100 (d) (-) Rs.
1000
20) If you are bullish about the Indian Rupee, you would ____. (a) Short USD/INR
currency futures (b) Go long USD/INR currency futures (c) Buy Dollars (d) Say n
eutral since markets may turn volatile
21) Presume Mr. A is expecting a remittance for USD 5000 on 29 August. Wants to
lock in the foreign exchange rate today so that the value of inflow in Indian Ru
pee terms is safeguarded. Mr. A can do so by ________. (a) Buying five contracts
of USD/INR futures (b) Selling five contracts of USD/INR futures (c) Selling fi
ve thousand contracts of USD/INR futures (d) Buying five thousand contracts of U
SD/INR futures
85
22) On August 1, 2008, an active trader in the currency futures market expects I
NR will appreciate against USD, caused by softening of crude oil prices in the i
nternational market and hence helping India’s trade balance. On the basis of his
view, he should: (a) Go long on USD/INR futures contract (b) Go short on USD/IN
R futures contract (c) Do nothing (d) Both A and B
23) One year interest rates in US and India are say 5% and 10% respectively and
the spot rate of USD in India is Rs. 43. Then one year USD/INR futures fair valu
e is : (a) Rs. 41.25 (b) Rs. 43.70 (c) Rs. 42.65 (d) Rs. 41.63
24) Under normal circumstances the Futures price trades at a ____ price than the
Spot price : (a) Higher (b) Lower (c) Same price as spot (d) Depends on the typ
e of contract
25) Professional Clearing Members are one of the entities in the clearing and se
ttlement system of the Currency Derivatives Segment. True or False? (a) True (b)
False
26) There are designated currency future’s market makers assigned for making mar
kets in the Currency Derivatives Market Segment. True or False? (a) True (b) Fal
se
27) (a) (b) (c) (d)
The best buy order in the trading system is the order with the ______? Lowest qu
antity Highest quantity Lowest price Highest price
28) (a) (b) (c) (d)
If an order does not find a match in the trading system, it is _____. Removed fr
om the trading system after seven days Removed from the trading system at the en
d of the day Removed from the trading system on the expiry day Removed from the
trading system when the buyer / seller wishes
86
29) A client of a trading member is required to enter into _____ with the tradin
g member before he can commence trading. (a) An understanding (b) An arrangement
(c) Negotiations (d) An agreement
30) (a) (b) (c) (d)
A branch manager can define limits for ________. Dealers in his branch Any deale
rs The Corporate Manager The trading member
31) A Corporate manager is higher in the user hierarchy than the Branch Manager.
True or False? (a) True (b) False
32) While entering a stop loss order, one needs to specify the _____ (a) High pr
ice (b) Trigger price (c) Low price (d) Price band
33) The limit price is always set higher than the market price? True or False. (
a) True (b) False 34) (a) (b) (c) (d) Best sell order would be the one having th
e: Lower price than last traded price(LTP) Highest among the offer prices Lowest
among the offer prices Higher price than last traded price(LTP)
35) An Indian refiner enters into a contract to export 1000 barrels of oil with
payment to be received in US Dollar (USD) in next three months. His risk is: (a)
When INR weakens, he makes a loss (b) When INR weakens, he makes a profit (c) W
hen INR strengthens, he makes a profit (d) When INR strengthens, he makes a loss
87
36) The Currency Derivatives Segment trading system indicates the _____ for each
contract. (a) Client names (b) Basis (c) Arbitrage gain (d) Cost of carry 37) T
he Currency Derivatives Segment trading system has a ticker window. True or Fals
e. (a) True (b) False 38) Proprietary position : Buy 20*1000*40.0000 indicates :
(a) A Buy position of 20 contracts with contract size of 1000 and a price of Rs
. 40.0000 (b) A Buy position of 1000 contracts with contract size of 20 and a pr
ice of Rs. 40.0000 (c) A Buy position of 2000 contracts with contract size of 10
00 and a price of Rs. 40.0000 (d) A Buy position of 20000 contracts a price of R
s. 40.0000 39) In the Currency Derivatives Segment, clients positions are arriv
ed at by summing together _____positions of each individual client. (a) Gross (b
uy + sell) (b) Net (buy - sell) (c) Net or Gross (d) Client’s positions are not
taken into account in the Currency Derivatives Segment 40) For a USD/INR Currenc
y Futures contract, the previous day s settlement price is Rs.40.0000 and today
s settlement price is Rs.41.0000. An investor s ‘Sell’ position of 50 contracts
is brought forward from the previous day. What will be his market to market sett
lement value? (a) (-) Rs. 50,000 (b) (+) Rs. 50,000 (c) (-) Rs. 5,000 (d) (+) Rs
. 5,000 PLEASE NOTE THAT THESE ARE ONLY SAMPLE QUESTIONS PROVIDED AS A GUIDE TO
CANDIDATES AND MAY NOT BEAR ANY RESEMBLANCE TO QUESTIONS IN THE CERTIFICATION EX
AMINATION.
88
ANSWERS
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
(d) (a) (b) (d) (a) (a) (a) (c) (c) (b) (c) (a) (c) (d) (a) (d) (b) (c) (b) (a)
21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40
(b) (b) (d) (a) (a) (b) (d) (b) (d) (a) (a) (b) (b) (c) (d) (d) (a) (a) (b) (a)
Please visit www.nism.ac.in for more information about NISM and NISM Certificati
on Examinations.
89
APPENDIX C
EXCHANGES TRADING IN CURRENCY FUTURES
Bombay Stock Exchange (BSE) Bombay Stock Exchange Ltd., popularly known as BSE,
is the oldest stock exchange in Asia with a rich heritage. It was established as
"The Native Share & Stock Brokers Association" in 1875. BSE s pivotal and pre-
eminent role in the development of the Indian capital market is widely recognize
d. Today, BSE is the world s number ‘1’ exchange in terms of the number of liste
d companies and the world s 5th in transaction numbers. The BSE Index, SENSEX, i
s India s first stock market index that enjoys an iconic stature, and is tracked
worldwide. BSE provides an efficient and transparent market for trading in equi
ty, debt instruments and derivatives. It has a nation-wide reach with a presence
in more than 359 cities and towns of India. BSE also offers Currency Futures tr
ading (US Dollar- Indian Rupee contracts currently) through its Currency Derivat
ives Segment christened BSE-CDX. For more information please visit www.bseindia.
com. MCX Stock Exchange Ltd. (MCX – SX) MCX Stock Exchange Ltd. (MCX – SX) has b
een promoted by Multi Commodity Exchange of India Ltd. (MCX) and Financial Techn
ologies (India) Ltd (FTIL). MCX - SX’s currency derivatives segment commenced op
erations on 7th October, 2008, within the regulatory framework of Securities & E
xchange Board of India (SEBI) and Reserve Bank of India (RBI). The all-India ele
ctronic trading platform of MCX-SX offers participants the benefits of high liqu
idity, trade transparency, easy online accessibility and counterparty guarantee
through MCX – SX Clearing Corporation Ltd. (MCX-SX CCL), established on the line
s of global clearing corporations. MCX-SX has emerged as the first exchange in I
ndia to provide currency futures rates on a real-time basis through mobile acros
s all service providers, to publish a primer on currency futures trade for guida
nce of interested parties and to launch websites in various regional languages.
MCX – SX has also signed MOUs with various trade associations across India. For
more information please visit www.mcx-sx.com. National Stock Exchange (NSE) Nati
onal Stock Exchange (NSE) commenced operations in 1994 and provides a nationwide
electronic trading platform for various types of securities for investors under
one roof. These instruments are available for trading under different segments:
Wholesale Debt Market Segment; Capital Market Segment, Futures and Options Segm
ent and Currency Derivatives Segment. Derivatives trading at NSE commenced in th
e year 2000, and the product base includes trading in futures and options on S&P
CNX Nifty Index, CNX IT Index, Bank Nifty Index, CNX Nifty Junior Index, CNX 10
0 Index, Nifty Midcap 50 Index, S&P CNX Defty Index ; futures and options on aro
und 200 single stocks; and currency futures on the USD/INR contracts presently.
NSE’s trading presence is now in over 1,500 cities across India. NSE ranks 3rd i
n the world, in terms of number of transactions executed on a stock exchange; 2n
d in the world, in terms of the number of contracts traded in Single Stock Futur
es; 3rd in the world, in terms of number of contracts traded, in Stock Index Fut
ures; and 2nd in Asia, in terms of number of contracts traded, in equity derivat
ives instrument. For more information please visit www.nseindia.com.
91
LIST OF ABBREVATIONS
AG CAD CBOT CM CME CRAR CRR DP ETCF FEDAI FEMA FIFO FII FX GBP GDP ICAI INR IOC
KYC LTP MTM NOP NPA NRI OTC PAN PCM Pro/Cli RBI SC(R)A SDR SEBI SPAN STT TCM TM
TWS UCC USD USD/INR VaR Aggregate Gap Canadian Dollar Chicago Board of Trade Cle
aring Member Chicago Mercantile Exchange Capital Risk Adjusted Ratio Cash Reserv
e Ratio Depository Participant Exchange Traded Currency Futures Foreign Exchange
Dealers Association of India Foreign Exchange Management Act First-in First-out
Foreign Institutional Investor Foreign exchange Great Britain Pound Gross Domes
tic Product Institute of Chartered Accountants of India Indian Rupee Immediate o
r Cancel Know Your Customer Last Traded Price Mark-to-Market Net Open Position N
on Performing Assets Non-resident Indian Over-the-Counter Permanent Account Numb
er Professional Clearing Member Proprietary order / Client order Reserve Bank of
India Securities Contracts (Regulation) Act, 1956 Special Drawing Rights Securi
ties and Exchange Board of India Standard Portfolio Analysis of Risk Securities
Transaction Tax Trading-cum-Clearing Member Trading Member Trader Workstation Un
ique Client Code Us Dollar US Dollar – Indian Rupee Forex Transaction Value-at-R
isk
93
400 705 www.nism.ac.in