What are Currency Futures?
As long as there is global trade there will be global capital flows and countries will encroach into each other’s currencies. This necessitates the need for a vibrant currency market much like there is a commodity market. The currency futures market is a derivative of movement of exchange rate and interest rates.
A currency future contract thus is a legally binding agreement where one can buy or sell a financial instrument in the future at a price that has been agreed upon beforehand. Lots and delivery time of these currency futures are standardized.
Trading facility in currency futures is available to all resident individuals, HUFs and corporates who are eligible under the criteria mentioned under Foreign Exchange Management Act. Like other derivative markets, currency futures attract a margin and are subject to mark to market (MTM) and margin call.
The National Stock Exchange (NSE) introduced the currency futures segment in August 2008. Subsequently, BSE MCX SX joined the bandwagon and today it is a vibrant market witnessing a combined turnover of Rs 2000 crore daily as corporates throng into this market owing to easy access, liquidity and the opportunity to hedge their currency risks.
Now lets us see how the currency futures work
- An Indian resident invests $200,000 abroad for a year at the current rate of exchange ($1= Rs 62)
- Suppose his investments yield 20% returns in a year, he makes Rs 24.83 lakh rupees.
- However if the value of the rupee appreciates to Rs 60 , he will make a mere Rs 12 lakhs
- If he sells a 12 month futures contract at the spot price of Rs 62, amounting to $ 200,000, he could cover his losses by buying the dollar in the futures market.
- On the other hand if the rupee depreciates to say Rs 65, he can make up his losses in the futures market by the profits in the international market.
- Thus the investor is hedged against both a rise and fall in currency, therefore ensuring safe returns.
How can SMEs / MSMEs benefit from Currency Futures?
Most SMEs/MSMEs are exposed to considerable currency risk due to their exposure in FCCBs or foreign currency loans. In domestic markets banks consider SMEs/MSMEs risky and do notgive them favorable terms of lending if they seek bank loans. In these case, access to exchange traded futures help them cover their foreign exchange risk effectively. The similar phenomenon holds true for exporters who can hedge their currency risk and manage their own books without having to depend on the banking system.
Risks involved in Currency Futures Trading
Risk of currency futures mainly pertains to the movements in the currency exchange rate. There is no rule of thumb to determine in which direction the rates will move. A judgement will be based on the knowledge and understanding of the factors that affect currency rates. As an SME / MSME or a retail investor it is not only difficult to have a correct judgement of these rate fluctutations always. For effective currency risk management you can depend on the research carried out at Beeline and keep your portfolio well hedged against currency risks.
