Assistant Professor, Department of Finance, University of Petroleum & Energy Studies Dehradun, Uttarakhand, India.Head, Center for Infrastructure & Project Finance, Research and Development Centre, College of Management and Economic Studies, University of Petroleum & Energy Studies Dehradun, Uttarakhand, India.
Derivatives play an integral role in helping companies to manage risk and are likely to occupy an increasingly prominent place at firms that are seeking shelter from the volatility of the financial markets. India moved away from pegged exchange rate to the Liberalized Exchange Rate Management System (LERMS) in 1992 and the market determined exchange rate regime in 1993 which is considered to be an important structural change in the exchange rate market. With increased volatility in exchange rate market and to mitigate risk arising out of it, currency futures was introduced in India in 2008 which is considered to be an also important structural change. This paper will mainly focus on the currency derivatives are largely utilized by the firms in order to minimize their exposure to fluctuation in foreign exchange. For currency derivative the underlying instrument could be a currency pair (1 or more) which forms a contract between the two parties. Also this paper aims to get through with currency derivatives trading in India, like how are the contracts formed, what exchanges do currency derivative trading, size of order etc. Another facet that would be discussed is hedging of the currency derivatives. Hedging is important for both Exporters and Importers to manage their foreign exchange risk. Apart from hedging through banks through forwards and options where collateral have to be kept to enter into trade transactions and agreements like ISDA etc need to be signed, one can enter into futures transactions for 1–3 months (which are liquid) through currency exchanges promoted by NSE and MCX. Hedging the inherent price risk arising from the storage of a commodity with a future market transaction is an effective means to control risk and therefore is an important rationale for the existence of organized future markets.
The major advantage of futures contracts is the existence of a liquid secondary market so they can be sold at any time on the open market and do not need to be held until maturity date.
Currency Futures are standardized instruments traded on exchanges that enable users to hedge price risk and/or take positions on how the underlying will move.USD/INR Futures are traded on NSE and MCX-SX and the volume has picked up tremendously over the last few months. It offers an excellent opportunity to resident individuals and corporate to hedge USD exposures or trade in the currency. Futures market provides for hassle-free operations with minimum transaction cost and especially beneficial for SME's and corporate which have issues obtaining limits with their bankers. This would also be discussed by minimum variance hedging model.
