Risk Management in global currency markets by r5uhfBp


									Risk Management in Global Currency Markets

Introduction to Currency Markets
Indian Currency Markets
Basics in Currency Markets
Global Currency Markets
Fundamental Factors affecting USDINR
Over-the-Counter Currency Derivatives vs. Exchange Traded
Currency Derivatives
Managing Currency risk
Impact of USDINR Volatility on international Commodity prices
Technical Analysis Based Strategies
Introduction to Currency markets

•   Largest financial market in the world
•   ADTV globally is over US$ 3 trillion
•   Forex derivatives accounts for 40% of ADTV
•   Futures contracts introduced in 1972 at the CME
•   Minimum trading size for most deals is $100,000.
•   Forex as an asset class
•   Main trading centers are London, NY, Tokyo &

•   (and now…..MUMBAI)

•   Large banks
•   Central Banks
•   Government
•   Multinationals & Commercial Companies
•   Hedge Funds
•   Institutions
•   Retail Forex Brokers
•   Speculators
Top 10 Banks Account for 75% of Volumes

      May 2007
       Name            % of volume
  •   Deutsche Bank      19.3%
  •   UBS AG             14.8%
  •   Citi                9.0%
  •   RBS                 8.9%
  •   Barclays            8.8%
  •   BOA                 5.2%
  •   HSBC                4.4%
  •   Goldman Sachs       4.1%
  •   JPMorgan           3.3%
  •   Morgan Stanley     2.8%        Source: Euromoney FX survey
Indian Currency markets
Exchanges in India

 • NSE (29th Aug)

 • BSE (3rd Oct)

 • MCX-SX (7th Oct)
Exchanges in India

       21 Day Comparison from 1st Trading Day
                 Volume (Lots)         Value (Crs.)
                Average    Total    Average     Total

 MCX-SX        71241.76   1496077   349.38    7337.009

 NSE           56861.10   1194083   260.26     5465.46

 BSE            4624.95    97124     22.10    464.1764

MCX-SX, a subsidiary of Multi Commodity Exchange of India
Ltd (MCX) was inaugurated on 6th October 2008

Operates under the regulatory framework of Securities and
Exchange Board of India (SEBI) and Reserve Bank of India
    About MCX

•   MCX ranks among the world top 10 commodity futures
    exchange in 2007

•   It ranks no.1 in silver, no.2 in natural gas, and no.3 in gold,
    crude oil, and copper futures trading globally

•   MCX is ISO 27001:2005 certified, the global benchmark for
    information security systems.

•   MCX operates from over 600 cities with over 1,900 members
    and more than 52,000 trading stations

•   Over 50 globally benchmarked and domestic commodities are
    traded on MCX.

• Average daily turnover is Rs.18,000 crore.
• MCX has recorded a market share of over 85% during the first
  quarter of financial year 2008-09.
• MCX has strategic alliances with NYMEX, LME, TOCOM,
  NYSE Euronext, CCX, SHFE, and others.

 With 51% stake in MCX-SX, MCX will be key for bringing in
   the actual users of commodities to hedge their currency
                     exposure on MCX-SX
Currency Futures in India

 Concept – Standard volume of a particular currency to be
 exchanged on a specific settlement date
 Participation – corporates, banks, SME, individuals, investors,
 Intermediaries – brokers facilitate broader participation
 Leverage – Margining System
 No counterparty default risk –Effective and Efficient hedge
 Easy Settlement – in INR currency
 Real-time access – electronic trading platform
 Offset positions – without delivery
Basics in Currency markets
Few Terms

• Base Currency

• Term Currency

• Bid/Ask

• Pips

    Future Rate = So e (rd-rf) T


    So = Spot Rate
    rd = Domestic Rate of Interest
    rf = Interest Rate in the foreign country
    T = Tenure
Major Currencies across the Globe

    Symbol       Country       Currency   Nickname

     USD      United States     Dollar     Buck
     EUR      Euro members      Euro       Fiber
     JPY          Japan          Yen        Yen
     GBP       Great Britain    Pound      Cable
     CHF       Switzerland      Franc      Swissy
     CAD         Canada         Dollar     Loonie
     AUD        Australia       Dollar     Aussie
     NZD       New Zealand      Dollar      Kiwi
Global Currency markets
Global Foreign Exchange Markets:

   US$ 3.22 Trillion (Rs. 160 Lakh Crores) – Global
   daily foreign exchange trading turnover
   US$ 1.02 Trillion (Rs. 55 Lakh Crores) – Global
   daily spot transactions turnover
   Global OTC derivatives trading turnover is at US$ 2
   Trillion + (Rs. 105 Lakh Crores)
   Exchange Traded Foreign Currency Derivatives in
   2007 is 334.70 Million contracts – increase of
   39.43% over 2006 – US$ 100 Billion (Rs. 5 Lakh
   Crores) everyday
Leading Global Currency Derivatives

 Global premier FX exchanges
     CME (US), EURONEXT.LIFFE (Europe), BMF (Brazil),

 Other countries include Japan, Canada, Mexico, Russia, Turkey,
 Israel; More recently in South Africa and Korea

 CME is the largest FX exchange that offers
    US$ 80 Billion (INR 4 Lakh Crores) volumes on daily basis
    41 individual FX futures (incl. cross currencies)
    31 option products; operates 24-hours a day
    Both cash settled & delivery based products are available
Major Events in International and Indian Monetary System
1. Free float of currencies - 1973.
2. Oil crisis in 1973 - quadrupling of oil prices
3. European Currencies float against US$ - 1978
4. Post emergency years
5. Majority Govt. formed - 1984-85
6. Liberalization of Indian Economy: devaluation of INR - 1991
7. East and South East Asian Currency crisis - 1997
8. Nuclear tests by India - 1998
9. Robust economic growth in India
10. High crude oil and commodity prices
Need for Hedging against Currency
Volatility: USD / INR
Increasing Volatility of USD / INR

                                                Robust economic
                                                Policy Liberalization:
                                                ECB, FII, FDI
                                                Towards full capital
                                                Remittance Scheme

 SEBI-RBI have allowed trading in currency futures for the first time
          in India based on the USD / INR exchange rate.
Merchandize Trade
Increasing Imports and Exports:

                                  increase in demand
                                  for commodities
                                  Growing population
                                  merchandized trade
                                  and services
                                  Liberalization of
                                  Indian Economy
Speculation in Forex
 Price moves are two-way and nullify each other

  FX    0.5% every day but only 15-25% a year

  Equity 0 – 5% a day and up to 100% a year

   FX Market                             Equity Market
 Small but sure movements        Congestion & breakout
Immediate reversal               Persistent spikes
No “gaps” in price moves        “gaps” occur in trending
Predominantly day traders        L-T investors
Zero-sum Game for Speculators
 Total wealth is always constant
  Why?        FX = price of one currency in another

              Rise of one means the fall of the other

 Compare this to Equity Market

    Index        = wealth created
    Index        = wealth destroyed

This is the reason for boom & bust in equity market
Fundamental Factors Affecting USDINR
Factors Affecting USDINR
Factors which affect trading decisions

    Macro economic factors      Cross currency rates
    Monetary Policy              (USD, Euro, UK Pound, Yen)
    RBI intervention            Gold & Oil prices
    Strength of other           BOP position
     currencies                  Real Effective Exchange
    Performance of other         Rate
     markets                     Economic Indicators (GDP,
                                  Employment etc)
    Over-the-counter Markets
Exchange Traded Currency Markets
Advantages from Currency Futures

  Provide an additional tool for hedging currency risk.
  Further development of domestic foreign exchange market.
  Commodity traders can hedge in currency futures
  Provide a platform to retail segment of the market to ensure
  broad based participation based on equal treatment.
  Efficient method of credit risk transfer through the
  Create a market to facilitate large volume transactions to go
  through on an anonymous basis
Products Available

  Over the counter   Exchange traded

  • Spot             • Currency Futures
  • Forward          • Currency Options
  • Options
  • Swaps
Forward Vs. Futures

 Forward Contracts                    Future Contracts
 • OTC                            •    Exchange Traded
 • Counterparty risk              •    Exchange assumes risk
 • Terms of contract changeable   •    Terms defined by Exchange
 • Poor liquidity                 •    High Liquidity
 • Few Players                    •    Many Players
 • No Margins                     •    Margins
 • Settled by taking Physical     •    Generally Cash Settled
 • Relationship                   • Price Transparency
 • Skill to Structure             • Standard structure
 • No Regulations                 • Abide by Regulations
Need For Hedging Against Currency

   Increased demand / supply of foreign currency has
   increased hedge requirement
   Existing OTC Market Microstructure
   OTC markets require larger contract values– not within
   reach of SME
   Tighter Spreads for SME and individuals leads to higher
   transaction cost
   Counterparty default risk in OTC markets
Benefits of Currency Futures

  Linear Payoff – not complicated for market participants to
  Standardized Contracts, small lot size – US$ 1,000
  Electronic Settlement of MTM Profits / Losses
  No counterparty default risk – novation by clearing house
  Efficient price discovery due to high liquidity
  Large number of market participants
  Transparency – realtime dissemination of prices
  Access through internet from remote locations
Benefits of Currency Futures

 Additional tool for hedging currency risk
 Broader participation – leading to enlarged forex market
 Permit trades other than hedges with a view to moving gradually
 towards fuller capital account convertibility.
 Enhanced retail participation
 Efficient method of credit risk transfer through the Exchange
 Facilitate large volume transactions
 Trade match is anonymous
 Well regulated structure
 Ready national level reference rates at any point of time during
 trading hours
Contract Specification Snapshot

 Underlying                        USD / INR
 Trading Hours                     9:00 AM to 5:00 PM
 Size of Contract                  Minimum Lot Size is US$ 1,000
 Price Quotation                   In INR
 Tenor of Contract                 Maximum of 12 Months
 Available Contracts               Monthly
 Settlement Mechanism              In INR
 Settlement Reference Rate         RBI USD/INR Reference Rate

                                   Last working day of month, except
 Final Settlement Date             Saturday.
 Note: The above product specification is as per the RBI-SEBI Standing Technical
 Committee Report on Exchange Traded Currency Futures
Changes in Open Interest (OI), Price (P) & Volume (V)

    ‘V’ confirms the ‘P’ trend                       OI endorses it

  Price      Vol       OI        Indication

                              Strongly bullish

                              Topish   Last fool buying

                              Strongly bearish

                              Bottoming

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