What are currency derivatives?
Currency
derivatives are exchange-based futures and options contracts that allow
one to hedge against currency movements. Simply put, one can use a
currency future contract to exchange one currency for an another at a
future date at a price decided on the day of the purchase of the
contract. In India, one can use such derivative contracts to hedge
against currencies like dollar, euro, U.K. pound and yen. Corporates,
especially those with a significant exposure to imports or exports, use
these contracts to hedge against their exposure to a certain currency.
While
all such currency contracts are cash-settled in rupees, the Securities
and Exchange Board of India (SEBI), early this year, gave a go-ahead to
start cross currency contracts as well on euro-dollar, pound-dollar and
dollar-yen.
How can one trade in currency derivatives?
The
two national-level stock exchanges, BSE and the National Stock Exchange
(NSE), have currency derivatives segments. The Metropolitan Stock
Exchange of India (MSEI) also has such a segment but the volumes are a
fraction of that witnessed on the BSE or the NSE. One can trade in
currency derivatives through brokers. Incidentally, all the leading
stock brokers offer currency trading services too.
It is just like
trading in equity or equity derivatives segment and can be done through
the trading app of the broker. While a dollar-rupee contract size is
$1,000, one can trade by just providing the 2-3% margin.
Why were such derivatives introduced on exchange platforms?
Prior
to the introduction of currency derivatives on exchanges, there was
only the OTC – over the counter – market to hedge currency risks and
where forward contracts were negotiated and entered into. It was kind of
an opaque and closed market where mostly banks and financial
institutions traded. Exchange-based currency derivatives segment is a
regulated and transparent market that can be used by small businesses
and even individuals to hedge their currency risks
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