What are Currency Derivatives?
A currency future is a contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date.
Currency future contracts allow investors to hedge against foreign exchange risk. In India, Currency Derivatives are available on four currency pairs viz. US Dollars (USD), Euro (EUR), Great Britain Pound (GBP) and Japanese Yen (JPY).
Why Currency Futures?
Currency futures operate as traditional stock and commodity futures. There are many advantages to using them for hedging as well as speculating, some traders use these instruments for profit, just as they would use futures on the spot market.
To hedge means “to minimize loss or risk”. It means, taking a position in the futures market that is opposite to a position in the physical market, with a view to reduce or limit risk associated with unpredictable changes in the exchange rate.
It means locking in a profit by simultaneously entering into transactions in two or more markets where there is a price differential of the same underlying. If the relation between forward prices and futures price differs, it gives rise to arbitrage opportunities. If there is price differential between two exchanges, it gives rise to arbitrage opportunities.
Eligibility for trade in currency futures
Any resident Indian or company, including banks and financial institutions, can participate in the currency futures market. At present, foreign institutional investors and non-resident Indians are not permitted to participate in the currency futures market.