InvestorQ : How are currency futures different from the forward rupee that the bank provides?
Arti Chavan made post

How are currency futures different from the forward rupee that the bank provides?

Answer
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2 years ago


Normally, retail investors don’t have access to forward markets. You need to be a fair sized business to access the forward market. On the other hand, the currency futures market can be accessed by anyone with a very small capital base. There are some basic parameters on which the futures market is different from the forwards market. Here are a few key areas of differences…

While the forward market is an OTC market, the futures market is an exchange traded market. That means contracts on the currency futures market tend to be structured by the exchange and guaranteed by the clearing corporation of the exchange. They are bought and sold on the exchange and the liquidity depends on the demand and the supply generated for the contract.

The futures market being a guaranteed market is free of counterparty risk. As mentioned earlier, all trades on the currency futures exchange are guaranteed by the clearing corporation. The rupee forward market being an OTC market does carry technical counterparty risk. However, since all the participants are large banks and institutions, this risk is more theoretical than real.

Transaction lot sizes are much smaller in the currency futures exchange. Most banks will not be willing to write a forward cover unless it has a certain minimum size. Also the cost of forward cover requires that it is of a minimum economical size to be viable to the banker and to the customer who may be an importer or an exporter.

A forward cover can only be taken against an underlying open currency position. Either you should have a foreign currency receivable or a foreign currency payable. There are no such conditions in the currency futures market. You can also take a view on the dollar or the Pound or the Euro and take a position in futures accordingly. In futures it is also possible to trade in the currency. For example, if you think that the dollar will strengthen then you can just go in and buy the USDINR futures or buy a call option on the USDINR. On the other hand, if you have a negative view on the USD; i.e. you expect the rupee to appreciate then you can just sell the USD INR futures or you can just buy a put option. The trading screen, order placement and the risk management are exactly like the equity and F&O trading screen and hence you are already familiar with it. While both the rupee forward market and the currency futures market can be used to hedge your currency risk, the forward market is a delivery market and all transactions must result in actual delivery or purchase of dollars. The currency futures market, on the other is a market where all transactions are settled in cash. Hence it is much easier to speculate in the currency futures market.