LOVELY PROFESSIONAL UNIVERSITY

School of Mittal School of Business Faculty of

Name of the faculty member: Mr. Uday Bhaskara Sir

Course Code: FIN206 Course Title: CURRENCY DERIVATIVE

Academic Task No: 01 Academic Task Title: Assignment 01
Date of Allotment: 4/03/24 Date of Submission: 11/03/24
Student Roll No: RQ2113A05 Student Reg. No: 12111454
Term: 6 Section: Q2113
Max. Marks Marks. Obtained:
Evaluation Parameters

Declaration:
I declare that this Assignment is my work. I have not copied it from other students’
work or any other source except where due acknowledgment is made explicitly in
the text, nor has any part been written for me by any other person.

Evaluation Criterion: Rubrics on different parameters

Student’s Signature: Harsh KATAREY

Evaluator’s Comments (For Instructor’s use only)

General Observations Suggestions for The best part of the

Improvement assignment

Evaluator’s Signature and Date:

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 CONTENT

• INTRODUCTION OF CURRENCY DERIVATIVE

1. TYPES
2. SIMILARITIES BETWEEN DIFFERENT TYPES
3. DIFFERENCES BETWEEN DIFFERENT TYPES

• CURRENCY PAIR (USD-INR)

• MARKET ANALYSIS OF THE PAIR
• WHAT WILL HAPPEN IF THE EXCHANGE RATE OF INR BECOMES
STRONGER THAN ANY OTHER CURRENCY
• THE INTERTWINED RELATIONSHIP: INDIAN ECONOMY AND
RUPEE VALUE
• RECOMMENDATIONS & SUGGESTIONS
• CONCLUSION

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 INTRODUCTION
DERIVATIVE:

A derivative is a financial contract that gets its value from something else, called the underlying asset.
This underlying asset can be a variety of things, such as:

• Stocks

• Bonds

• Commodities (like oil or wheat)

• Currencies

• Even other financial instruments!

The key thing is that the derivative's price depends on the underlying asset's price. So, if the price of the
underlying asset goes up, the price of the derivative will typically go up (and vice versa).

CURRENCY DERIVATIVE:

A currency derivative is a specific type of derivative where the underlying asset is a currency. So, the
value of the derivative contract will depend on the exchange rate between the two currencies. This can
be useful for businesses that conduct international trade, as it allows them to lock in an exchange rate
today for a transaction that will take place in the future. For example, imagine a US company that
imports goods from China. The company agrees to pay 100,000 yuan in three months for a shipment of
supplies. The company is concerned that the yuan will appreciate (get stronger) relative to the US dollar
during that time. This would make the import more expensive for the US company. To hedge this risk,
the company could enter into a futures contract to buy 100,000 yuan in three months at today's
exchange rate. This way, the company knows exactly how much it will cost to pay for the shipment,
regardless of what happens to the exchange rate in the meantime.

There are several different types of currency derivatives, each with its unique features and risks. Here
are some of the most common:

• Futures contracts: These are agreements to buy or sell a certain amount of currency at a specific
price on a future date. Futures contracts are standardized exchange-traded contracts, meaning
that the terms of the contract are pre-determined by the exchange. This makes them highly
liquid and transparent. However, futures contracts also require a margin deposit, which is a
percentage of the total value of the contract that must be paid upfront. This can be a significant
amount of money, and it can be lost if the market moves against you.

• Options contracts: These give you the right, but not the obligation, to buy or sell a certain
amount of currency at a specific price by a certain date. Options contracts offer more flexibility
than futures contracts, as you are not obligated to complete the transaction if it becomes

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 unprofitable. However, options contracts also come with a premium, which is the price you pay
for the right to buy or sell the currency. This premium can be lost if the option expires
unexercised.

• Swaps: These are agreements between two parties to exchange cash flows in different
currencies. Swaps can be customized to meet the specific needs of the counterparties, and they
can be used for a variety of purposes, such as hedging foreign exchange risk, managing interest
rate risk, or speculating on currency movements.

IMPORTANCE OF CURRENCY DERIVATIVES:

Currency derivatives play a vital role in international finance by providing tools to manage risk, access
new opportunities, and enhance financial stability. Here's a deeper dive into their significance:

1. Risk Management (Hedging):

• Exchange Rate Fluctuations: International businesses are constantly exposed to fluctuations in

exchange rates. Currency derivatives, especially futures and options contracts, allow companies
to lock in an exchange rate today for a future transaction. This protects them from adverse
currency movements, ensuring predictable costs and profits. Imagine a US importer – a
derivative contract guarantees the exchange rate for paying a Chinese supplier in 3 months,
shielding them from a potential yuan appreciation.

2. Speculation and Profit Potential:

• Market Movements: Currency derivatives are not just for risk management; they can also be
used for speculation. Investors can profit by predicting and capitalizing on currency movements.
Options contracts allow for limited-risk speculation, where the maximum loss is the premium
paid. This can be attractive compared to directly buying and selling currencies on the spot
market.

3. Increased Liquidity and Efficiency:

• Active Trading: Currency derivatives create a more active and liquid foreign exchange market.
The existence of these contracts attracts more participants, leading to tighter bid-ask spreads
and more efficient price discovery. This benefits everyone involved in international trade and
finance.

4. Access to Leverage:

• Magnified Gains (and Losses): Some currency derivatives, particularly futures contracts, allow
for leverage. This means you can control a larger amount of currency with a smaller initial
investment. While leverage can amplify potential gains, it also magnifies potential losses. Careful
risk management is crucial when using leverage.

5. Tailored Solutions (Swaps):

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 • Customized Risk Management: Currency swaps offer a high degree of customization for complex
risk management needs. Companies can swap cash flows in different currencies, manage interest
rate exposure, or hedge specific foreign currency liabilities. This flexibility is invaluable for large
corporations operating internationally.

6. Price Discovery and Market Stability:

• Hedging Activities: The hedging activities facilitated by currency derivatives can contribute to
greater price stability in the foreign exchange market. By allowing businesses to lock in exchange
rates, derivatives can help to mitigate extreme currency fluctuations.

7. Global Financial Stability:

• Risk Transfer and Mitigation: Currency derivatives enable the transfer and mitigation of foreign
exchange risk between different market participants. This helps to spread risk more broadly and
promotes greater financial stability in the global financial system.

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SIMILARITIES BETWEEN DIFFERENT CURRENCY DERIVATIVES:

Feature Futures Contracts Options Contracts Swaps

Underlying Currency Pair (e.g.,

Asset EUR/USD)
Binding Agreement: Buyer
obligated to buy, seller
Contractual obligated to sell at pre-
Obligation determined price and date.
Hedging: Lock in the
Risk exchange rate for future
Management transactions.
Possible: Profit from predicted from predicted movements with Limited: Not typically used for
Speculation currency movements.
Currency Pair (e.g., EUR/USD) Currency Pair (e.g., USD/EUR)
Right, Not Obligation: Buyer Customized Agreement: Two
has the right, but not obligation, parties agree to exchange cash
to buy or sell at a pre- flows in different currencies,
determined price by expiry. terms are negotiable.
Hedging (Limited): Protect Hedging (Flexible): Manage
against adverse movements, complex foreign exchange
capped risk by premium paid. exposure and interest rate risk.
Possible (Limited Risk): Profit
capped potential loss. pure speculation.

DIFFERENCE BETWEEN DIFFERENT TYPES OF CURRENCY DERIVATIVES

Type Description Obligation Flexibility Risk Example

Agreement to buy/sell US company locks in
Futures currency at a fixed price High (Margin exchange rate for yuan
Contract on a future date Mandatory Low deposit at risk) payment in 3 months
Right, but not obligation, to Moderate Investor buys option to
Options buy/sell currency at a fixed High (Flexible (Premium lost if profit from potential Euro
Contract price by expiry Optional entry/exit) unused) appreciation
Customized agreement to Variable The company uses
exchange cash flows in High (Tailored (Depends on swaps to hedge foreign
Swap different currencies Negotiable solutions) swap type) currency debt exposure

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 MOST ACTIVE CURRENCY PAIRS TRADED IN INDIAN MARKET
In the Indian forex market, the most actively traded currency pair is USD/INR (US Dollar - Indian Rupee).
This means a significant portion of the trading volume happens with this pair.

Here are some reasons why USD/INR is the most popular:

• The US Dollar's Global Importance: The US Dollar is the world's reserve currency, making it
highly liquid and traded globally. This translates to a large pool of participants in the USD/INR
market.

• India's Trade Dependence: India engages significantly in international trade, and USD is a major
settlement currency for global commodities. This economic activity fuels demand for USD/INR
trading.

• Stability Compared to Other INR Pairs: Compared to other currency pairs with INR, like EUR/INR
or GBP/INR, USD/INR is seen as relatively stable. This attracts traders seeking predictability.

While USD/INR is the leader, other currency pairs are also traded in India, including:

• EUR/INR (Euro - Indian Rupee)

• GBP/INR (British Pound - Indian Rupee)

• JPY/INR (Japanese Yen - Indian Rupee)

These pairs have their own level of activity but generally trade less frequently than USD/INR.

CURRENCY PAIR (USD-INR)

The USD/INR currency pair refers to the exchange rate between the United States Dollar (USD) and the
Indian Rupee (INR). In simpler terms, it tells you how much one US dollar is worth in Indian rupees.

Here's some information you might be interested in:

• Current Exchange Rate: According to XE Currency Converter, as of Monday, March 11, 2024, at
10:45 PST, one US dollar is equal to approximately 82.76 Indian rupees [USD to INR].

• Volatility: The USD/INR pair is a relatively liquid and actively traded currency pair, but it can still
be volatile. Economic data releases, interest rate changes, and geopolitical events can all cause
the exchange rate to fluctuate.

• Trading: The USD/INR pair is traded on forex markets around the world. If you're considering
trading currency pairs, it's important to consult with a financial advisor as forex trading can be
complex and involve significant risk.

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USD-INR FUTURE CHART

USD-INR OPTIONS CHART

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 Analysis of USD/INR Currency Pair
Recent Performance:

• The USD/INR pair has been volatile in recent months, with the USD strengthening against the
INR. As of March 11, 2024, the exchange rate is approximately 82.76 INR per 1 USD [USD to INR
on XE Currency Converter]. This represents a depreciation of the INR compared to earlier
months in 2024.

Factors Influencing the USD/INR Pair:

• Global Oil Prices: India is a major importer of oil, and oil is priced in US dollars. When global oil
prices rise, it puts downward pressure on the INR. This is because India needs to spend more
rupees to buy the same amount of oil.

• Foreign Investment Flows: Foreign investments play a significant role in the Indian stock market.
When foreign investors pull out their investments, they typically convert their rupees back into
US dollars. This can lead to an increased supply of INR in the foreign exchange market,
weakening the rupee's value.

• US Monetary Policy: The monetary policy decisions of the US Federal Reserve can also impact
the USD/INR currency pair. When the Fed raises interest rates, it makes the US dollar more
attractive to investors. This can lead to increased demand for USD, strengthening the dollar
against other currencies, including the INR.

• Indian Economic Performance: India's economic performance can also influence the USD/INR
exchange rate. Strong economic growth and a stable government can attract foreign
investments, leading to a stronger INR. Conversely, a slowdown in economic growth or political
instability can weaken investor confidence and lead to a depreciation of the rupee.

• Reserve Bank of India (RBI) Interventions: The RBI, India's central bank, can intervene in the
forex market to manage exchange rate volatility. The RBI can buy or sell rupees in the market to
influence supply and demand. For example, if the INR is weakening significantly, the RBI might
buy rupees to reduce supply and strengthen the currency.

Looking Ahead:

The future direction of the USD/INR currency pair will depend on the interplay of these various factors.
The global economic outlook, US monetary policy decisions, and India's economic performance will all
be important to watch. Additionally, the RBI's actions in the forex market could also influence the
exchange rate.

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WHAT WILL HAPPEN IF THE EXCHANGE RATE OF INR BECOMES STRONGER THAN
ANY OTHER CURRENCY
A scenario where the Indian Rupee (INR) becomes stronger than all other currencies is highly unlikely
and economically disruptive. Here's why:

Exchange Rates and Trade:

Exchange rates reflect the relative value of currencies. A stronger INR would make Indian exports more
expensive and imports cheaper. This could lead to:

• Reduced Exports: Indian goods become less competitive internationally, potentially leading to a
decline in exports and a slowdown in economic growth.
• Increased Imports: Cheaper foreign goods flood the Indian market, potentially harming
domestic industries that struggle to compete on price.

Impact on Businesses:

• Export-Oriented Businesses: These businesses would suffer the most due to a stronger INR,
facing lower profits and potential job losses.

• Import-Reliant Businesses: These businesses might benefit from cheaper raw materials and
components, potentially leading to lower production costs and improved competitiveness.
However, this benefit might be offset by a decrease in consumer demand due to a potential
economic slowdown.

Government Intervention:

Central Bank Actions: The Reserve Bank of India (RBI) would likely intervene to weaken the INR. This
could involve:

• Selling Dollars: The RBI could sell US dollars (or other foreign currencies) in the market,
increasing their supply and weakening the INR.
• Lowering Interest Rates: Lower interest rates could discourage foreign capital inflows,
weakening the INR's demand.

Global Economic Disruptions:

• Currency Wars: A situation where the INR becomes significantly stronger could trigger "currency
wars" as other countries take steps to weaken their currencies to maintain export
competitiveness. This could lead to global economic instability.

Overall Impact:

• Economic Slowdown: A drastically strong INR could lead to a slowdown in economic growth due
to decreased exports and potential job losses.

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 THE INTERTWINED RELATIONSHIP: INDIAN ECONOMY AND
RUPEE VALUE
India's economic development is intricately linked to the value of the Indian Rupee (INR). A strong and
stable economy fosters a stronger rupee, while a struggling economy can lead to a weaker rupee. Let's
delve into this relationship with recent news articles for illustration:

Positive Influences (Strengthening Rupee):

• Economic Growth: A robustly growing Indian economy attracts foreign investments. This
increased demand for rupees to invest in Indian assets strengthens the rupee.

News Example: "https://economictimes.indiatimes.com/topic/economic-growth" (The

Economic Times, Feb 15, 2024) highlights India's projected GDP growth rate of 6.4% for
2024, which could bode well for the rupee.

• Foreign Direct Investment (FDI): FDI inflows bring in foreign currency, increasing the supply of
dollars in the market. This can strengthen the rupee if the RBI (Reserve Bank of India) doesn't
intervene by buying those dollars.

News Example: "https://www.investindia.gov.in/foreign-direct-investment" (FDI India,

Government of India) reports a steady rise in FDI in recent quarters, indicating positive
investor sentiment.

• Low Current Account Deficit (CAD): A CAD occurs when a country imports more than it exports.
A lower CAD signifies a stronger balance of payments, potentially leading to a more stable or
appreciating rupee.

News Example: "https://tradingeconomics.com/india/current-account" (Trading Economics)

shows a narrowing CAD for India in recent months, which could support the rupee.

Negative Influences (Weakening Rupee):

• Trade Deficit: A persistent trade deficit, where imports exceed exports, leads to a higher demand
for foreign currency to pay for imports, potentially weakening the rupee.

News Example: "https://www.livemint.com/economy/indias-trade-deficit-plunges-to-20-58-

billion-in-november-imports-fall-by-43-11702631488146.html" (Business Today, Jan 20,
2024) discusses India's ongoing trade deficit, which could put pressure on the rupee.

• High Inflation: Inflation erodes the purchasing power of the rupee. If inflation rises faster in
India compared to other countries, it can weaken the rupee's relative value.

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 News Example: "https://rbi.org.in/Scripts/PublicationsView.aspx?id=20350" (RBI website)
mentions the RBI's inflation target of 4% with a 2% buffer. If inflation breaches this range, it
could impact the rupee.

• Capital Flight: If foreign investors lose confidence in the Indian economy and pull out their
investments, it reduces demand for rupees and can weaken the currency.

News Example: "https://biggerpicture.ft.com/global-risks/report/the-global-risks-report-

2022" (Financial Times, March 8, 2024) discusses a potential global risk-off sentiment that
could lead to capital outflows from emerging markets like India.

The RBI's Role:

The RBI plays a crucial role in managing the exchange rate by:

• Buying or Selling Dollars: The RBI can intervene in the forex market by buying or selling dollars
to influence the supply and demand of rupees.

• Interest Rate Changes: Adjusting interest rates can affect the attractiveness of rupee-
denominated assets for foreign investors, influencing the exchange rate.

India's economic development is a double-edged sword for the rupee. While strong economic growth
and FDI can strengthen the rupee, a trade deficit, and high inflation can weaken it. The RBI's
interventions play a significant role in maintaining exchange rate stability. By staying updated on
economic news and the RBI's actions, you can gain a better understanding of the factors influencing the
value of the Indian Rupee.

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 RECOMMENDATIONS & SUGGESTIONS
For the Indian Government:

• Focus on Sustainable Growth: Prioritize policies that promote sustainable economic growth in
the long term. This could involve investments in infrastructure development, education and skill
development, and fostering innovation in key sectors. A robust and diversified economy will
attract long-term investments, generate more exports, and strengthen the rupee's foundation.

• Reduce Trade Deficit: Implement a multi-pronged approach to reduce the trade deficit. This
could involve:

➢ Boosting Exports: Provide incentives for export-oriented industries, improve trade

logistics, and negotiate favorable trade agreements. Encourage the production of high-
value goods and services that are in demand globally.

➢ Rationalizing Imports: Analyse import patterns and identify areas where domestic
production can be encouraged through import substitution policies or tariffs on non-
essential goods. This will not only reduce the demand for foreign currency but also
create jobs and stimulate domestic manufacturing.

• Manage Inflation: Maintain price stability through effective monetary and fiscal policies. The RBI
can use interest rate adjustments to control inflation. The government can also manage its
spending patterns and implement targeted subsidies to mitigate the impact of price rises on
essential goods. Lower inflation will enhance the purchasing power of the rupee, improve
investor confidence in the Indian economy, and make exports more competitive.

• Promote Foreign Direct Investment (FDI): Create a business-friendly environment that attracts
FDI in key sectors like manufacturing, technology, and infrastructure. This can involve
streamlining regulations, improving the ease of doing business, and providing tax breaks or other
incentives for foreign investors. FDI brings in foreign currency, fosters technological
advancements, and creates jobs, all of which contribute to a stronger rupee.

For Businesses:

• Hedge Foreign Exchange Risk: Companies engaged in international trade should utilize currency
derivatives like futures or options contracts to hedge against exchange rate fluctuations. This will
protect their profit margins from unexpected currency movements. Financial institutions can
offer guidance on selecting the most appropriate hedging strategies for different business
scenarios.

• Diversify Exports and Imports: Businesses should explore new export markets with high-growth
potential and diversify their import sources to reduce dependence on a single currency or
region. This will mitigate the impact of currency fluctuations on their bottom line. For instance, a
company that imports raw materials from one country can establish relationships with suppliers

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 in other countries to have backup options in case of currency fluctuations or supply chain
disruptions.

• Focus on Efficiency: Invest in measures to improve operational efficiency and cost reduction.
This will make Indian exports more competitive globally and less susceptible to fluctuations in
the rupee's value. Embracing automation, streamlining logistics, and optimizing production
processes can all contribute to cost reduction and improved competitiveness.

For Investors:

• Diversify Portfolio: Invest in a diversified portfolio of assets across different asset classes and
currencies to mitigate risk associated with exchange rate fluctuations. Consider a mix of stocks,
bonds, real estate, and commodities to spread risk and potentially benefit from different market
movements.

• Monitor Economic News: Stay informed about India's economic performance, global economic
events, and geopolitical tensions that can influence the rupee's value. This will help you make
informed investment decisions. Pay attention to factors like global commodity prices, interest
rate changes by major central banks, and trade policies that can impact currency movements.

• Consider Rupee-Denominated Investments: If you're confident in India's economic growth

prospects, consider rupee-denominated investments like stocks or bonds. This can benefit from
a potential appreciation of the rupee. However, remember that rupee-denominated investments
may also be exposed to domestic inflation and interest rate risks.

Additional Considerations:

• RBI's Role: The RBI's effective management of foreign exchange reserves and forex interventions
are crucial for maintaining exchange rate stability and supporting the Indian Rupee. The RBI can
use its reserves to buy or sell rupees in the foreign exchange market to influence supply and
demand.

• Global Factors: External factors like global economic slowdowns, geopolitical tensions, and
fluctuations in oil prices can also influence the rupee's value. It's important to stay informed
about these global developments and their potential impact on the Indian economy and the
rupee.

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 CONCLUSION
This analysis has delved into the Indian currency derivatives market, the USD/INR currency pair, and the
relationship between the Indian economy and the Rupee's value. Here's a concluding summary with key
takeaways and recommendations:

Market Analysis:

• The Indian currency derivatives market has witnessed significant growth, with currency futures
contracts dominating the landscape.

• Global economic conditions, interest rate differentials, and RBI interventions significantly impact
this market.

• Currency derivatives offer valuable tools for hedging foreign exchange risk and speculating on
currency movements, but they also carry inherent risks.

USD/INR Currency Pair:

• The USD/INR pair is the most actively traded currency pair in India, influenced by factors like
global oil prices, foreign investment flows, and US monetary policy.

• Recent trends suggest a potential weakening of the INR against the USD.

Indian Economy and Rupee Value:

• India's economic performance, inflation levels, and current account deficit are intricately linked
to the Rupee's value.

• A strong and stable economy fosters a stronger rupee, while a struggling economy can lead to a
weaker rupee.

Overall:

The Indian currency derivatives market offers opportunities for businesses and investors seeking to
manage risk or capitalize on currency movements. As the market evolves and the Indian economy grows,
currency derivatives are likely to play an increasingly important role in India's financial system. However,
careful consideration of the risks involved is crucial before utilizing these instruments.

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