Decoding Currency Futures

There has been a spurt in trading volumes on currency futures contracts on the National Stock Exchange (NSE) and Multi Commodity Exchange (MCX-SX). SEBI has acknowledged that the exchange-traded currency futures market is more efficient than the over-the-counter (OTC) interbank forex market. Here's a primer on the new product for the uninitiated:

What it is: Unlike the spot market, a currency futures market works on a forward contract between two parties, which involves an agreement to buy or sell a specified quantity of an underlying currency at a specified future rate and on a specified date.

Why it's needed: The foreign exchange exposure of Indian companies is rising, which poses a risk in the balance sheet if not hedged properly. There was clearly an urgent need for an instrument to hedge the foreign currency risk.

Who can participate: The online trading platform is open to all types of participants like speculators, investors or genuine hedgers like exporters and importers. In fact, it's a new asset class for investors.

How to trade: The NSE and MCX-SX offer online platforms. They started off in October 2008 after the RBI gave its goahead. The currency futures contracts range from a minimum of one month to a maximum of 12 months.

How it works: If you are an importer and have some payment to make in the next six months to, say, a US supplier in dollars, you can hedge your foreign exchange exposure today. The importer can just buy a futures contract on the NSE or MCX-SX trading platform.

What's next: RBI has recently expanded the currency futures trading basket from only US dollar-rupee to other currencies like euro-rupee, pound sterlingrupee and yen-rupee. Watch out for more.