Currency Derivatives

Syllabus and chapter weightage

Weightages are taken from the official syllabus table published in the NISM workbook, so you can see exactly where the marks are.

Every chapter can be read free, no account needed — tap a chapter to open its plain-English Foundation lesson.

Sample questions

5 questions from the chapter tests, one per chapter. Pick your answer before you open the explanation.

1. Question 1 · Chapter 1: Introduction to Currency Markets

   Which term best describes the EUR currency?

   1. A.Free floating
   2. B.Managed float
   3. C.Pegged to USD
   4. D.Pegged to gold
   Show the answer

   Answer: A. Free floating

   The most traded currency pairs in the world are called the Majors. The list includes following currencies: Euro (EUR), US Dollar (USD), Japanese Yen (JPY), Pound Sterling (GBP), Australian Dollar (AUD), Canadian Dollar (CAD), and the Swiss Franc (CHF). These currencies follow free floating method of valuation.

   A clean float, also known as a pure exchange rate, occurs when the value of a currency, or its exchange rate, is determined purely by supply and demand in the market.

   Option B describes India's position, not the euro's. The currency regime in place for the Indian rupee with respect to the US dollar is a de facto controlled exchange rate. This is sometimes called a "managed float". A dirty float (managed float) is an exchange rate regime in which the exchange rate is neither entirely free (or floating) nor fixed.

   Option C is wrong — pegging is what developing countries did: developed countries gradually moved to a market determined exchange rate (For e.g. USD, EUR, JPY etc.) and developing countries adopted either a system of pegged currency or a system of managed exchange rates.

   Option D belongs to a system that no longer exists anywhere. The gold standard is not currently used by any government. Britain stopped using the gold standard in 1931 and the U.S. followed suit in 1933 and abandoned the remnants of the system in 1973.

   The euro is managed by the Frankfurt-based European Central Bank (ECB) and the Eurosystem, and is the second-largest and second-most traded currency in the international markets... after the United States dollar — with a 30.5% share of global daily turnover.

2. Question 2 · Chapter 2: Foreign Exchange Derivatives

   Which of the following is the role of derivatives?

   1. A.Risk management
   2. B.Financing
   3. C.Cash or liquidity management
   4. D.All of the above
   Show the answer

   Answer: A. Risk management

   Derivatives are tools to manage price risk.

   And the workbook is explicit that this is the primary function: while the primary function of derivatives is risk management, the derivatives market also performs the following functions...

   Those other functions are not financing or liquidity management. They are price discovery, market efficiency, access to unavailable assets or markets, price stability, deeper cash markets, speculation, and shifting speculative trades from unorganized market to organized market.

   Options B and C describe things a company does with cash and credit, not with derivatives. A derivative satisfies on trade date, there should be no full cash outlay — it is not a way of raising money.

   How risk management works through them: since the value of the derivatives is linked to the value of the underlying asset, the contracts are primarily used for hedging risks. For example, an investor may purchase a derivative contract whose value moves in the opposite direction to the value of an asset the investor owns. In this way, profits in the derivative contract may offset losses in the underlying asset.

   And the framework of approaches: if you want to take risk, you will trade in derivatives which is called speculation. When you want to avoid risk, you manage it one of the three ways: elimination (called hedging); insurance and minimization (called diversification).

   One caution the chapter is careful to add about the speculative use: this is not the only use, and probably not the most important use, of financial derivatives. Financial derivatives are considered to be risky. If not used properly, these can lead to financial destruction in an organization.

3. Question 3 · Chapter 3: Exchange Traded Currency Futures

   What is the settlement method for USDINR futures in India?

   1. A.Cash
   2. B.Physical, based on delivery
   3. C.Can be cash or physical, at the participant's choice
   4. D.Physical for hedgers and cash for speculators
   Show the answer

   Answer: A. Cash

   Mode of Settlement: Cash Settled in Indian Rupees.

   And the rule is universal in this market: currently, all exchange-traded currency futures and option contracts are cash settled in Indian rupees.

   That includes the cross-currency contracts — EURUSD, GBPUSD and USDJPY are also Cash Settled in Indian Rupees, even though neither leg is the rupee.

   What cash settlement means: in the case of cash settlement only the profit and loss resulting from positions is paid / received from the participants. In case of physical settlement, participants must physically give/take delivery of stocks/underlying asset to settle the open transactions instead of settling them with cash.

   Options C and D invent a choice that does not exist. The exchange fixes it: in the futures market, exchange decides all the contract terms of the contract other than price.

   Option B describes the forward market instead. For forwards, contracts are settled bilaterally mainly through physical delivery. Gross settlement without netting is followed — which is why the comparison table lists delivery-based settlement more helpful to importers and exporters among the forward's advantages.

   And it is listed as a genuine limitation of futures: since it is cash settled, users need to access cash/spot market for actual delivery of currency.

   The price used: all open positions on the last trading day of the currency futures contract are marked to the final settlement price, which for INR pairs is the FBIL reference rate on last trading day. Final Settlement: T+2.

4. Question 4 · Chapter 4: Exchange Traded Currency Options

   The price which the option buyer pays to the option seller to acquire the right is called the:

   1. A.Premium
   2. B.Strike price
   3. C.Agreed price
   4. D.Sell price
   Show the answer

   Answer: A. Premium

   The price that the option buyer pays to the option seller to acquire the right is called the option price or option premium.

   In the workbook's land example, Rs. 50000/- is the option premium — described as an upfront fee... Consider this as a non-refundable fee.

   Option B is a different term entirely: the pre-specified price at which the underlying asset may be purchased or sold by the option holder is called the strike price of the option — Rs.10,00,000 in that example.

   Do not confuse the two. The premium is what changes hands at the start; the strike is the price at which the underlying may later be bought or sold.

   What the premium buys: an option is a contract that gives the option buyer the right, but not the obligation, to buy or sell the underlying asset on or before a specified date/day, at a pre-determined price. For acquiring this right, the option buyer must pay a certain price/premium to the option seller.

   And what it means for each side: the party which buys the rights but not the obligation and pays a premium for buying the right is called as the option buyer and the party which sells the right and receives a premium for assuming such obligation is called the option seller/writer.

   The premium is also the buyer's entire risk — your potential loss is limited to the premium amount you paid for buying the option — and the writer's entire reward: your maximum profit is the premium received.

   It has two components: intrinsic value and time value.

5. Question 5 · Chapter 5: Strategies using Exchange Traded Currency Derivatives

   One-month USDINR in the OTC market is quoting 74.75/75.00 and futures for the same maturity are 75.50/75.60. What is the arbitrage trade and the profit per USD if carried to maturity?

   1. A.Buy USDINR forward in OTC and sell in futures, 50 paise
   2. B.Sell USDINR forward in OTC and buy in futures, 85 paise
   3. C.Buy USDINR forward in OTC and sell in futures, 60 paise
   4. D.Buy USDINR forward in OTC and sell in futures, 75 paise
   Show the answer

   Answer: A. Buy USDINR forward in OTC and sell in futures, 50 paise

   The arbitrage profit arises from selling in the market where the price is higher and buying in the market where the price is lower.

   Futures are higher, so sell there; the forward is lower, so buy there.

   Buying the forward means paying the offer: 75.00. Selling futures means receiving the bid: 75.50.

   75.50 − 75.00 = 0.50, or 50 paise per USD.

   The other options misread the quotes. Using 74.75 as the buying price gives 75 paise; using 75.60 as the selling price gives 60 paise. Both take the wrong side of a two-way quote — you always buy at the offer and sell at the bid.

   Option B reverses the direction entirely, selling in the cheap market and buying in the dear one — a guaranteed loss.

   Why the opportunity exists at all: ideally currency futures and currency forwards should be trading at the same level if their settlement dates are the same. A difference in pricing means mispricing and an opportunity to set an arbitrage trade to capture the mispricing.

   And it is locked in: the chapter demonstrates with its own numbers that arbitrage profit would have been constant at 0.09 irrespective of final settlement price as long as both OTC contract and futures contract were settled at the same price.

   With two real cautions. If either leg of the transaction is illiquid then the risk on the arbitrage deal is huge as only one leg may get executed and the other may not. And currency future market is cash settled while the currency forward market has delivery-based settlement, creating settlement-date risk.

   Plus brokerage, stamp duty, margin cost and impact cost etc. must be factored in.

Frequently asked questions

What is the passing mark for NISM Series I?

You need 60% to pass NISM-Series-I: Currency Derivatives. On a 100-mark paper that is 60 marks.

Is there negative marking in NISM Series I?

There is negative marking of 25% of the marks for that question, so a wrong answer costs you 0.25 marks on a 1-mark question. Guess only when you can eliminate at least two options.

How long is the NISM Series I exam?

The exam runs for 120 minutes and carries 100 marks in total.

How long is the NISM Series I certificate valid?

NISM certifications are generally valid for 3 years from the date of passing, after which they must be renewed. Confirm the current position on nism.ac.in before your certificate lapses.