Cross currency derivatives

Most Indian currency contracts have the rupee on one side. USDINR, EURINR, GBPINR, JPYINR.

Some do not. EURUSD, GBPUSD and USDJPY contracts have no rupee leg at all.

That is what the workbook means by cross currency derivatives: in the exchange traded currency derivatives context, derivatives on a currency pair not involving the Indian rupee.

Why list them in India? The workbook gives two reasons. To enable direct hedging of exposures in foreign currencies, and to permit the execution of cross-currency strategies by market participants.

Think of an Indian software firm billing a European client in euros while paying an American vendor in dollars. Its real risk is the euro against the dollar. Before these contracts it would have had to hedge EURINR and USDINR separately, and wear the mismatch. Now it can hedge EURUSD directly.

The futures came in 2018. Options on the same three pairs followed.

One thing does not change. Whatever the pair, settlement is in Indian rupees.

The definition and the dates (Chapter 3, section 3.1). The NSE launched currency futures in August 2008 in a separate currency derivatives segment, starting with USD-INR; from February 2010 futures on EUR-INR, GBP-INR and JPY-INR were launched; and further in 2018, Cross Currency Futures contracts on EUR-USD, GBP-USD and USD-JPY were also introduced. In the exchange traded context, cross currency derivatives means derivatives on a currency pair not involving the Indian rupee.

The rationale (Chapter 2, section 2.7). To expand the exchange traded hedging tools, recognised stock exchanges were permitted to introduce currency options; and with a view to enabling direct hedging of exposures in foreign currencies and to permit execution of cross-currency strategies by market participants, exchange traded currency futures and options were introduced in three cross-currency pairs, viz., EUR-USD, GBP-USD and USD-JPY.

The underlying. For cross currency futures the underlying may be the exchange rate in US Dollars for Euro and Pound Sterling, and the exchange rate in Japanese Yen for US Dollars.

Contract specifications — futures:

Two structural differences from the INR contracts.

1. Contract cycle. INR-based currency futures have weekly and monthly contracts; cross currency futures may have only monthly contracts. The cross currency options cycle is 3 serial monthly contracts followed by 3 quarterly contracts of the March / June / September / December cycle.
2. Trading hours. Cross currency contracts run to 7.30 pm; the INR option contracts close at 5.00 pm. Exchanges currently have different market timings for contracts involving the rupee and those not involving it.

Price bands. There are no daily price bands for currency futures contracts. To prevent erroneous order entry, operating ranges are kept at +/- 3% of the base price for contracts with tenure up to 6 months and +/- 5% for tenure greater than 6 months, relaxed in increments of 1% when a market-wide trend is observed. For cross currency options, price bands are delta-based, computed daily from the previous close of the underlying and volatility.

Final settlement price. Computed using the FBIL reference rate for USD-INR and the corresponding FBIL exchange rate for EUR-INR, GBP-INR or JPY-INR, as applicable, on the last trading day.

Valuing a position in rupees. For EUR-USD and GBP-USD contracts, use the latest available FBIL USD-INR reference rate. For USD-JPY, use the latest available FBIL JPY-INR rate — which is published for 100 units of yen.

The workbook's own contract-value table. Three cross currency positions, valued first in the quote currency and then in rupees.

Note the division by 100 in the last row. The FBIL JPYINR reference rate is for 100 units of JPY, so a position denominated in yen must be divided by 100 after multiplying. Skip it and the answer is a hundredfold too big.

What a tick is worth.

A real cross-currency exposure. An Indian IT services firm bills a German client EUR 2,00,000 and owes an American cloud vendor USD 2,10,000 in the same month.

The second route is exactly the direct hedging of exposures in foreign currencies the workbook gives as the reason these contracts exist. And the settlement still lands in rupees, so the firm never has to hold either foreign currency to close the position.

The operating range in practice. A EURUSD contract with a base price of 1.0800 and a tenure of 4 months has an erroneous-order-entry range of +/- 3%:

Had the tenure been more than 6 months, the range would be +/- 5%, giving 1.1340 and 1.0260.

Chapter 3, section 3.1, defines cross currency derivatives and dates the 2018 futures launch; section 3.3 carries the cross currency futures contract specification table and section 3.4 the contract-value worked examples with the FBIL conversion footnote. Chapter 2, section 2.7, gives the rationale — direct hedging of foreign currency exposures and cross-currency strategies. Chapter 4, section 4.9, carries the cross currency option specifications. The examinable points are the three pairs, the lot sizes, the tick sizes and tick values, monthly-only cycles, the 7.30 pm close, and above all that settlement is in Indian Rupees whatever the pair.

• Exactly three pairs: EUR-USD, GBP-USD, USD-JPY. No others.
• Settlement is cash settled in Indian Rupees, even though no rupee appears in the contract. This is the single most counter-intuitive fact in the chapter.
• Lot sizes are 1,000 of the base currency — 1,000 EUR, 1,000 GBP, 1,000 USD for USDJPY. The 100,000 unit lot belongs to JPYINR, not USDJPY.
• The JPYINR reference rate is per 100 yen. Divide by 100 when converting a USDJPY position into rupees.
• Cross currency futures may have only monthly contracts; the weekly contracts belong to the INR pairs.
• Cross currency contracts trade until 7.30 pm; INR option contracts close at 5.00 pm.
• There are no daily price bands on currency futures — only operating ranges of +/- 3% up to 6 months and +/- 5% beyond, relaxed in 1% steps.
• Cross currency swap is a different thing entirely — an OTC product, another name for a currency swap. These are exchange traded futures and options.