How currency trading can benefit you

[Sukumar.N]

How currency trading can benefit you
============================

Given frequent sharp movements in the US dollar-rupee rate, it looks
as though currency futures are not going to be just another trading
instrument; they’re likely to be very useful for many people in a
variety of situations. Because of small lots, everyone can participate
in this market.

Margins levied are even lower than for gold in commodity futures.
Currency futures are the most liquid of markets. And the tick size
(the minimum price movement in a market) announced is just a quarter
of one paisa, which makes entry and exit easier for retail clients.

Importers and exporters use currency futures to hedge foreign currency
exposure. Some of the business from the OTC (over-thecounter) market
controlled by banks will be transferred to the currency futures
markets.

Transparency and liquidity will ensure that companies with exposure of
less than $5 million find the currency futures markets much
friendlier. But what’s in it for you? Why should an ordinary investor
be interested in currency futures?

What is in it for you
==============

Let us say you bought a kilo of gold on the commodity futures exchange
at Rs 11,000 per ten grammes. So you paid Rs 11 lakh, plus an
exchangespecified margin of about 4%. You’re betting gold prices will
go up—in rupees. But in fact, gold prices depend on international gold
prices denominated in US dollars. So you’re really betting gold prices
will go up in global markets.

If the price does go up from, say, $700 per ounce to $707, you’d
expect a gain of 1% in rupees, too. But in the meantime, if the rupee
appreciates against the dollar, from Rs 42 to Rs 4 1 . 5 0 , your
dollar price gain is effectively wiped out. The rupee price of gold
may remain roughly the same. So if you trade a commodity with
international pricing, it makes sense to take a position on currency
futures markets.

How to fix the problem
================

To counterbalance the effect of the currency on the commodity, and so
that you have a pure commodity play, you should sell the US dollar in
currency futures markets when you take a buy position in the
commodity. In our example, you’d sell the dollar in currency markets
at Rs 42, and buy it back at Rs 41.50, with value and timings
coinciding with the commodity positions.

Whatever loss is booked in the commodity position due to currency
movement will accrue as profit from the currency futures market.
Similarly, if you take an initial sell position in the commodity, buy
the US dollar in the currency market of equal value. In either case,
you’d need to unwind the commodity and the currency positions
together.

Income from abroad
===============

Let's take another situation: if you receive money from abroad, your
monthly rupee income is continuously at risk. Suppose you get $2,000 a
month from abroad.

At Rs 49, you get Rs 98,000 this month. But if the price falls to Rs
47, your rupee income will drop to Rs 94,000—a loss of Rs 4,000 in a
month. You can reduce uncertainty by selling $2,000 every month for
the next 12 months right now. Every time you physically encash the
dollars, “de-hedge” the immediate month position. For instance:

Money to be received next month (December 31) = $2,000
Sell $2,000 on December 1 at current price, say Rs 49 to the dollar
On Dec. 31, say the dollar is at Rs 47. Encash US dollars from your
bank at Rs 47, and buy back your sold dollar position, again at Rs 47
So, the physical currency conversion will give you 47 x 2,000 =
94,000, and the futures position will give you (49 – 47) x 2000 = Rs
4,000 Net proceeds are 94,000 + 4,000 = 98,000


Investing abroad
============

Let's consider yet another situation. Suppose you invest US$ 200,000
(the annual upper limit) abroad, your returns are at risk from day
one, no matter how the investment fares. If you converted Rs 98 lakh
to $200,000 at Rs 49, you’d lose if the rupee rose to Rs 47. So even
if your investment remained the same in dollars after a year, you’d be
poorer by Rs 4 lakh when moving your money back to India.

The solution is to sell $200,000 when remitting abroad, at around the
same rate of purchase (Rs 49 in our example). Assuming as above, you’d
get Rs 94 lakh back when you reconvert your dollars to a stronger
rupee, plus you’d get Rs (49 – 47) x 200,000 = Rs 4 lakh from your
profit in the futures markets.

Children's education abroad
====================

A common situation is paying for a child’s education abroad. Such
needs should be securely hedged based on your ability to pay today,
rather than by mortgaging your financial future to the vagaries of
currency markets.

Your relationship manager can guide you on this.

Market prospects
=============

This is one of the oldest reasons for currency trading—your view of
where the market will go. Information is easily available in the
media, and careful analysis will let you form opinions on prospects.

For example, when equity markets crashed in January, FII sale figures
were easily available. It was clear they were selling equity, buying
dollars with the proceeds, and repatriating the dollars. This, and
rising oil prices, weakened the rupee.



N.Sukumar
Research Analyst
www.kences1.blogspot.com