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Apr 14, 2018 09:32 AM IST | Source: Moneycontrol.com

Use currency derivatives to hedge your foreign risk or for arbitrage

Globally, this is the market which has historically seen the most amount of traction and liquidity; however, domestically most efforts to build a buoyant market for exchange-traded currency have missed the mark hitherto.

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By Nikhil Kamath

Currency derivatives are financial derivatives whose payoff depends on the foreign exchange rate between two currencies. In the Indian context, all the currency pairs have Rupee on one side of the pair.

These instruments can be used for currency speculation, arbitrage or hedging foreign risk.

Globally, this is the market which has historically seen the most amount of traction and liquidity; however, domestically most efforts to build a buoyant market for exchange-traded currency have missed the mark hitherto.

The government has taken a lot of steps to encourage activity in currency markets, with Reserve Bank of India (RBI) recently announcing that full rupee convertibility should be a reality in a couple of years.

Full capital convertibility means a foreign investor can repatriate his money into his own local currency at will, which is not allowed in the country now.

The National Stock Exchange (NSE) on the other hand, has extended concessions on transaction charges for currency derivatives by two months, a move that will help bring in more liquidity in the segment.

USD/rupee remains the most significant contract in this segment, with over 70 percent of volume coming in from this contract alone.

This contract has seen a lot of traction over the last couple of quarters, devaluation in the Chinese Yuan, stalled reforms process, falling exports and widening rainfall deficit has affected the rupee negatively.

The rupee is currently trading at multi-year lows around the 65.5 level. The market regulator, SEBI, has issued a circular revising the positional limits applicable to both domestic and foreign investors for exposure in currency derivatives.

After the formal approval, SEBI in a circular also revised the limits upwards to USD 15 million in conjunction with the RBI revision.

All these factors in conjecture could help the currency derivative market in India develop and evolve to match its peers in the western world.

Disclaimer: The author is Co-founder & Head of Trading, Zerodha. The views and investment tips expressed by brokerage firms on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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