Every nation has its own currency, which constantly fluctuates in value compared to other currencies. The economy of a nation, its central bank policy, supply and demand, foreign exchange reserves, and a variety of other factors all affect the value of its currency. Investors are drawn to strong, stable currencies. Currency futures may be used to do this. So how does it function? Because of the US economy's health and the confidence that investing retailers have in it, a currency like the US Dollar is seen as robust. Investors consequently favour holding more dollars relative to other currencies, and according to the rules of supply and demand, the price will rise the more demand there is.
The criteria we've listed above will determine how valuable a country's currency is to other currencies, and these factors are constantly changing due to both internal and international circumstances. For instance, the Dollar will become less expensive than the Euro if European growth is more robust than US growth. As a result, the dollar will be worth more per unit of the Euro. The central bank of a nation may also be necessary. For instance, the Reserve Bank of India (RBI) may sell dollars on the currency market if the Indian rupee is weak versus the dollar. As a result, the dollar will lose value versus the rupee due to the more excellent supply of dollars relative to that currency.
Effects Of Exchange Rate Changes
Any economy may be impacted by significant currency changes. For instance, if the rupee drops in value versus the US dollar, imports would become more expensive and exports less so. Importers will suffer as a result, while exporters will gain. Given that India is a significant oil importer, this will result in more costly oil imports, raising the cost of fuels like diesel and gasoline. Since they will impact every item that needs to be carried, these rising fuel costs have an inflationary effect. However, if the rupee gains strength versus the US dollar, export prices will increase. Therefore, exporters will make less money. Sectors like information technology will be impacted by this. In turn, these swings tempt investors to choose currency futures trading. Let's examine its nature and operation.
What are Currency Futures?
As we've seen, both importers and exporters are impacted by fluctuations in the currency's value. They will, of course, wish to safeguard themselves against such currency risk. They use futures contracts to do this. In India, currency futures were first offered on the NSE in 2008 and then expanded to the MCX-SX, BSE, and United Stock Exchange. Finally, in 2010, currency alternatives were offered.
These futures are offered in pairs since one currency's value depends on another. For instance, you may purchase them in Indian rupees vs the US dollar (USD), euro (EUR), pound sterling (GBP), or yen (JPY) (JPY).
Let's examine how to deal with foreign exchange futures. Suppose an IT business wishes to protect itself against currency risk if the IND appreciates against the USD. It may buy 1 lakh worth of futures contracts at the spot rate of 70 INR to the USD, often known as the current rate. Therefore, the corporation will be able to exercise its contract and avoid a loss of Rs 5 lakh if the value of the rupee increases and the rate is Rs 65 to the USD. Similarly, an importer may wager against the rupee's value depreciating versus the US dollar. Trading in currency futures serves more than simply hedging needs. Speculators account for the majority of it. In this case, the positions are settled before the futures contracts' expiration date since they are not interested in holding them until then.
How are Currency Futures Traded?
Any broker will allow you to open a forex trading account. However, you will require an initial margin, which is a portion of the total number of transactions you make. For instance, if the margin is 4% and the trades total Rs 1 crore, you would need to provide the broker Rs. 4 lakh in the margin.
You may buy substantial holdings in currency futures at a low cost. Naturally, the possibility for profit and loss increases as the position's significance increases. You will benefit handsomely if your wagers are correct. On the other hand, you risk losing a lot of money if you are incorrect. Currency options are a secure bet since they provide you with the option of not executing the contract at the strike price, making them less risky. The NSE in India offers contract sizes of 1000 for most currencies in terms of futures contracts. It is one lakh in the case of the Japanese Yen. At the end of the month, cash is paid for both currencies and options. In other words, real money is not exchanged.
Wrapping Up
In order for the commodities market to run smoothly, futures contracts are crucial. Miners, farmers, manufacturers, and other market players may operate without being concerned about daily fluctuations in the market since they are able to lock in pricing in advance.
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