Currency SWAP

A currency swap is an agreement between two parties to exchange the principal loan amount and interest applicable on it in one currency with the principal and interest payments on an equal loan in another currency.

These contracts are valid for a specific period, which could range up to ten years, and are typically used to exchange fixed-rate interest payments for floating-rate payments on dates specified by the two parties. 

Since the exchange of payment takes place in two different currencies, the prevailing spot rate is used to calculate the payment amount. This financial instrument is used to hedge interest rate risks.

How Does a Currency Swap Work?

A currency swap agreement specifies the principal amount to be swapped, a common maturity period and the interest and exchange rates determined at the commencement of the contract. The two parties would continue to exchange the interest payment at the predetermined rate until the maturity period is reached. On the date of maturity, the two parties swap the principal amount specified in the contract.

The equivalent amount of the loan value in another currency is calculated by using the net present value (NPV). This implies that the exchange of the principal amount is carried out at market rates during the inception and maturity periods of the agreement.

Benefits of Currency Swaps

The benefits of currency swaps are:

• Help portfolio managers regulate their exposure to interest rates.

• Speculators can benefit from a favorable change in interest rates.

• Reduce uncertainty associated with future cash flows as it enables companies to modify their debt conditions.

• Reduce costs and risks associated with currency exchange.

• Companies having fixed rate liabilities can capitalize on floating-rate swaps and vise versa, based on the prevailing economic scenario.

Limitations of Currency Swaps

The drawbacks of currency swaps are:

• Exposed to credit risk as either one or both the parties could default on interest and principal payments.

• Vulnerable to the central government’s intervention in the exchange markets. This happens when the government of a country acquires huge foreign debts to temporarily support a declining currency. This leads to a huge downturn in the value of the domestic currency.

Risk Associated with Commodities Markets

No risk can be eliminated, but the same can be transferred to someone who can handle it better or to someone who has the appetite for risk. Commodity enterprises primarily face the following classes of risks, namely: the price risk, the quantity risk, the yield/output risk and the political risk. Talking about the nationwide commodity exchanges, the risk of the counter party (trading member, client, vendors etc) not fulfilling his obligations on due date or at any time thereafter is the most common risk.

This risk is mitigated by collection of the following margins: - 

·         Initial Margins

·         Exposure margins

·         Market to market of positions on a daily basis

·         Position Limits and Intra day price limits

·         Surveillance 

Commodity price risks include: - 

·         Increase in purchase cost vis-�-vis commitment on sales price

·         Change in value of inventory

·         Counter party risk translating into commodity price risk 

Key Factors for success of commodity market

The following are some of the key factors for the success of the commodities markets: - 

·         How one can make the business grow?

·         How many products are covered?

·         How many people participate on the platform? 

Key Factors For Success Of Commodities Exchanges

The following are some of the key factors for the success of the commodities exchanges: -

Strategy, method of execution, background of promoters, credibility of the institution, transparency of platforms, scaleable technology, robustness of settlement structures, wider participation of Hedgers, Speculators and Arbitrageurs, acceptable clearing mechanism, financial soundness and capability, covering a wide range of commodities, size of the trade guarantee fund, reach of the organisation and adding value on the ground. In addition to this, if the Indian Commodity Exchange needs to be competitive in the Global Market, then it should be backed with proper "Capital Account Convertibility".

The interests of Indian consumers, households and producers is most important, as these are the people who are exposed to risk and price fluctuations.

Key Expectations Of Commodities Exchanges

The following are some of the key expectations of the investor's w.r.t. any commodity exchange: - 

·         To get in place the right regulatory structure to even out the differences that may exist in various fields.

·         Proper Product Conceptualization and Design.

·         Fair and Transparent Price Discovery & Dissemination.

·         Robust Trading & Settlement systems.

·         Effective Management of Counter party Credit Risk. 

Self-Regulation to ensure: Overview of Trading and Surveillance, Audit and review of Members, Enforcement of Exchange rules.

Option Trading

An option is a contract written by a seller that conveys to the buyer the right — but not the obligation — to buy (in the case of a call option) or to sell (in the case of a put option) a particular asset, at a particular price (Strike price / Exercise price) in future. In return for granting the option, the seller collects a payment (the premium) from the buyer.

Exchange traded options form an important class of options which have standardized contract features and trade on public exchanges, facilitating trading among large number of investors. They provide settlement guarantee by the Clearing Corporation thereby reducing counterparty risk. Options can be used for hedging, taking a view on the future direction of the market, for arbitrage or for implementing strategies which can help in generating income for investors under various market conditions.

OPTION TERMINOLOGY

· Index options: These options have the index as the underlying. In India, they have a European style settlement. Eg. Nifty options, Mini Nifty options etc.

· Stock options: Stock options are options on individual stocks. A stock option contract gives the holder the right to buy or sell the underlying shares at the specified price. They have an American style settlement.

· Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.

· Writer / seller of an option: The writer / seller of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.

· Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.

· Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price.

· Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.

· Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity.

· Strike price: The price specified in the options contract is known as the strike price or the exercise price.

· American options: American options are options that can be exercised at any time upto the expiration date.

· European options: European options are options that can be exercised only on the expiration date itself.

· In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cashflow to the holder if it were exercised immediately. A call option on the index is said to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is below the strike price.

· At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cashflow if it were exercised immediately. An option on the index is at-the-money when the current index equals the strike price (i.e. spot price = strike price).

· Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative cashflow if it were exercised immediately. A call option on the index is out-of-the-money when the current index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price.

· Intrinsic value of an option: The option premium can be broken down into two components - intrinsic value and time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max[0, (St — K)] which means the intrinsic value of a call is the greater of 0 or (St — K). Similarly, the intrinsic value of a put is Max[0,K — St],i.e. the greater of 0 or (K — St). K is the strike price and St is the spot price. 

Time value of an option: The time value of an option is the difference between its premium and its intrinsic value. Both calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an option's time value, all else equal. At expiration, an option should have no time value.

What is Derivatives?

Commodities whose value is derived from the price of some underlying asset like securities, commodities, bullion, currency, interest level, stock market index or anything else are known as “Derivatives”.

In more simpler form, derivatives are financial security such as an option or future whose value is derived in part from the value and characteristics of another security, the underlying asset.

It is a generic term for a variety of financial instruments. Essentially, this means you buy a promise to convey ownership of the asset, rather than the asset itself. The legal terms of a contract are much more varied and flexible than the terms of property ownership. In fact, it’s this flexibility that appeals to investors.

When a person invests in derivative, the underlying asset is usually a Commodity, Bond, Stock, or Currency. He bet that the value derived from the underlying asset will increase or decrease by a certain amount within a certain fixed period of time.

‘Futures’ and ‘Options’ are two commodity traded types of derivatives. An ‘options’ contract gives the owner the right to buy or sell an asset at a set price on or before a given date. On the other hand, the owner of a ‘futures’ contract is obligated to buy or sell the asset.

The other examples of derivatives are Warrants and Convertible bonds (similar to shares in that they are assets). But derivatives are usually contracts. Beyond this, the derivatives range is only limited by the imagination of investment banks. It is likely that any person who has funds invested, an insurance policy or a pension fund, that they are investing in, and exposed to, derivatives – wittingly or unwittingly.

Shares or bonds are financial assets where one can claim on another person or corporation; they will be usually be fairly standardised and governed by the property of securities laws in an appropriate country.

On the other hand, a contract is merely an agreement between two parties, where the contract details may not be standardised.

Derivatives securities or derivatives products are in real terms contracts rather than solid as it fairly sounds.

Financial New Resources

Top 7 News Sources for Financial Trader

Getting the latest important news is a vital requirement for every Forex, stocks or options trader. The Internet is full of various sites, but not all them feature financial news or provide such news in a timely manner. This list consists of top ten sources for the trader’s news that are updated often and are not mixed up with irrelevant news.

• Bloomberg — the ultimate news source about everything that is in any way related to the financial markets. Categorization by the regions helps in finding important international news.

• Forbes.com Breaking News — a great site to get the recent financial information, it also provides free news from several paid news sources (i.e. Associated Press). Stock market traders will like the coverage of almost all kinds of companies.

• Reuters Business & Finance — Reuters is one of the most professional informational companies in the world and they offer news as a free service to everyone.

• BusinessWeek — they may be too old-fashioned, but BusinessWeek still features some exclusive news content and the very professional analysis.

• Financial Times — I like FT for they are not as US-centered as some other financial news sites, they offer a pretty good world news outlook. Can be recommended as a source of Forex related news if you prefer trading exotic currency pairs.

• CNNMoney — opposite to FT, CNN prefers news from United States, but it’s still good because the majority of world stocks are concentrated on the Wall Street. It will also be useful to the Forex dollar traders.

• CNBC — a "must have" bookmark for every currency trader; news on foreign currency markets are delivered at the top quality level.

Currency and Commodity Trading

Forex is the largest financial market in the world, it is relatively unfamiliar terrain for retail traders. Until the popularization of internet trading a few years ago, FX was primarily the domain of large Financial institutions, Multinational Corporations and Secretive Hedge funds. 

But times have changed, and individual investors are hungry for information on this fascinating market. Whether you are an FX novice or just need a refresher course on the basics of currency trading, read on to find the answers to the most frequently asked questions about the forex market.

Currency Trading Basics

All currency trades involve the buying of one currency and the selling of another, simultaneously. Currency quotes are given as exchange rates; that is, the value of one currency relative to another. The relative supply and demand of both currencies will determine the value of the exchange rate.

When a currency trader places a trade he wants the currency purchased to appreciate in value versus the currency sold. His ability to determine the direction that the exchange rate will move, will dictate his gain or loss in a trade.

What is Commodity Trading?

Investors should always learn the basics of trading before they put their money into it. Commodity trading like any other form of trading is similar in concept only thing here we are trading in certain commodities instead of shares or foreign currencies as in other forms of trading.

Commodity trading gives you options to hedge against inflation while also promising you good return. Commodities market also helps you in diversifying your portfolio hence if another form of investment of yours runs bad then you can always rely on the commodities market in order to maintain profits. 

Commodity trading is not just for the institutional investors but also for the retail investors though investors should always invest after having done research and having the knowledge of the market so that if there is a sudden slump in the market they are not adversely affected by it in a huge way.