NISM Series I Currency Derivatives – Chapter 3: Exchange Traded Currency Futures
Welcome to Part 3 of our NISM Series I Currency Derivatives short notes series on PassNISM.in. This chapter introduces one of the most tested topics in the exam — exchange traded currency futures. You will learn the key terminology, how futures differ from forwards, the concept of interest rate parity, and the advantages and limitations of currency futures.
Haven't read the previous chapters yet? Start here: Chapter 2 – Foreign Exchange Derivatives.
What is a Currency Futures Contract?
A currency futures contract is a standardized, legally binding agreement traded on a recognized exchange to buy or sell a specific amount of a foreign currency at a price agreed upon today, for delivery on a specific future date.
Key characteristics of currency futures:
- Both buyer and seller are obligated to fulfill the contract on the settlement date
- They are linear products — profit and loss calculations are straightforward (similar to index futures)
- The two critical figures for P&L calculation are contract size (how many currency units per contract) and tick value (minimum price movement and its monetary value)
Key Currency Futures Terminology
The NISM Series I exam tests definitions heavily. Learn every term below precisely.
| Term | Definition |
|---|---|
| Spot Price | The current price at which the underlying currency pair trades in the cash (spot) market |
| Futures Price | The current price of the specified futures contract for a future delivery date |
| Contract Cycle | The period over which a contract is available for trading. Currency futures on SEBI-recognized exchanges have monthly contracts from 1 month up to 12 months expiry |
| Value Date / Final Settlement Date | The last business day of the contract month; settlement rules follow FEDAI (Foreign Exchange Dealers' Association of India) guidelines including known and subsequently declared holidays |
| Expiry Date (Last Trading Day) | The day trading ends in the contract — two working days before the final settlement date |
| Contract Size (Lot Size) | The amount of the underlying currency that must be delivered under one contract |
| Initial Margin | The deposit that a trader must place in the margin account when first entering a futures position |
| Marking-to-Market (MTM) | At the end of each trading day, the margin account is adjusted to reflect the day's gain or loss based on the closing futures price. Profits are credited and losses are debited daily |
| Tick Value | The monetary value of the minimum price movement in one contract. Used to calculate exact profit or loss from price movement |
| Tenor of a Contract | The total period during which the contract is available for trading — also called the "cycle" of the contract |
Exam Tip: The expiry date is always 2 working days BEFORE the value date. This is frequently tested. Currency Futures vs. Forward Contracts: Key Differences
While both forwards and futures achieve the same economic goal — locking in a future exchange rate — they differ substantially in structure and risk:
| Feature | Forward Contract | Currency Futures |
|---|---|---|
| Market | OTC (private agreement) | Exchange-traded (public) |
| Standardization | Fully customizable (amount, date) | Standardized (fixed lot size and expiry) |
| Counterparty Risk | Present — either party could default | Eliminated — clearing house steps in |
| Collateral | Usually not required | Initial margin mandatory |
| Settlement | Physical delivery of currency | Cash settled (no physical delivery) |
| Daily MTM | Not applicable | Required every trading day |
| Liquidity | Lower | Higher (standardized and exchange-traded) |
| Price Transparency | Limited to parties involved | Fully public and real-time |
| Underlying requirement | Proof of underlying trade needed (in India) | Not required |
| Access | Restricted to authorized dealers (RBI-licensed banks) and entities with forex exposure | Open to all market participants including retail investors |
| Cost of Trading | Higher (bank spread) | Lower (exchange fees + brokerage) |
Advantages of Currency Futures
- Price Transparency: All prices are live, public, and available in real time on the exchange
- No Counterparty Credit Risk: The clearing corporation acts as the central counterparty, guaranteeing settlement for all participants
- Broad Market Access: The OTC forward market is restricted to authorized dealer banks and entities with forex exposures. Currency futures on exchanges are accessible to all — including retail participants and speculators with no underlying forex exposure
- Lower Transaction Cost: Exchange-traded futures have lower overall costs compared to OTC forward contracts
Limitations of Currency Futures
- Imperfect Hedge: Because futures contracts are standardized in lot size and expiry dates, the exact amount and timing of a hedger's actual exposure often cannot be perfectly matched — leading to some basis risk (imperfect hedge)
- Margin and Daily Settlement Cost: Hedgers must maintain margins and absorb daily MTM gains and losses. Some businesses prefer OTC forwards where collateral is typically not required upfront
Interest Rate Parity (IRP): A Core Concept
Interest Rate Parity is a fundamental concept that explains the relationship between spot and futures exchange rates based on interest rate differentials.
What Does Interest Rate Parity State?
The difference between the futures exchange rate and the spot exchange rate is approximately equal to the difference between the domestic interest rate and the foreign interest rate (assuming no taxes or transaction costs).
Put simply: if Indian interest rates are higher than US interest rates, the INR futures price will be at a premium (higher) relative to the spot price. This premium compensates for the interest rate advantage of holding INR.
Why Does This Matter?
Interest rate parity ensures that arbitrage opportunities between the spot forex market and the money market are eliminated over time. If the futures price deviated significantly from what IRP predicts, traders would exploit the difference until prices realigned.
The IRP Formula
While the NISM exam does not require complex derivations, the concept can be expressed as:
Futures Price = Spot Price × [(1 + Domestic Interest Rate) / (1 + Foreign Interest Rate)]
Refer to the examples in the official NISM workbook for numerical practice — the exam is known to test this concept with calculation problems.
Key Takeaway: The country with the higher interest rate will see its currency trading at a forward discount (futures price below spot in currency terms relative to the lower-rate country). The country with the lower interest rate will see its currency at a forward premium. Currency Pairs Currently Traded on Indian Exchanges
Under SEBI's framework, currency futures are currently available on the following pairs on recognized Indian stock exchanges:
INR Pairs (Four Pairs)
- USDINR
- EURINR
- GBPINR
- JPYINR
Cross Currency Pairs (Three Pairs)
- EURUSD
- GBPUSD
- USDJPY
Pricing Rules to Remember
- Base price on Day 1: The theoretical futures price (calculated using interest rate parity)
- Base price on subsequent days: The daily settlement price of the previous trading day
- Closing price: Calculated as the last 30-minute weighted average price (VWAP) of that contract
Quick Revision: Must-Know Points for the Exam
- Currency futures are standardized, exchange-traded contracts — not OTC
- Both parties are obligated to fulfill the contract at settlement
- Expiry date = 2 working days before final settlement date (value date)
- Value date = last business day of the month
- Marking-to-market happens every trading day at the closing settlement price
- Futures eliminate counterparty risk; forwards do not
- Futures are accessible to all participants; OTC forwards are restricted to authorized dealers and entities with underlying forex exposure
- Futures = imperfect hedge (standardized terms); Forwards = better hedge but with counterparty risk
- IRP: Futures price = Spot price adjusted for interest rate differential between the two countries
- 4 INR pairs + 3 cross currency pairs are currently traded on Indian exchanges
Internal Links
- Chapter 2: Foreign Exchange Derivatives – Forwards, Futures, Options and Swaps
- Chapter 4: Strategies Using Currency Futures
- Take a Free NISM Series I Mock Test
- Download NISM Series I Study Material
- NISM Derivatives Exams – Overview
This is Part 3 of our 7-part NISM Series I Currency Derivatives Short Notes series on PassNISM.in. Continue to Part 4 covering strategies using currency futures.