Currency Derivatives: Terminology

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Derivative: product whose value is derived off of one or more basic variables, called underlying assets.

Forwards: a customized OTC contract between two parties where settlement takes place on a future date at prices agreed upon today.

Swaps: arrangement between two parites to exchange cash flows in the future according to a prearranged formula.
            Interest rate swaps
            Currency swaps

Market players:
  • hedgers
  • speculators
  • arbitrageurs  

Tick: minimum size of price change. The market price will change only in multiples of the tick.

Lot: aka contract amount – the minimum amount that can be traded
The profit or loss associated with the change of one tick = tick x contract amt.

Market cycle: the period over which a contract trades.

Final settlement date aka value date: last business day of the month – for inter-bank settlements in Mumbai. Set by Foreign Exchange Dealer’s Association of India (FEDAI).

Expiry date aka last trading day – day on which trading on the contract ceases. Two working days prior to final settlement date.

Contract size: the amount of asset that has to be delivered in one contract. Aka lot size.
Interest rate parity:

F = S + [S X (RQC – RBC) X Period]

Where
F à Forward price
S à Spot price
 RBC à rate of interest on base currency
RQC à Rate of interest on quoted currency
Period à Forward period in years

Future value of a currency with higher interest rate is at a discount (in relation to spot price) to a currency with lower interest rate.

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