Foreign Exchange Derivatives

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More units in NISM Series I

• Introduction to Currency Markets16
• Exchange Traded Currency Futures15
• Exchange Traded Currency Options20
• Strategies Using Exchange Traded Currency Derivatives19
• Trading Mechanism in Exchange Traded Currency Derivatives13
• Clearing, Settlement and Risk Management in Exchange Traded Currency Derivatives18
• Regulatory Framework for Exchange Traded Currency Derivatives12
• Accounting and Taxation11
• Codes of Conduct and Investor Protection Measures13

Practise all of NISM Series I

Exam format

All 13 questions on Foreign Exchange Derivatives, with answers

1. Q1A principal rationale for introducing exchange-traded currency derivatives in India was to:

   • A

     Option A. Provide a deposit-taking channel for holding foreign-currency balances

     Why it is wrong: A derivative position is not a foreign-currency deposit account.

   • B

     Option B. Set one administratively fixed exchange rate for future trade invoices

     Why it is wrong: A traded derivative price is not an administratively imposed exchange rate for all future invoices.

   • C

     Option C. Offer standardised, transparent instruments for managing currency risk — Correct answer

   • D

     Option D. Arrange physical currency delivery for every import and export payment

     Why it is wrong: The underlying commercial payment and the derivative hedge are separate transactions.

   Answer: C. The answer identifies risk transfer through standardised exchange-traded instruments. A business can face uncertain rupee receipts or payments because its contract is denominated in a foreign currency. A currency derivative can create an offsetting financial exposure. An organised exchange provides standard contract terms and a trading framework for that purpose. This is a risk-management role. It is different from accepting deposits, fixing the currency’s exchange rate or executing every business’s underlying payment. Remember: Identify risk management and market infrastructure as the role of currency derivatives.

   Hint, shown before you answer in practice mode: Common mistake: Confusing a currency hedge with the business’s actual foreign-currency payment.

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2. Q2A participant simultaneously buys a lower-priced currency futures contract on one exchange and sells an economically equivalent contract on another to capture the price difference. This activity is:

   • A

     Option A. Arbitrage — Correct answer

   • B

     Option B. Directional speculation

     Why it is wrong: Directional speculation depends on a favourable market move. The stated transaction pairs opposite exposures to exploit a price discrepancy.

   • C

     Option C. Hedging a commercial receivable

     Why it is wrong: No commercial receivable is identified. The stated purpose is relative pricing, not offsetting an existing business exposure.

   • D

     Option D. Market making

     Why it is wrong: Market making involves providing two-way trading liquidity. The described activity is taking a specific cross-market price difference.

   Answer: A. The trade seeks to capture a price difference between equivalent instruments. The purchase and sale have opposite economic exposures in equivalent contracts. The stated objective is to capture the difference between their prices. That describes arbitrage. Practical execution costs, timing, contract differences and settlement arrangements still matter. Calling a trade arbitrage does not prove that its implementation is risk-free. Remember: Classify the trade by its economic purpose, not simply by the fact that it includes both a purchase and a sale.

   Hint, shown before you answer in practice mode: Common mistake: Assuming every simultaneous buy and sell is a hedge of an existing business exposure.

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3. Q3Which statement correctly distinguishes an OTC currency forward from an exchange-traded currency future?

   • A

     Option A. Both must use the same standard contract amount and maturity date.

     Why it is wrong: An OTC forward need not use the same amount and maturity as an exchange futures contract.

   • B

     Option B. The forward is exchange-standardised while the future is tailored bilaterally.

     Why it is wrong: This reverses the usual structures of the two instruments.

   • C

     Option C. The future can be tailored to any maturity date while the forward cannot.

     Why it is wrong: Listed futures do not let each client choose any desired contract maturity. Customisation is the forward’s distinguishing feature.

   • D

     Option D. The forward can be customised while the future follows exchange-set contract terms. — Correct answer

   Answer: D. This answer captures negotiated OTC terms versus standardised listed terms. In an OTC forward, the parties can negotiate features such as the currency amount and settlement date. An exchange lists futures with specified contract sizes and maturities. A hedger chooses among those listed terms. Exchange standardisation can aid trading and offsetting positions, but it can leave a mismatch with a business’s exact cash flow. Remember: Use the customisation-versus-standardisation distinction before comparing other features.

   Hint, shown before you answer in practice mode: Common mistake: Assuming every currency derivative can be matched exactly to any invoice amount and payment date.

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4. Q4A company and a bank agree today to exchange INR for USD on a near date and reverse the same USD principal against INR three months later, at rates agreed today. No periodic interest payments are exchanged. Which instrument is described?

   • A

     Option A. An FX swap — Correct answer

   • B

     Option B. An outright forward

     Why it is wrong: An outright forward alone does not include the linked near-date exchange.

   • C

     Option C. A cross-currency interest-rate swap

     Why it is wrong: The described contract exchanges principals without periodic interest streams. That differs from the interest-rate-swap structure named here.

   • D

     Option D. A purchased currency call option

     Why it is wrong: A purchased call gives the buyer a choice to exercise. The scenario specifies agreed principal exchanges rather than an option right.

   Answer: A. The linked near and far principal exchanges are the defining structure of the FX swap described. The arrangement has two linked principal exchanges. Their directions are opposite and both exchange rates are agreed at inception. This fits the FX-swap description. An outright forward has only the future exchange, while a currency-interest-rate swap involves periodic interest obligations and an option gives a right rather than the stated two-way obligation. Remember: Look for two opposite principal exchanges at different dates when identifying an FX swap.

   Hint, shown before you answer in practice mode: Common mistake: Treating every two-currency contract as an interest-rate swap or overlooking the near leg.

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5. Q5Relative to an exporter’s original rupee-receipt benchmark, an exchange-rate move increases the value of its dollar receivable by ₹40,000. Its matched currency hedge loses ₹40,000 over the same interval. Ignoring costs, what is the combined change relative to that benchmark?

   • A

     Option A. A gain of ₹40,000

     Why it is wrong: This counts the receivable’s improvement but leaves out the hedge loss.

   • B

     Option B. A loss of ₹40,000

     Why it is wrong: This counts only the derivative and ignores the offsetting increase in the receivable.

   • C

     Option C. No net change — Correct answer

   • D

     Option D. A gain of ₹80,000

     Why it is wrong: This adds the absolute sizes of two changes that have opposite signs.

   Answer: C. The equal and opposite changes cancel on the assumptions stated. The receivable contributes +₹40,000 relative to the common benchmark. The hedge contributes −₹40,000. Combined change = ₹40,000 − ₹40,000 = ₹0. The hedge loss gives back the favourable currency movement rather than creating an additional ₹40,000 loss for the combined position. Remember: An offsetting derivative loss can be consistent with the economic purpose of a hedge.

   Hint, shown before you answer in practice mode: Common mistake: Calling a hedge unsuccessful merely because its derivative leg loses money.

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6. Q6At maturity, an outright FX forward and a purchased European FX call are both less favourable to the buyer than dealing at the spot rate. Ignoring negotiated cancellation, which contract permits the buyer simply not to exercise?

   • A

     Option A. Only the purchased call — Correct answer

   • B

     Option B. Only the outright forward

     Why it is wrong: This reverses the distinction between an option and a forward.

   • C

     Option C. Both contracts

     Why it is wrong: The forward does not contain a unilateral right to walk away merely because spot is more attractive.

   • D

     Option D. Neither contract

     Why it is wrong: The option buyer can choose not to exercise. The already-paid premium does not remove that right.

   Answer: A. The call buyer holds an exercise right, whereas the outright forward buyer has an obligation. An unfavourable spot comparison does not by itself remove the forward buyer’s obligation. Closing or cancelling a forward is a separate transaction, not an option embedded in the contract. The purchased call can expire unexercised when exercising is unfavourable. Its premium remains a cost, so non-exercise does not imply a cost-free outcome. Remember: Distinguish the option buyer’s exercise choice from a forward party’s contractual obligation.

   Hint, shown before you answer in practice mode: Common mistake: Treating the ability to negotiate or offset a forward as the same as an option’s exercise right.

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7. Q7Which example fits the price-linked contract limb of the derivative definition in section 2(ac)(B) of the Securities Contracts (Regulation) Act?

   • A

     Option A. An ordinary savings deposit paying a fixed rate of interest

     Why it is wrong: Its fixed deposit interest does not make it a contract derived from a securities-price index.

   • B

     Option B. A contract whose value depends on an index of underlying share prices — Correct answer

   • C

     Option C. An ordinary share representing direct ownership in a company

     Why it is wrong: The share is an underlying security. Direct ownership alone is not the price-derived contract described in this limb.

   • D

     Option D. A fixed-fee agreement to provide account administration

     Why it is wrong: A fixed service fee is not determined by the prices of underlying securities.

   Answer: B. This answer has the specified link to an index of prices of underlying securities. Look for a contractual value linked to underlying securities prices rather than direct ownership, deposit interest or a service fee. The index-linked contract has that defining relationship. This is one limb of an inclusive definition, not an exhaustive list of every type of derivative. Remember: Distinguish the underlying security from a contract whose value is derived from its price.

   Hint, shown before you answer in practice mode: Common mistake: Treating every financial agreement or every security as the same kind of derivative.

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8. Q8With market access and hedging costs unchanged, which change most directly increases a company’s need to manage currency risk? Assume it has no offsetting foreign-currency cash flows.

   • A

     Option A. Replacing foreign-currency invoices with fixed INR invoices

     Why it is wrong: This removes the stated foreign-currency amount from those invoice obligations rather than adding exposure.

   • B

     Option B. Reducing the company’s unhedged foreign-currency purchases

     Why it is wrong: Smaller unhedged purchases reduce the specified source of exposure.

   • C

     Option C. A larger volume of invoices payable in foreign currency at future dates — Correct answer

   • D

     Option D. Matching foreign-currency payments with same-date receipts in that currency

     Why it is wrong: A matching receipt provides a natural offset, reducing the net exposure instead of increasing it.

   Answer: C. More unoffset foreign-currency payments increase the amount of cash flow exposed to exchange-rate movements. A future foreign-currency payment has an uncertain INR cost until the exchange rate is fixed or the exposure is otherwise offset. Increasing such payments increases the amount at risk under the stated assumptions. The other changes reduce exposure or create a natural offset. This explains a possible increase in hedging demand. It does not imply that a derivative must be used or that market turnover will rise by an identical amount. Remember: Look at the size of the net foreign-currency exposure, not merely the number of international transactions.

   Hint, shown before you answer in practice mode: Common mistake: Confusing greater cross-border activity with greater currency risk when the cash flows are already matched or INR-denominated.

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9. Q9Two parties exchange principal in different currencies at inception, exchange interest payments in those currencies each quarter, and reverse the principal exchange at maturity. Which instrument matches this structure?

   • A

     Option A. A standard FX swap with only near and far exchanges

     Why it is wrong: A standard near/far FX swap does not add the stated quarterly cross-currency coupon exchanges.

   • B

     Option B. A same-currency interest rate swap

     Why it is wrong: An interest rate swap in a single currency does not match the stated two-currency principal and coupon cash flows.

   • C

     Option C. An outright currency forward

     Why it is wrong: An outright forward fixes a future exchange. It does not include the described initial exchange plus recurring coupons.

   • D

     Option D. A cross-currency swap — Correct answer

   Answer: D. This answer matches both the two-currency principal structure and the periodic interest legs. The principal is in two currencies, so this is not merely an exchange of interest in one currency. The quarterly interest legs distinguish the arrangement from a standard FX swap containing only the initial and final currency exchanges. That combination identifies a cross-currency swap. No particular current benchmark rate is needed to identify the structure. Remember: Look for periodic interest legs when distinguishing a cross-currency swap from a standard FX swap.

   Hint, shown before you answer in practice mode: Common mistake: Treating every arrangement with two currency exchanges as the same instrument.

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10. Q10An exporter shorts USD-INR futures against a dollar receipt due in two months. USD-INR rises today, creating a daily futures settlement loss. The export proceeds are not yet available. Which risk is illustrated most directly?

    • A

      Option A. The importer risk of an unhedged dollar payable

      Why it is wrong: The firm is an exporter with a dollar receivable, not the importer with a dollar payable described in this option.

    • B

      Option B. Funding the interim cash settlement of the hedge — Correct answer

    • C

      Option C. A failure of the futures price to reflect the dollar move

      Why it is wrong: The stated futures movement is in the same direction as USD-INR. No pricing failure is supplied.

    • D

      Option D. A permanent loss of the export receivable itself

      Why it is wrong: The scenario does not state that the buyer has defaulted or that the export receivable has disappeared.

    Answer: B. Daily settlement can require money now even though the offsetting business receipt comes later. The short futures position loses when its settlement price rises. That loss is settled under the daily futures mechanism. A higher USD-INR rate would increase the rupee value of the later dollar receipt, but the exporter cannot yet use that future receipt as cash. The immediate issue is therefore liquidity or funding timing, not proof that the economic hedge has failed. Remember: Distinguish reduction of price exposure from the ability to fund interim hedge cash flows.

    Hint, shown before you answer in practice mode: Common mistake: Treating a future offsetting gain as cash already available to meet today’s settlement.

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11. Q11A firm will receive USD 80,000 and pay USD 15,000 on the same date. It can use that receipt to make the payment, and has no other USD exposure or hedge. What is its remaining economic USD exposure?

    • A

      Option A. A net receivable of USD 65,000 — Correct answer

    • B

      Option B. A net payable of USD 65,000

      Why it is wrong: Receipts exceed payments, so the remaining exposure is a receivable rather than a payable.

    • C

      Option C. A gross receivable of USD 95,000

      Why it is wrong: Adding opposite-direction cash flows overstates the net amount subject to conversion.

    • D

      Option D. No remaining exposure because both flows are in USD

      Why it is wrong: Only the matching USD 15,000 is offset. The larger receipt leaves an unmatched balance.

    Answer: A. The matching payment absorbs USD 15,000 and leaves USD 65,000 to be received net. USD 15,000 of the receipt can fund the equal-currency payment. That part does not need to be converted into INR. Net USD remaining = 80,000 − 15,000 = USD 65,000 receivable. The net receipt still loses INR value when USD-INR falls, other things equal. Offsetting some cash flows does not eliminate the residual exposure. Remember: Net available receipts against same-currency payments before measuring the unmatched economic cash flow.

    Hint, shown before you answer in practice mode: Common mistake: Adding receipts and payments, or treating any opposite cash flow as a complete hedge.

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12. Q12Under RBI’s definition, which settlement feature identifies a non-deliverable foreign exchange derivative contract (NDDC)?

    • A

      Option A. Both underlying currency notionals are physically exchanged at maturity

      Why it is wrong: Exchanging both underlying currency notionals is inconsistent with the defining non-delivery feature.

    • B

      Option B. Neither notional delivery nor any cash settlement can occur

      Why it is wrong: Cash settlement remains part of the definition, even though notional currencies are not delivered.

    • C

      Option C. The contract is cash-settled without delivering the underlying currency notionals — Correct answer

    • D

      Option D. Only the initial exchange of principal is required, with no later settlement

      Why it is wrong: The definition does not require an initial principal exchange and does not remove the cash-settlement obligation.

    Answer: C. This combines both elements of the definition: no underlying-notional delivery and cash settlement. RBI defines an NDDC as an OTC foreign exchange derivative with no delivery of the notional amounts of the underlying currencies. It is cash-settled. The word non-deliverable therefore does not mean that a loss produces no payment obligation. Remember: Distinguish notional currency delivery from payment of a cash-settlement amount.

    Hint, shown before you answer in practice mode: Common mistake: Reading non-deliverable as meaning no money can be payable.

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13. Q13A currency derivative is entered into on an electronic trading platform, not traded on a Recognised Stock Exchange. Under RBI’s definition, which statement about its classification is correct?

    • A

      Option A. It can be an OTC derivative despite being transacted electronically — Correct answer

    • B

      Option B. It is exchange-traded because its execution uses an electronic platform

      Why it is wrong: Electronic technology is not sufficient to establish that a trade took place on a Recognised Stock Exchange.

    • C

      Option C. It is OTC only if both underlying currency notionals are delivered

      Why it is wrong: The OTC definition includes both deliverable and non-deliverable contracts.

    • D

      Option D. It becomes exchange-traded solely when the trade is electronically reported

      Why it is wrong: Electronic reporting does not, by itself, change where a derivative was traded or convert the venue into a Recognised Stock Exchange.

    Answer: A. Electronic-platform execution is expressly compatible with the OTC definition. RBI’s definition of OTC derivatives excludes derivatives traded on Recognised Stock Exchanges and expressly includes derivatives traded on electronic trading platforms. The facts specify electronic-platform execution outside a Recognised Stock Exchange. The electronic medium alone does not make the contract exchange-traded. The definition also includes both deliverable and non-deliverable OTC derivatives. Settlement form is not the electronic-versus-exchange test. Remember: Identify the venue’s regulatory status rather than inferring OTC or exchange status from the screen used.

    Hint, shown before you answer in practice mode: Common mistake: Treating every electronically executed or reported derivative as exchange-traded.

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Exchange Traded Currency Futures

15 questions on Exchange Traded Currency Futures. Its quiz opens on that unit.