Do exchange traded currency derivatives (futures and options) Provide a better hedging alternative compared to currency forwards (otc product)?

Abstract

Indian business entities had ushered in to new era post liberalization in 1990’s. This brought challenges and opportunities both. The cross border trade and currency flows across international borders increased substantially. Traditionally, the Indian exporters and importers relied on conventional products like Currency Forwards to hedge their foreign currency risk arising out of trade transactions. A need was felt to enlarge the choice of hedging instruments available and then exchange traded currency derivatives were introduced to provide a cost effective and transparent alternative by RBI. This study examines whether the objective of providing the exchange traded currency derivatives viz. Futures and Options was served. This study is based on the effective exchange rates realized using the conventional Forwards and then comparing the same with the rates realized using exchange traded currency derivatives. It was found that the exchange traded currency derivatives provide a significantly (statistically) better rates compared to traditional Currency Forwards.