Logistics of Hedging INR investment with USD INR future

Question

I am a beginner so please forgive any gaps in my understanding of Forex Futures. Based on RBI's decision earlier this year to let NRI's invest in rupee futures I want to propose a Currency Futures Trade I want to make to protect my Rupee Term Deposits in India. The gist is that if there is a rupee appreciation I can use it to hedge against future depreciations of the rupee.

Now here is an example of how I think this would work(See Follow Questions after the example):

1. For the sake of a hypothetical argument, let's say I have deposited 6,000,000 Rs into a Fixed Term Deposit(FD) in india at 7.5% interest rate on Dec 1st 2017. This FD matures on Dec 1st 2018. Let's assume that the exchange rate when this was done was 60 Rs to 1 USD(i.e. 10$). I want to hedge the return of my FD against currency movement.

2. Assume that in July 2018 the rupee futures are trading at 59 Rs to a dollar. I buy a 6 month contract for Dec 2018 USD/INR Future(i.e. to buy $ and sell Rs). I buy 60 contracts- assume minimum units of 100,000 Rs each.

3. Dec 2018 arrived and the FD has matured and the spot exchange rate is 65 Rupees to a $. I cash settle the futures contract and make a profit of 1,694$ (6,000,000(1/59 - 1/60)). I intend to pay 6,000,000 from the proceeds of my FD.

I am assuming that I take the future to expiration and cash settle it.

Q. Have I understood this correctly and Is this kind of a trade doable with current norms for NRI's?

and if so

Q. How would I do this? Could you recommend exchanges/banks etc that do this?

Answer 1

That is not the right PnL. You'll be buying the USD back at a rate of 59, not 65. The majority of your PnL (vs doing nothing) will come from the deposit.

start: 100,000 USD

convert to 6m INR at 60 USDINR

deposit 6m INR @ 7.5%

end: 6m x (1.075) = 6.45m INR

convert to USD, 6m INR @ 59 USDINR (the terms of the futures contract) = 101,695 USD

You still have 450,000 INR left - I assume you will convert at the market rate = 450,000 INR x 65 USDINR = 6923 USD

So that's a total of 108,618 USD - minus the 100,000 you put in = 8618 USD PnL.

If you want to correctly hedge the FX component, you should hedge the final outcome value of the deposit, not the upfront deposit amount.

I have no idea about the legal and tax implications but you should consider:

You will have to place initial and variation margin (possibly in INR) with the exchange. You will need to keep this topped up if the futures contract goes against you. This can be substantial.

You will also have to consider the possibility of a default on the deposit. I don't know any Indian banks, but if banks in the US can go bust, then so can they.