Impact Of Currency Future Trading On Base Metals - Free Essay Example

Abstract: Currency Future is a future contract in which specified currency can be bought or sell at pre determined price and date. In developed nations like US and UK the currency price increment impact on physical trading volume, it decrease it on currency price increment and increase it on currency price decrement. Like this, same thing happened in developing nations. In India the base metals prices so much impacted due to currency future price volatility. In India, the currency future trading was started on 29th Aug. 2008 in National Stock Exchange (NSE), in Multi Commodity Exchange (MCX) on 7th Oct. 2008 and in Bombay Stock Exchange on 1st Oct. 2008. The objective of this paper is to measure the correlation of base metals with currency future trading i.e. US $. This research paper is an attempt to consider the investor behaviour regarding currency future trading in India. Some factors which have been considered for research are currency future, base metals and price movement in upward or in downward side. The results are analyzed with the help of statistical tools and techniques. Key Words: Base Metal, Currency Future, Volatility Introduction Currency Futures means a standardised foreign exchange derivatives contract traded on a recognised stock exchange to buy or sell one currency against another on a specified future date, at a price specified on the date of contract, but does not include a forward contract. Currency derivatives can be described as contracts between sellers and buyers whose values are derived from the underlying which in this case is the exchange rate. Currency Derivatives are mostly designed for hedging purposes, although they are also used as instruments for speculation. Currency Derivatives i.e. Currency Future are standardised in terms of contract sizes, trading parameters settlement procedures and traded on regulated exchange. The contract size is fixed and is referred to as lot size. Future contract are traded through exchanges, the settlement of the contract is guaranteed by the exchange or clearing corporation and hence there is no counter party risk. In INDIA the currency future trading was started on 29th Aug. 2008 in National Stock Exchange (NSE), in Multi Commodity Exchange (MCX) on 7th Oct. 2008 and in Bombay Stock Exchange on 1st Oct. 2008. Currency Future trading play a vital role in developed nations and developing nations. It makes the so much volatility in metal prices in terms of online trading as well as in physical trading. After the starting of currency future trading in India the volatility increase in the MCX non precious metal. The total number of contract traded before starting of currency future trading in non precious metal are 84186 (lots) and after the starting of currency future trading 69358 (lots). It shows that there is lot of volatility in the metal market sometime it increases the volume or sometime it decrease the volume. Multi Commodity Exchange of India Ltd (MCX) is a state of the art electronic commodity future exchange. The head quartered of MCX in Mumbai. The demutualised exchange set up by Financial Technologies (India) Ltd (FTIL) has permanent recognition from the Government of India to facilitate online trading and clearing and settlement operations for commodity futures across the country. The operations started in Nov 2003. MCX offers more than 40 commodities across various segments such as bullion, ferrous and non ferrous metals and a number of agro-commodities on its platform. The exchange is the worlds largest exchange in Silver, the second largest in Gold and Copper. MCX has been certified to three ISO standards including ISO 9001- 2000 Quality Management System standard, ISO 14001: 2004 Environmental Management System standard and ISO 27001:2005 Information Security Management System standard. Literature Review Since the beginning of trading in financial futures and options in the 1970s, the effect of financial derivatives trading on the underlying spot markets has been of great interest to both academics and practitioners. One of the issues commonly investigated by finance researchers is whether futures trading increases the price volatility of underlying markets and thus leads to destabilisation of these markets. Previous studies provide mixed evidence on this issue. To investigating the market behaviours (such as currency price volatility, metal market depth and trading volume) is an important aspect of research on the market microstructure literature. Tauchen and Pitts (1983)1 argue that these three variables are closely related. However, most studies deal with mutual contemporaneous relationship between two of those three dimensions and reach no consistent results. Very few empirical papers investigate the dynamic nature of the interactions, such as the feedback effects between those three variables. The relationship between currency future and trading volume has been examined frequently and usually is in a positive correlation between volatility and trading volume. Copeland (1976)2, develop sequential arrival of information models where new information flows into market to generate both trading volume and price movement. Karpoff (1987)3, reviews empirical and theoretical research on the relation between price changes and trading volume in financial markets. Eighteen of nineteen empirical papers support the positive correlation between volatility and trading volume. Bessembinder and Segun (1993)4 accommodate persistence in the positive relationship on eight futures market by ARCH-GARCH empirical method. In those studies above, it is consistently positive contemporaneous relation between return volatility and trading volume but lacks consistent in the relation between return volatility and market depth or between market depth and trading volume. Furthermore, there are few studies for the analysis of return volatility and trading volume incorporating with the market depth, which is proven to be fundamentally related to trading activity and market behaviour of return volatility (Bessembinder and Seguin, 1992)5. As suggested by Malliaris (1997)6, the origin of futures markets is related to the necessity to manage the risk associated with volatile spot price changes of certain assets. It can also be claimed that futures contracts became more popular since the economic deregulation in 1970s, which resulted in increased volatility in foreign currencies, debt instruments and stock indexes. Market observers and regulators have generally acknowledged the crucial role that futures markets have in risk transfer and price discovery, but they have often expressed concern over the potential role that futures activity may have in destabilizing the markets. Antoniou and Holmes (1995)7 examined the impact of trading in the FTSE-100 index futures on the spot price volatility and concluded that futures trading improves the quality and speed of information flowing to spot markets. Their evidence suggests that there has been an increase in spot price daily volatility, but that this due to increased information in the market and not to speculators having adverse destabilizing effect. Some studies provide empirical results that support the opinion that trading in futures can destabilize the spot market. For example, Figlewiski (1980)8 investigates the futures contracts for Treasury Bills (GNMA pass through certificates) and provides evidence that futures market activity increases the volatility of cash prices. More recent study by Bae, Kwon and Park (2004)9 focuses on the effect of the introduction of index futures trading in the Korean markets on spot price volatility. The authors concluded that introducing the futures and options trading on the Korean stock exchange resulted in both larger spot price volatility and greater market efficiency (allowing for quicker adjustment of market prices to information). The combined average daily turnover of the currency futures contracts in all the three exchanges (NSE, BSE, MCX) increased from USD 1.1 billion in March 2009 to 2.5 billion in September 2009 à ¢Ã¢â€š ¬Ã¢â‚¬Å" which means a growth of more than 125% in just six months period. Objectives of Research Paper To know the impact of Currency Future US$ on base metal with reference to India. Hypothesis of Research Paper Null Hypothesis: There is positive impact of currency future US$ on base metals, if US$ increases than the price of base metals increases and vice versa. Data Analysis The impact of currency future i.e. US$ on base metals is totally depend on the day to day trading prices of currency as well as metals. To find out the impact of currency on base metals we need the daily transaction prices, for this we collect it from secondary resources. To find out the correlation of currency future and base metals I summarise the data in average form. I collected per day USD INR pricing data for twenty seven months and calculated its average per month. For the base metals, I selected five metals (viz. Aluminium, Copper, Lead, Nickel, and Zinc) collected their pricing data for each day for twenty seven months and calculated its average per month. Table 1: Data for average closing rate of base metals and US$ in Indian Rupee. MONTH WITH YEAR WISE US $ ALUMINIUM AVG(INR) COPPER AVG(INR) LEAD AVG(INR) NICKEL AVG(INR) ZINC AVG(INR) Oct.(08) 49.19 102.96 230.27 71.31 567.65 62.00 Nov.(08) 49.16 91.91 187.13 64.21 540.38 57.65 Dec.(08) 48.80 73.38 152.75 47.27 481.86 54.44 Jan.(09) 48.93 70.11 161.84 55.75 564.14 59.14 Feb. (09) 49.33 66.32 165.30 54.42 516.73 55.57 Mar. (09) 51.35 68.98 195.43 64.18 500.56 63.17 Apr. (09) 50.11 72.56 225.97 70.25 567.19 69.98 May. (09) 48.58 71.39 225.93 70.46 616.29 72.54 Jun. (09) 47.86 76.07 241.59 80.00 717.74 74.88 Jul.(09) 48.50 81.30 254.93 81.40 715.30 76.90 Aug.(09) 48.38 93.25 299.62 92.52 936.68 88.20 Sep.(09) 48.52 89.15 302.76 106.96 844.04 91.19 Oct.(09) 46.73 88.20 298.31 104.95 868.83 97.30 Nov.(09) 46.58 91.38 312.38 107.43 792.86 102.66 Dec.(09) 46.66 102.41 330.51 109.12 808.17 111.75 Jan.(10) 46.00 103.11 339.52 108.98 852.54 111.78 Feb.(10) 46.37 95.74 319.70 99.36 886.78 100.50 Mar.(10) 45.55 101.00 341.79 99.33 1024.22 104.03 Apr.(10) 44.52 103.75 346.13 101.09 1155.72 105.93 May.(10) 45.78 94.55 317.15 87.12 1014.32 91.27 Jun.(10) 46.65 90.25 302.74 79.90 906.59 81.89 Jul.(10) 46.92 93.77 318.31 86.95 921.26 87.13 Aug.(10) 46.70 98.22 341.41 97.36 1003.43 96.14 Sep.(10) 46.14 100.34 357.69 101.24 1054.40 99.58 Oct.(10) 44.55 104.70 371.56 106.45 1060.99 105.98 Nov.(10) 45.10 105.36 382.68 107.11 1033.46 103.43 Dec.(10) 45.24 106.96 417.10 109.34 1092.18 103.46 Table 2: Analysis of Data (Table No. 1) by Karl Pearsons Correlation Coefficient Method. ALUMINIUM -0.787 COPPER -0.267 LEAD -0.770 NICKEL -0.897 ZINC -0.850 Here we can see in the table no. 2 there is correlation coefficient between currency future and base metals. Aluminium, Copper, Lead, Nickel and Zinc are inversely correlated to currency future. There is impact on the Aluminium -0.787, the copper -0.267, lead -0.770, nickel -0.897 and zinc -0.850. When the currency future prices raise the base metals prices decrease and sometimes the base metals prices increase. It shows that the currency future and base metals are inversely correlated. Conclusion The data analysis of the currency future and the base metals shows that there is a correlation between them. When there is volatility in the currency future and base metals it impacts the relation between them. Sometimes it makes the positive relation between currency future and base metals and sometimes it makes the negative relation between them. Due to this the economic condition of India is so much impacted. When the prices volatility increases in base metals it creates the problem in physical metals trading that impact directly or indirectly to the economic condition of our nation. The data analysis represents the inverse linear relationship between currency future and base metals. Scope of research There is so much scope of this research because it is a new concept in India. Before two years ago the currency future trading was started in India. The currency future trading is a concept which is not very common. People are not so much aware about it. This paper is related with base metals only but further the whole metal market is influenced by it.