How much should I pay for a Dollar next year?

September 2, 2013
Currency Queries

How much should I pay for a Dollar next year?

Imagine your friend getting admission to Computer Science at MIT in the USA for next year. He has to pay a tuition fee of 1000 Dollars. He wants it in September 2014, at the time of admission. The recent rise of Dollar against the Rupee has scared him, and he wants to make sure that he gets Dollars next year at a reasonable price. Because he does not understand Dollar Rupee and all that, he comes to his trader friend – YOU!

Currency1

How much should I pay for a Dollar next year?

He explains the situation. He wants Dollars, and he wants it only next year. But, he wants to lock the price of Dollar today because he thinks Dollar could go to 100. He asks you to give him the Dollars next year. You agree to help your friend. How would you handle this?

Well, to start with, even you think that Dollar is going to go to 75, or 80 or whatever. And because you are a sane person, you do not want to take any risks. So the best strategy is

  1. Buy the 1000 Dollars right away
  2. Keep it in your safe for a year in your locker
  3. Give it to your friend next year

Dollar is at 66, so you buy Dollars for 66*1000 =66,000

So next year, you will take 66,000 Rupees from your friend right? NO, you will take 72,600 from him. How? Let us see

Scenario 1:

You don’t have the 66,000 Rupees with you to buy 1000 Dollars. So you will borrow 66,000 from a bank. The bank charges 10% interest rate every year. Actually they charge more, but 10% makes calculations easy. So next year you will have to return

66,000 + 6,600 Rupees interest = 72,600 Rupees

Scenario 2:

You have the 66,000 Rupees with you to buy 1000 Dollars. But instead of buying Dollars with it for your friend you could have put it in an FD at 10% interest and made:

66,000 + 6,600 Rupees interest = 72,600 Rupees

So the correct price for next year is indeed 72,600 Rupees. This also means price of one Dollar for next year is:

72,600/1000= 72.6 Rupees

This price in future at which you will sell or buy Dollars is called the future price or forward price*. This is the most basic part of currency trading.

*There are many differences between the futures and forwards, but for now it is enough to understand that futures are available on NSE and open for you to trade, whereas forwards are only for those big bad banks. So why bother about forwards? ๐Ÿ™‚

ABID

Abid is an IIM A passout, other than the fact that he probably knows about everything on this planet earth, he is also an expert at trading currency, fixed income and equity. He writes financial blogsย and is presently ideating on the next big thing.

Nithin Kamath

CEO @ Zerodha and partnering startups through Rainmatter to help grow and improve the capital market ecosystem in India. Love playing poker, basketball, and guitar. โ€œYou don't have to be a hero to accomplish great things---to compete. You can just be an ordinary chap, sufficiently motivated to reach challenging goals.โ€ - Edmund Hillary

43 comments

  1. Gallardo says:

    Very Nice, have been waiting on this for a while.

  2. Ajit says:

    Thanks Abid, good initiative, informative in a simple way

  3. kumudhan says:

    in text you told – your friend have to pay 10,000 dollars. but in cartoon you say 1,000 dollars.confusing.na?

  4. Spink says:

    Abid,

    The scenario 2 above, I take the 66000 and put it in FD. At the end of the year, I make 72600, but what if the dollar is at 100? I need Rs 1lk to buy that 1000 dollars now, what happens now?

    • Nithin Kamath says:

      Spink,

      Guess you are confused on this, You have already bought the 1000 dollars and kept in the locker to give it to your friend next year. But when that friend comes back to you next year, will you give him the dollars at 66 itself? What about your cost of buying and keeping it for 1 year?

      The 2 scenarios explain how much you should charge your friend over and above the price of 66.

      Hope this clarifies.

      Cheers,

    • siddhh says:

      So, in both scenario i’ve bought dollars @ Rs.66 right? And the friend also wants $ @ Rs.66. Say if $ is at Rs.75 next sept, What I charge him and what’s my gain..?

    • Nithin Kamath says:

      we are not really talking about a gain for you. The idea is what would be your cost, in both cases we are assuming that the cost would be 10% for the year and hence you should ideally charge your friend @72.6 and not at 66, if you have to hold dollars for him till end of the year with your money.

  5. Abid says:

    @Spink – Remember this is written from YOUR point of view. You do not need the dollars. Your friend does. So in scenario 2 where you put money in FD you have already decided to not help your friend with the dollars

  6. Rohit says:

    Hi Abid,

    Does it mean that as long as we have high interest rates compared to USD, the value of INR vs USD will always depreciate?

    Thanks – Rohit

    • Nithin Kamath says:

      Abid Sep 5 2013, 4:37 pm
      Hi Rohit,

      That is a very very clever remark! And the theoretical answer is – YES!

      Let me give a short cut breadcrumb trail

      High inflation => High interest rate

      High Inflation => Less valuable currency ( we call that purchasing power )

      Less purchasing power => Cheaper currency

      Put everything together ๐Ÿ˜‰

      But if you want to go all theoretical about it, I suggest a few links

      rateparity”>http://en.wikipedia.org/wiki/Interestrateparity

      rateparity”>http://en.wikipedia.org/wiki/Interestrateparity

      powerparity”>http://en.wikipedia.org/wiki/Purchasingpowerparity

      Cheers!
      Abid

    • Rohit says:

      Thanks for the links, Abid.

      Its bit of a double whammy for emerging countries like India. Hypothetically if US decides to hike their fed fund rate I believe INR would still decline (Just mere prospects of tapering bond purchases has had this effect on the INR)

      Thanks – Rohit

  7. Rocky says:

    Hi Abid,
    So with this logic, if the USD is 66 today then the USD futures of Sep14 expiry will be 72.60 (approx) – as per the Interest rate in India(lets assume 10% – as in the scenario)
    Is this right?

  8. kumudhan says:

    dont you think its too long you posted?atleast you should maintain the tempo….or you think im asking too much for a free course?

  9. sachin03 says:

    @Abid

    I am unable to access your webpage Sensibull since 2 days. Did the domain name change ? It was great learning for me and i was enjoying it a lot. Had not saved the contact emails then , so this was the only medium to reach you. Hope you are reading this and if you are please bring up the site.

    TIA

  10. Anantha.KN says:

    Nice article, gave brief discription of Currency

  11. nandan says:

    One bit that is not considered is that the person can invest his $1000 and get interest. So the real rate is the interest rate differential between the currencies.

    So if I can get 2% for USD for 1 year, I would buy $980.4 @ 66 today and put it in a bank to get $1000 next year…

  12. Sukesh says:

    Hello,

    I was eagerly waiting for more articles by Abid however i see only 2 articles in this section till now:

    1 – Introduction to Abid (I thought this article would be about bid and ask spreads or something on those lines by seeing the title ๐Ÿ™‚ )

    2 – How much should I pay for a Dollar next year?

    should i wait more for further articles or am i missing on something??

    Thanks

    • 2:) In theory maybe 70 next year, but these currency correlations are influenced by a lot of other factors too

      In trading terms of late price action on Nifty has established a correlation with the rupee ,
      The higher Nifty moves more Fii money comes in which in turn helps the rupee appreciate as well…..

      These are only few of the manifold factors that affect this ratio.

  13. satishreddy says:

    1)what is dollar index?
    2) timings to open dollar index in IST(indian standard time)
    3)what is correlation with dollar index and USDINR (is dollar index is like leading indicator to USDINR)

  14. satishreddy says:

    If dollar index move 80.35 to 80.76 so the US dollar gaining or losing? ..

    • Hanan says:

      If the Dollar Index moves up, it’s considered that the US Dollar has gained against a basket of six currencies which has been decided based on each currency’s strength and demand in the world market.

  15. puneet says:

    i have two queries regarding USDINR Near month contracts:
    1. How volatile is this asset. will i be able to trade in more than 100 lots at one go.
    2. If the USDINR moves from 62.0771 to 62.0000 then how much is the move in terms of INR trading One USDINR contract.

    • 1. Yes Puneet, you will be able to very easily enter and exit 100 lots of USDINR, without any impact cost as such.
      2. 100 lots of USDINR is $100,000, so if you are long at 62.0775 (it cannot be 0.0771, because minimum tick size is 0.0025) and if you buy buy back at 62.0000, you make a loss of 0.0775 x 100,000 = Rs 7750.

  16. puneet says:

    hi nithin
    i am having some confusion regarding currency derivatives.
    1. on which exchange are the currency traded on zerodha platform. cause the add scrip dialog box says CDS , it does not mention whether its MCX or NSE
    2. to be honest i am trying to make a transition from sharekhan to zerodha. Cause from this year i will be trading extensively and want to save on brokerage. but the intraday or 5 minute chart of trade tiger and zerodha do not match . i mean there is always a difference of 0.0025 in currency. i have so far only observed USDINR. also the volume and OI figures are differnt.
    3. Charts that are shown by zerodha are coming from third party or are they incorporated in the software.
    4. Now to be very honest again i am planning to watch the 15 minute chart on Trade tiger and take the actual trade with zerodha, thats why i need to be sure of the exchange on which trade is executed and the price too.
    5. does zerodha provide 15 minutes charts too, cause i dont see 15 minutes in the interval settings.

    i shall ask you more queries as i go along exploring the zerodha platform
    keep up the excellent support.
    thanks and regards

    • Puneet,

      1. It is available on both NSE and MCX-SX. If you add using the drop down CDS, it adds NSE currency. If you want to add MCX-SX currency, in the drop down choose MCX-SX. If you don’t see MCX-SX there, it would mean that you are probably using the older version of ZT(the current version is 100.7) or you are not yet enabled on MCX-SX.
      2. The charting, will have to check and confirm. Can you double check if you are comparing currency charts of NSE on both sharekhan and Zerodha?
      3. Charts are coming from the incorporated software itself, that said we are about to launch our new platform in the next couple of months, which will be way better, hopefully better than sharekhan also.
      4. The order when you place, goes to the exchange directly, execution speeds at Zerodha might actually be faster than sharekhan.
      5. Yes you can add custom time on the right top of the chart, where you can set at 15 mins.

      Cheers,

  17. puneet says:

    Nithin,
    the version available for download on ur site is 3.10.57.97.7
    is this the latest one.
    and also till what time are intraday margins available for Currency and Commodities on MCX

    thanks

  18. Vikas says:

    Hi,

    as nowadays there is big volatility in Ruble (Russian currency )
    can we trade it in ZT or PI, USDRubel / INRRuble ?
    I have currecnt enabled but – I can not see it list !

  19. maheshwar says:

    Hi Nithin,
    can you throw some light on this news piece https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=35689 1. are we now going to get a chance to trade in non-inr pairs as well,
    2.are you guys planning to offer
    3. will it be on MT4
    4. what will be the trading hours….
    would greatly appreciate your response.

    • It will on Indian stock exchanges, similar to USD INR. It will be open from 9am till 7.30pm as per SEBI. It will be an added contract to trade on Kite and Pi. We will automatically offer as soon as it gets enabled on exchanges.

  20. Sudhir says:

    Can I see currency feed (current value) on zerodha pi/kite.e.g. In kite or pi, I have no way of knowing what is USDINR current value like we have it on NEAT on NSE.

  21. vram says:

    Sir,

    When Zerodha will acquire membership of Dubai Exchange . Regards.

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