Derivatives are instruments which include:
Security derived from a debt instrument
share, loan, risk instrument or contract for
differences of any other form of security and,
b) A contract that derives its value from the price/index
of prices of underlying securities.
Types of Derivative Market
Future contract : is an agreement between two
parties to buy or sell an asset at a certain time in the
future, at a certain price.
Options : A contract that gives its buyer the right but
not obligation to buy or sell an asset at a fixed price
on or before a given date. An option to buy anything
is known as a CALL while an option to sell a thing is
called a PUT.
Swaps : are private agreements between
two parties to exchange cash flows in the
Forward : Customized contract between
two entities ,where settlement takes place
on a specific date in the future.
History of Derivative Market
As early as the 1650s, dealings resembling
present day derivative market transactions were
seen in rise markets in Osaka, Japan.
The first leap towards an organized derivatives
market came in 1848, when the Chicago Board
of Trade (CBOT), the largest derivative
exchange in the world, was established.
Client or investor is the one who is ready to invest on
commodities of the derivative market and ready to bear the risk.
He is the person who needs to choose his broker carefully and
should have knowledge about the derivative market before having
entry in it.
A derivatives broker is an investment professional who advises
individuals and corporations about how to buy, trade and sell
Brokers negotiate deals between entities for derivative swaps,
research international investment opportunities, counsel individual
investors, and analyze corporate asset portfolios to calculate how
much a company should risk in the derivatives market. His main
job is to present options to a client, help the client make a
decision on how to proceed and execute the final choice.
The broker's job is to work with a client to make an
appropriate investment plan and to provide investment tips.
Because the derivatives broker acts for the client in many
aspects of the investment process, it is very important that a
client choose a derivatives broker that he or she trusts and
works well with.
It is an agency or separate corporation of a future
accounts, clearing trades, collecting and maintaining
margin money, regulating delivery and reporting trading
Clearing houses act as third parties to all futures
and option contracts - as a buyer to every clearing
member seller and a seller to every clearing
Each futures exchange has its own clearing house.
All members of an exchange are required to clear
their trades through the clearing house at the end of
each trading session and to deposit with the
clearing house a sum of money (based on
clearinghouse margin requirements) sufficient to
cover the member's debit balance.
BENEFITS OF THE DERIVATIVE
MARKET (OF NEPAL)
Farmers, traders, exporters, importers can
insure their risk from the fluctuating product
prices by taking futures position in the derivative
Financial institutions can mitigate the interest
rate risk by locking their interest rate with
Investors can invest in the products and can get
End users can buy the goods at a predetermined price.
Investors have the advantage to determine the
conditions of the contract they wish to enter,
develop tailor-made contracts, while they
secure a certain degree of confidentiality in
respect to their transactions.
Trading process of Derivatives
Role Perform By Parties In Trading
Dual Role of Clearing & Settlement(C&S) and Market Making as a
•Clearing & Settlement Role
Can introduce market maker, brokers, clients, and responsible for
administrative works (provide margin/ commission leverage, creating
client profile, Broker and Sub-broker creation, margin call, fund
transfer, offline support etc).
•Market Making Role
Provide frequent bid and ask quotes simultaneously with quantity
within the parameter set by the exchange.
Plays a role to introduce sub-brokers /clients or can trade
on their own account.
• Providing advisory services to clients, training and
customer support etc.
Parties involve in commodity trading
NON CLEARING MEMBERS (Broker) MEMBERS
How to start trading
Trading commodities online is a simple process to
get started, but it is not something that should be
entered into lightly. The traditional method of
calling your commodity broker to place orders and
waiting for a callback to give you a filled order
price is quickly ending. Therefore, if you want to
trade commodities online, we will cover the
process of how to start.
When orders and quotes are entered into the central order
book, they are sorted by , price and entry time. Market orders
are always given the highest priority for matching purposes.
Orders and quotes in the central order book are anonymous: A
trader never knows the opposite side on a trade executed
through the exchange. Orders and quotes at a given price level
are aggregated, although the number of orders and quotes
making up the total remains unknown. Participants only see
the specific details of their own orders.
For all products, the best bid and ask prices, as well as their
respective aggregated bid and offer sizes, are always available
in real time.
Most of the derivatives markets are fully automated electronic
exchange, where there is no physical trading floor. The Exchange is
controlled through a centralized platform which is connected with
different ‘client’ front-ends called MEXN Trader.
The initial margin (IM) is levied on all open positions (Buy or sell
positions) of the Members and their clients. The IM calculation
on each commodity varies depending upon its market volatility.
The margin so calculated is reduced from the total margin of
the Member available with the exchange and accordingly
further exposure is given on the balance amount.
•Daily Price Limit
Daily price limit is the maximum and minimum level that
a price of any contract can reach for that particular day. It
is the maximum amount of gain or loss that can occur on
a particular contract/s. If a price of the contracts reaches
the daily price limit, trading on that contract shall be
suspended for certain time period or may be for the
remainder of the day. This is also called locked market.
The trading session in MEX Nepal is of 23 hours daily from
Monday morning to Saturday morning. Market opens at
03:45 on Monday morning and closes at 02:45 Saturday
morning during summer and during winter, the market
opens and closes one hour later.
You need to open a saving account in Bank
You must fill up Client Registration Form and
Member Client Agreement
Read Risk Disclosure Document
Identity Certificate and Address Prove.
Bank Statement Certificate
Credit risk on account of default by counter party: This
is very low or almost zeros because the Exchange takes
on the responsibility for the performance of contracts
Market risk is the risk of loss on account of adverse
movement of price.
Liquidity risks are the risk that unwinding of
transactions may be difficult, if the market is illiquid.
Legal risk is that legal objections might be raised;
regulatory framework might not allow some
Operational risk is the risk arising out of some
electricity, due to which it becomes difficult to
operate in the market.
Raises Volatility: Derivatives require a small initial
capital due to leveraging derivatives provide, therefore
a large no. of market participants can take part in
derivatives which leads to speculation and raises
volatility in the markets.
Higher no. of Bankruptcies: Due to the existence of
leveraged in derivatives, participants assume positions
which do not match their financial capabilities and
eventually lead to bankruptcies.
Increased need of regulation: There a Large no. of
participants who take speculative positions. It is
necessary to stop these activities and prevent people
from getting bankrupt and to stop the chain of defaults.
No regulatory body for derivative market.
SEBON has authorized to control derivative market
but not able to regulate it.
Due to lack of expert in Ministry of Finance and
other regulated bodies, there is no proper laws.
Still derivative market is existed with huge
The Present Situation of Derivative
Market in Nepal
The Nepalese Derivative Market is very young.
The investors haven’t been able to analyze the
Nepal has only a recent history of derivative
market, which opened with COMEN at the end
MEX was established in 2007 and NDEX on
November 20, 2008.
There is no regulating body in the Nepalese derivative
Over 90 percent people want to invest in gold and
Recently MEX and NSE has been merged to grab the
new opportunities in the market.
After merger MEX has now 120 brokers from 90
MEX is the leading derivative market in Nepal
according to trading volume and trading size.
Software used are MT4, MT5, KAAP, Hybrid Solution,
There are altogether 7 derivative exchange in Nepal.
List of Derivative Exchange in
Commodity and Metal Exchange Nepal
Limited (COMEN) (2006)
Mercantile Exchange Nepal Limited(MEX)
Nepal Derivative Exchange Limited(NDEX)
Nepal Spot Exchange Limited(NSE) (2010)
Wealth Exchange Limited (WEX) (2011)
National Spot Exchange Limited(NSX)
Commodity Future Exchange Nepal
Problems in Nepal
No experts to regulate derivative market.
No regulatory authority.
Lack of awareness among public.
The derivatives market is very dynamic and quickly developed into
the most important segment of the financial market
All in all the derivatives market in Nepal does not have a
longer history and thus seems to be still underdeveloped
Derivatives play an important role in the economy but are
associated with certain risks.
The crisis has highlighted that these risks are not sufficiently
mitigated in the over-the-counter (OTC) part of the
market, especially as regards credit default swaps (CDS).
Since the beginning of the financial crisis, the Commission
has been working to address these risks.
The derivatives market functions very well and is constantly
improving. The imperatives for a well functioning market are clear
The exchange segment in particular has put in place very effective
risk mitigation mechanisms mostly through the use of automation
For its user, the derivatives market is highly effective transaction
costs for exchange traded derivatives are particular low.
The derivatives market needs to focus on variety of commodities
that can manage the risks of that particular commodity
Derivative trading is an excellent way to prove money earns money.
It will make our investment portfolio more attractive and secure. It
offers a wide range of alternatives, including international
opportunities. This is the best way to utilize our money