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Chapter 1 (overview of derivatives)
 

Chapter 1 (overview of derivatives)

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    Chapter 1 (overview of derivatives) Chapter 1 (overview of derivatives) Presentation Transcript

    •  
    • WHAT ARE DERIVATIVES?
      • Derivatives are financial instruments whose value is derived from an underlying physical commodity or financial instrument
      • Example:
      • Price that is derived from the price of the instrument on which they are based such as :
      • crude palm oil futures are based on the price of palm oil traded in the commodities market, while stock index options are based on the FTSE Bursa Malaysia KLCI (FBMKLCI).
    • CONCEPT OF DERIVATIVES
      • A contract to buy and sell which is set today but will be fulfilled at a stipulated date later.
      • Derivatives products are financial instruments available to corporation and investor for the purpose of managing their exposure to financial markets’ volatility.
      • A derivative instrument’s value is derived from the value of some other more basic underlying instrument such as commodity prices, exchanges rates, interest rates and share prices.
    • CASH MARKET VS. DERIVATIVES MARKET
      • CASH MARKET
      • Is the market for immediate delivery of and payment for commodity or financial instruments.
      • DERIVATIVES MARKET
      • Delivery of and payment for commodity of financial instruments will be made in the future.
    • TYPES OF DERIVATIVE MARKETS
      • FUTURES
      • A futures contract is an agreement between two parties to buy or sell the underlying instrument at a specific time in the future for a specific price determined today.
      • Each contract specifies the commodity, the quantity, quality and time of delivery or cash settlement.
      • OPTIONS
      • An option provides the holder/buyer the right, but not the obligation, to purchase or sell a certain quantity of the underlying instrument at a stipulated price within a specific time period by paying a premium.
      • The seller of the options, has an obligation, which is activated if the buyer exercises that right.
    • BENEFITS OF DERIVATIVES
      • Managing the risk associated with holding the underlying asset position
      • Portfolio asset allocation purpose
      • Income generation through taking a position in these products
    • THE EXCHANGE
      • An exchange is a specific market place where derivatives are originated and traded.
      • Provides trading environment
      • Servers as communication centers, centralizing orders from various buyers and sellers and disseminating relevant information on price.
      • It is also self regulatory organization where it establishes rules governing:
      • Membership to the Exchange
      • The administration of the Exchange
      • Member & customer relationships
      • Trading practices
    • EXCHANGE TRADED VS. OVER THE COUNTER (OTC) DERIVATIVES
      • Differences between exchange traded market & OTC
      FEATURES OTC EXCHANGE TRADED Market Place Not Centralized Centralized Regulation Self-regulated Commission-regulated Trading Negotiated contract Standardized contract Margins payment No legal requirement Legal requirement Credit/ Default risk High Low Transparency No Yes Guarantee performance No Guaranted by clearing house
      • Development of Derivative Market in Malaysia
      • (Find it by yourself & please submit )
    • CLEARING HOUSE
      • The clearing house that clears the contracts traded in MDEX is known as the Malaysian Derivatives Clearing House Bhd (MDCH) which is managed independently from the exchange.
      • The primary function of a clearing house is to provide financial stability by guaranteeing the performance of all contracts traded.
      • Essentially, it acts as the counter party to all contracts traded by assuming the obligation of a buyer to the original seller and of a seller to the original buyer.
      • Novation- Is the substitution of the clearing house for the opposite contracting party in a futures or options contract. Through novation, the clearing house becomes the buyer to every seller and the seller to every buyer.
      • Responsible for all settlement procedures arising from options and futures trading.
      • The role of the clearing house can be summarized as follows:
      • It provides central clearing-ensuring all members fulfills their obligation.
      • It acts as a central bank to all exchange members by matching all trades transacted on the exchange
      • It sets margin levels and handles movement in margin requirement
      • It takes the responsibility of good delivery of each contract, thereby guaranteeing trades.
    • INTERMEDIARIES IN BM DERIVATIVES
      • FUTURE BROKERS
      • Conduct a futures broking business, act as intermediaries between the clients and Exchange in a marketplace
      • They can trade on behalf of clients.
      • Basic function:
      • Represent their customers in placing orders in the market
      • Collecting margins from the customers
      • Providing basic accounting records
      • Advising customers in their trading programs
      • FUTURE TRADING ADVISORS
      • Act as adviser to the investors on futures trading.
      • Can be companies or individuals.
      • Major difference between the futures trading advisers & future brokers is that future trading advisers cannot conduct business as a broker and are not direct members of the Exchange. They play an advisory role to the customers who are interested in participating in the futures & options market.
    • FUTURE FUND MANAGERS
      • A person who carry out a future fund management business.
      • Specialize in managing funds that trades in future & options
      • Employees of futures fund managers are called futures fund manager representative
    • USERS OF FUTURES & OPTIONS
      • HEDGERS
      • Hedgers are investors or fund managers who will trade future contracts to hedge their portfolio exposure from any unexpected price movement in the underlying or related market.
      • Their primary interest is to protect the value of their portfolio
      • SPECULATORS
      • Individuals who trade future contracts with the primary interest of profiting from the future market
      • Willing to assume the risk of price fluctuations & hope the profit.
      • The presence of speculators contribute significantly to the liquidity of the market.
      • Arbitragers
      • People who engage in arbitrage activities
      • Involves locking in a risk –less profit by simultaneously trading in two or more markets
      • Take advantage of relative price disparity between two related markets.