Derivatives Market

Derivatives Market

1. Corporations/investors used derivatives to manage their exposure to market volatilities

2. Provides an avenue where domestic and international investors can manage their risk exposures in an efficient and cost effective manner

3. Volatile market

   • Risk
     • Company objective -> to reduce risk
       • Use Derivatives -> Futures or options

4. Types

   • Exchange-Traded (ETD)
     • Acting as an intermediary – takes initial margin from both sides as a guaranteed settled through clearing house E.g: Bursa Malaysia Derivatives Clearing House
   • Over-the-counter (OTC)
     • Trade is conducted privately Trade negotiated contracts (tailored based on investors’ requirements) Use forward instrument

5. Regulatory and Legal Framework

   • The industry is governed by the Futures Industry Act 1993 (amended in 1995, 1998)
   • Highest power: MOF
   • Gives power to the MOF which in turn empowered the Securities Commission Malaysia (SC) to regulate the industry to ensure market integrity and protecting the investors

6. Derivatives Clearing House

   • Malaysian Derivatives Clearing House Berhad was established in 1995, later known as Bursa Malaysia Derivatives Clearing House
   • Provides financial stability by guaranteeing the performance of contracts by acting as counterparty to all contracts traded

7. Participants

   • Hedgers use derivatives to protect against losses
   • Speculators to gain financial advantage from the direction of a particular market.
   • Portfolio managers hedge the assets of mutual funds, exchange-traded funds or closed-end fund.
   • Multinational corporations gain profits & hedge funds

8. Types of Products

   • Commodity derivatives
     • Based on values of agriculture & precious metal
   • Equity derivatives
     • Single stock futures contracts is based on equity derivatives products that are available on BMD.
   • Financial derivatives
     • Based on Malaysian short-term interest rate instruments traded in money market

9. Futures

   • Buyer / seller are obliged to buy / sell underlying instrument at specific time in future for a specified price determined today.
   • Open Position VS Close Out
     • Expiry date of futures contract = last day of trading in a contract month If the futures is still OPEN (not reach the expiry date), delivery of assets or cash settlement MUST BE MADE. Normally, delivery is not take place. Positions are CLOSED OUT / RESOLD before expiry date
   • Margin requirement
     • All participants must deposit initial sum of money / other acceptable collateral with the futures brokers. Deposited in futures margin accounts

10. Options

    • Buyer / seller has the right (not obligation) to buy / sell certain underlying instrument at specific price at any time during the life of a contract.
    • Types
      • American option
        • Options can be exercised by buyer at any time until expiry date
      • European option
        • Options can be exercised only on expiry date
    • Call option – right to buy an underlying asset; buyer of this option can choose whether or not it is profitable to buy underlying asset and act accordingly
      • Option status is known by comparing strike price and market price of asset In the money option: market price > strike price Out of the money option: market price < strike price At the money option: market price = strike price
    • Put option – right to sell underlying asset; buyer of this option can choose whether it is profitable to sell the underlying assets and act accordingly
      • Strike price-price at which the underlying assets will be bought/sold if holder wants to exercise option