Challenges and Prospects of Derivative Market in Nepal

A proposal report on “Challenges and Prospects of Derivative Market in Nepal” Page 1

Chapter-1

INTRODUCTION

1.1.Background

With the advent of liberalization, privatization and globalization with the free economy

environment, maximum efforts are made in strengthening the investor confidence. The basic

reason underlined is in context to free and regular flow of funds to the corporate sector along

with establishing a strong investor base by including more and more middle and small

investors with their investible funds. In one way, the stock market is an experienced platform

for the any existing investors to go for accumulating their wealth by means of diversification

without any hedging to the prevailing risk factors, while the new concept of derivative market

trading mechanism has helped them a lot in minimizing the risk factors to a greater extent.

This has also led to the redefining the economy of the nation to a significant status before the

global scenario (Mishra, 2008).

The past decade has observed the abundant growth in the volume of international trade and

business due to the wave of globalization and liberalization all over the world. Therefore, the

demand of international money and financial instrument increased endlessly at worldwide.

The derivatives first came into existence in Japan rice market in early 1650s, whereas, in

Nepal its origin goes back to 2006. It is an emerging concept of Nepalese financial market.

The present context of globalization has linked the entire world as a single global market;

neither Nepal nor its financial market is an exception to this fact. Revolutionary technological

development has made quick and easy access to every possible market, as a result of this

shrunken world, the financial and economic inter-connect has further continued to intensify.

Due to the advancement of technology and the rapidly increasing size of the financial market

worldwide, its structure has become more sophisticated, yet crucial for an economic growth

of a nation. With ever increasing market openness, development of new financial techniques

and financial engineering, new financial products are constantly being introduced in both the

banking and non-banking sector of Nepali financial sector.

Derivative is one of these financial innovations in Nepal during the years of the country’s

financial development. Historically, the demand for derivative products as a financial

instrument to manage risks inherent in various business activities has evolved over the years

as a result of increasing macroeconomic instability, associated risks and volatility since the

1970s following the collapse of the Bretton Woods System. Understanding the fact that the

availability of derivative products very much depends on the market status, financial sector

openness, regulatory requirements and financial soundness of a nation; the structure of the

derivative market is limited to the presence of commodity derivatives in the case of Nepal

since the past few years; though the commodity market, as an alternative platform for

investment has undoubtedly grown by leaps and bounds. Moreover, with the liberalization of

the Nepal’s financial sector, Nepal Rastra Bank has also allowed commercial banks to have


exposures to foreign exchange forward contracts. However, activities are not meant to be

speculative in nature and the purpose is to mitigate the currency fluctuation risks.

Nevertheless, the sophistication of derivative markets bring along the question of financial

stability. Much of the publicized news about the derivative market in general worldwide and

commodity market, in particular here in Nepal, is associated with the financial mess at the

macro and micro levels respectively, whereas its benefits being shadowed under the cover of

misconceptions and lack of public awareness as well as critical understanding at the level of

concerned authorities. It’s always imperative to remember that such products themselves are

not the problem; the problem lies in the way it is managed and strategically used as per the

need and importance of a nation. That makes it essential to understand the nature of

derivative products, perhaps it may contribute to some extent towards development of the

Nepali financial sector as Nepal embrace ever-evolving activities of market living at the age

of 21st century’s global village.

The International Monetary Fund (2001) defines derivatives as “financial instruments that are

linked to a specific financial instrument or indicator or commodity and through which

specific risks can be traded in financial markets in their own right. The value of a financial

derivative derives from the price of an underlying item, such as an asset or index. Unlike debt

securities, no principal is advanced to be repaid and no investment income accrues.”

Derivative is a security whose price is dependent upon or derived from one or more

underlying assets (http://www.investopedia). The derivative itself is merely a contract

between two or more parties. Its value is determined by fluctuations in the underlying asset.

The most common underlying assets include stocks, bonds, commodities, currencies, interest

rates and market indexes. Most derivatives are characterized by high leverage.

As Nepalese securities markets continue to evolve, market participants, investors and

regulators are looking at different ways in which the risk management may be efficiently met

through the introduction of Derivative markets. Through the use of derivative products, it is

possible to partially or fully transfer price risks by locking in asset prices. As instruments of

risk management, these generally do not influence the fluctuations in the underlying asset

prices. Derivatives are risk management instruments, which derive their value form an

underlying asset. The underlying asset can be bullion, index, share, bonds, currency, interest

etc. banks, securities firms, companies and investors to hedge risks, to gain access to cheaper

money and to make profit, uses derivatives. Derivatives are likely to grow even at a faster

rate in future.

Derivatives are defined as financial instruments whose value derived from the prices of one

or more other assets such as equity securities, fixed-income securities, foreign currencies, or

commodities. Derivative is also a kind of contract between two counter parties to exchange

payments linked to the prices of underlying assets (Sreenu, 2012).

The emergence of the market for derivative products most notably forwards, futures and

options can be traced back to the willingness of risk-averse economic agents to guard

themselves against uncertainties arising out of fluctuations in asset prices. By their very

nature, financial markets are markets by a very high degree of volatility. Through the use of

http://www.investopedia.com/terms/s/security.asp

http://www.investopedia.com/terms/l/leverage.asp


derivative products, it is possible to partially or fully transfer price risks by locking – in asset

prices. As instruments of risk management these generally don’t influence the fluctuations in

the underlying asset prices. Derivatives may be traded for a variety of reasons. A derivative

enables a trader to hedge some preexisting risk by taking positions in derivatives markets that

offset potential losses in the underlying or spot market (Sarkar, 2006).

Natural hedges, defined as situations in which aggregate risk can be reduced by derivatives

transactions between two parties (called counterparties), exist for many commodities, for

foreign currencies, for interest rates on securities with different maturities, and even for

common stocks where portfolio managers want to “hedge their bets”. Natural hedges occur

when futures are traded between cotton farmers and cotton mills, copper mines and copper

fabricators, importers and foreign manufacturers for currency exchange rates, electric utilities

and coal miners, and oil producers and oil users. In all such situations, hedging reduces

aggregate risk and thus benefits the economy (Brigham & Ehrhardt, 2008).

In the financial sector there are more new probable opportunities. There are no sufficient

financial instruments for trading. Investors have to be limited in some instruments. They

cannot diverse their portfolios in sufficient sectors. Due to the lack of diversification in

portfolio the investors have to bear huge loss if the market turns to the opposite direction of

the investor what he/she has expected and forecasted. In the context of financial sector there

one stock exchange for trading stock of listed commercial banks, development banks,

financial companies, some hotels and other few manufacturing companies. In the exchange

investors can trade stock, bonds, preferred stocks and other securities. To meet the necessity

in the investment sector the concept of commodities trading and its market has been

established with the establishment of Commodities and Metal Exchange Nepal Ltd.

(COMEN). It is just that commodities market has been enter in the financial hub of Nepal but

there is not any further development in the commodities market.

The objective of study is to analyze the growth pattern of derivatives, problems faced by the

instrument and future prospects of this significant device in Nepal. The present paper

highlights the history of derivatives market in Nepal, application of financial derivatives, key

players of derivative market and the uses of the derivative market.

1.2.Statement of the Problems

Capital market is one of the most important sectors of the financial system of any country as

it has a direct impact on the development of the country. Risk is the main feature of any

capital market as well as commodity market. The complex nature of financial structuring has

exposed corporate to newer types of risks such as exchange risk, interest rate risk, market

risk, inflation risk etc. Business activities are increasing day by day and are resulting in

increase magnitude and frequency of above mentioned risks. Financial markets are, by

nature, extremely volatile and hence the risk factor is major concern for financial agents

(Kumari, 2011). To reduce the risk, the concept of derivatives comes into picture.


There is only one stock market in Nepal---Nepal Stock Exchange (NEPSE) while there are

five commodity exchanges currently operating - Commodities and Metal Exchanges Nepal

Limited, Mercantile Exchange Nepal Limited, Nepal Derivatives Exchange, Nepal Spot

Exchange and Wealth Exchange. The stock market has been operating in Nepal since the last

two decades while it has been just half a decade the concept of commodity market started to

materialize. It seems that the investors are looking upon the idea of commodity exchanges as

a promising investment avenue. Whenever the anomalies surface in the stock market, they

tend to channelize their investment into the commodity market for the security of their

equities.

The Nepalese Derivative Market is very young. The investors haven’t been able to analyze

the situation properly. They are not smart enough to study the situation and take good

judgments. There is no regulating body in the Nepalese derivative market. Most of the

investors find the derivative market as some sorts of gambling place where people gather

together for gambling purpose and try to make out high returns with least investments.

It is generally stated that regulation has an important and critical role to ensure the efficient

and smooth functioning of the markets. According to Sahoo (1997) the legal framework for

derivatives trading is a critical part of overall regulatory framework of derivative markets.

The purpose of regulation is to encourage the efficiency and competition rather than

impeding it. Hathaway (1998) stated that, while there is a perceived similarity of regulatory

objective, there is no single preferred model for regulation of derivative markets.

Various researches have been done in case of derivative market in Nepal but there is still

some lacking for bringing out the actual figure of derivative market. Till date, Studies have

been conducted for theoretical development purpose only but the challenges, development

and future prospects regarding Nepalese derivative market are not properly traced out.

Therefore, this study tries to examine the challenges and future prospects of derivative market

in Nepal.

After analyzing and interpreting various facts, it has been come up to find the following

problems:

1. What are the challenges of derivative market in Nepal?

2. What are the future prospects of derivative market in Nepal?

3. What contribution does the derivative market have on Nepalese economy?

4. Does regulatory body play a significant role for developing derivative market?

5. Are all investors aware regarding derivative market in Nepal?

1.3.Purpose of the Study

The Major objective of this study is to assess the future challenges and prospects of

derivative market in Nepal. Other Specific objectives of the study are as follows:


1. To have an overview of Nepalese derivative market.

2. To trace the historical developments in derivative market in Nepal.

3. To study the types of derivatives traded in Nepalese markets.

4. To study about risk management with the help of derivatives.

5. To assess the regulations and policies framed in regard of developments of derivative

market in Nepal.

6. To understand the concept of the Derivatives and Derivative Trading.

7. To know the role of derivatives trading for Nepalese economy.

8. To analyze the performance of Derivatives Trading in Nepal.

9. To analyze pros and cons of derivative market in Nepal.

1.4.Significant of the Study

In recent times the Derivative markets have gained importance in terms of their role in the

economy. The increasing investment in derivatives (domestics as well as overseas) have

attracted the interest in this area. Through the use of derivative products, it is possible to

partially or fully transfer price risks by locking-in assets prices. As the volume of trading is

tremendously increasing in the derivatives market, this analysis will be of immense help to

the investors.

The study is conducted to know the future challenges and prospects of financial derivative

market in Nepal. It seems that the investors are looking upon the idea of commodity

exchanges as a promising investment avenue. This study covers the recent development of

derivative market so it is important to all investors for analyzing and making investment

decision. This study is also helpful to regulatory body and government for formulation of

legal provision regarding to derivative market of Nepal. At the same time, this study is also

significant to trace out the development, growth and challenges of derivative market in

Nepal.

1.5.Research Questions

The study focus to trace out following problems:

1. What factors pose challenges for the development of derivative market in Nepal?

2. Does the derivative market showing good indication for the investor?

3. Is there any legal provision for protecting investor fund in derivative market?

4. What are the future prospects of derivative market in Nepal?

5. How does the derivative market affect to the country economy?

6. What are the alternatives investments available in the derivative market for investors?


1.6.Limitation of the Study

The main purpose of the study is to examine the challenges and prospects of derivative

market in Nepal. The study has only made humble attempt at evaluating derivative market

only in Nepali context. The study is not based on international perspective of derivatives

markets, which exists in NASDAQ, CBOT etc. The limitations of the study are as follows:

1. The study is limited by time and cost factors.

2. The limited period of study may not be detailed and full-fledged in all aspects.

3. The development of derivative market in Nepal is a recent origin so it is be very

difficult to get authentic information.

4. The data provided by the prospects may not be 100% correct as they have their

limitations.

5. The lack of information sources for the analysis part.


Chapter-2

LITERATURE REVIEW AND THEORETICAL FRAMEWORK

2.1. Literature Review

The trading of financial derivatives has received extensive attention, while at the same time it

has led to a debate over its impact on the underlying stock market from various facets by the

academicians. The researchers all over the world have done research on derivative trading

and were able to find out various facts about derivative and its trading. In this literature

review efforts have been made to bring into the picture the research done about various issues

throughout the world and Nepalese case by the researchers.

The present context of globalization has linked the entire world as a single global market;

neither Nepal nor its financial market is an exception to this fact. Revolutionary technological

development has made quick and easy access to every possible market, as a result of this

shrunken world, the financial and economic inter-connect has further continued to intensify.

Due to the advancement of technology and the rapidly increasing size of the financial market

worldwide, its structure has become more sophisticated, yet crucial for an economic growth

of a nation. With ever increasing market openness, development of new financial techniques

and financial engineering, new financial products are constantly being introduced in both the

banking and non-banking sector of Nepalese financial sector.

Derivatives are financial contracts or financial instruments whose prices are derived from the

price of something else (known as the underlying). The underlying price on which a

derivative is based can be that of an asset (e.g., commodities, equities (stock), residential

mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange

rates, stock market indices, consumer price index (CPI) i.e. inflation derivatives), or other

items. Credit derivatives are based on loans, bonds or other forms of credit. Derivatives allow

risk about the price of the underlying asset to be transferred from one party to another. The

main types of derivatives are forward, futures, options and swaps.

The word “Derivative” is a magic word. There can be derivative of everything e.g.,

commodities, equities (stock), residential mortgages, commercial real estate, loans, bonds),

an index (e.g., interest rates, exchange rates, stock market indices, consumer price index

(CPI) i.e. inflation derivatives), or other items. So there is scope for everyone and every

sector like growers, traders, exporters, importers, financial institutions, industrialists,

investors and end.

The market liquidity crisis that ensued following the collapse of Lehman Brothers in July

2007 resulted in significant losses to seemingly sophisticated but unwary investors in

derivatives markets and caused substantial collateral damage in related markets (Wilmarth,

2009). The financial crisis resulted in various regulatory initiatives to reform the over-the

counter (OTC) derivatives markets, including the prescription that most derivative contracts

should be traded on exchanges or electronic trading platforms and cleared through central


counterparties. The effectiveness of these reforms to mitigate market liquidity risk requires

further investigation.

According to a study by Edwards (1995), OTC derivatives would cause a systemic crisis

because of the following hypothetical sequence: (1) an initial shock due to the failure of a

large end-user; (2) the failure of a large derivatives dealer; (3) counterparty spillover effects;

(4) market linkages spreading the “price break” (5) other dealers developing large credit

problems which could, if these dealers are banks, create a loss of confidence, causing bank

runs and bank failures; (6) deterioration in confidence, markets become less liquid, causing

price breaks and forced liquidations of securities by investors around the world (liquidity

crisis). The author however argues that, although a systemic crisis can never be ruled out, the

“notion that the expansion of OTC derivatives markets has somehow increased the likelihood

of a systemic crisis has no obvious factual basis” (Placeholder1) (Edwards, 1995) and that

there is no factual basis for additional regulation of this market. This is because pressures

from rating agencies and self-preservation incentives impose management and capital

discipline on dealers.

In a study by Scholes, (1996) in which the author argues that “there is no empirical evidence

that supports the conjectures that OTC derivative contracts can lead to massive failures and

create systemic risk” and that more restrictive regulatory rules in the derivatives markets may

destroy well-functioning markets, which would destroy market liquidity. The author argues

that dealers have, and continue to make infrastructure investments, and allocate or reserve

sufficient contingent capital to support their derivative businesses, and that these measures

are better alternatives to regulatory solutions.

According to Greenspan, (1997) “By far the most significant event in finance during the past

decades has been the extraordinary development and expansion of financial derivatives…”

Avadhani, (2000) stated that a derivative, an innovative financial instrument, emerged to

protect against the risks generated in the past, as the history of financial markets is repleted

with crises. Events like the collapse of the fixed exchange rate system in 1971, the Black

Monday of October 1987, the steep fall in the Nikkei in 1989, the US bond debacle of 1994,

occurred because of very high degree of volatility of financial markets and their

unpredictability. Such disasters have become more frequent with increased global integration

of markets. Sahoo, (1997) opines “Derivatives products initially emerged, as hedging devices

against fluctuation in commodity prices and the commodity-linked derivatives remained the

sole form of such products for many years. Marlowe (2000) argues that the emergence of the

derivative market products most notably forwards, futures and options can be traced back to

the willingness of risk-averse economic agents to guard themselves against uncertainties

arising out of fluctuations in asset prices. It is generally stated that regulation has an

important and critical role to ensure the efficient and smooth functioning of the markets.

According to Sahoo (1997) the legal framework for derivatives trading is a critical part of

overall regulatory framework of derivative markets. The purpose of regulation is to

encourage the efficiency and competition rather than impeding it. Hathway ( 1988) stated

that, while there is a perceived similarity of regulatory objective, there is no single preferred

model for regulation of derivative markets.


Derivatives include a wide range of financial contracts, including forwards, futures, swaps

and options. Forward contract is an agreement between two parties calling for delivery of,

and payment for, a specified quantity and quality of a commodity at a specified future date.

The price may be agreed upon in advance, or determined by formula at the time of delivery or

other point in time” (Definition of Forward Contract, 2012). Just like other instruments, it is

used to control and hedge currency exposure risk (e.g. forward contracts on USD or EUR) or

commodity prices (e.g. forward contracts on oil). Patwari & Bhargava (2006) explain it in

simple words and further add that one of the parties to a forward contract assumes a long

position and agrees to buy the underlying asset at a certain future date for a certain price and

the other agrees to short it. The specified price is referred to as the delivery price. The parties

to the contract mutually agree upon the contract terms like delivery price and quantity.

Sirisha (2001) explain the Types of Futures which are Foreign Exchange, Futures Currency

Futures, Stock Index Futures, and Commodity Futures etc.

The Nepalese Derivative Market is very young. Only few researches for theoretical

development purpose are found in this field. The investors haven’t been able to analyze the

situation properly. They are not smart enough to study the situation and take good

judgments. There is no regulating body in the Nepalese derivative market. Most of the

investors find the derivative market as some sorts of gambling place where people gather

together for gambling purpose and try to make out high returns with least investments. But

it is very important that one must realize that there is a difference between gambling and

speculation and the future markets are not like “Satta” markets.

Participants in physical markets use futures market for price discovery and price risk

management. In fact, in the absence of futures market, they would be compelled to

speculate on prices. Futures market helps them to avoid speculation by entering into hedge

contracts. It is however extremely unlikely for every hedger to find a hedger counterparty

with matching requirements. The hedgers intend to shift price risk, which they can only if

there are participants willing to accept the risk. Speculators are such participants who are

willing to take risk of hedgers in the expectation of making profit. Speculators provide

liquidity to the market; therefore, it is difficult to imagine a futures market functioning

without speculators.

The survey and review of literature about the financial sector reforms in world and Nepal

reveals that the reforms have been pursued vigorously and the results of the reforms have

brought about improved efficiency and transparency in the financial sector. The reforms also

brought into inter-linkage of financial markets across the globe leading to new product

development and sophisticated risk management tools. Derivatives in general perform as an

instrument to hedge the risk arising from movement in prices not only in commodity markets

but also in securities market.

The need for such a study was felt as previous studies relating to the impact of derivatives

securities on Nepalese Stock market do not cover the future prospects of derivative market in


Nepal. In the financial sector there are more new probable opportunities. There is no

sufficient study regarding derivative market in Nepal.

The objective of study is to analyze the growth pattern of derivatives, problems faced by the

instrument and future prospects of this significant device in Nepal. Further, the study also

highlights the historical development of derivative market, various alternatives available for

trading, and economic impact of derivative market in Nepal.

2.2. Theoretical Framework

Capital market is one of the most important sectors of the financial system of any country as

it has a direct impact on the development of the country. Risk is the main feature of any

capital market as well as commodity market. The complex nature of financial structuring has

exposed corporate to newer types of risks such as exchange risk, interest rate risk, market

risk, inflation risk etc. Business activities are increasing day by day and are resulting in

increase magnitude and frequency of above mentioned risks. Financial markets are, by

nature, extremely volatile and hence the risk factor is major concern for financial agents

(Kumari, 2011). To reduce the risk, the concept of derivatives comes into picture.

In the financial sector there are more new probable opportunities. There are no sufficient

financial instruments for trading. Investors have to be limited in some instruments. They

cannot diverse their portfolios in sufficient sectors. Due to the lack of diversification in

portfolio the investors have to bear huge loss if the market turns to the opposite direction of

the investor what he/she has expected and forecasted. In the context of financial sector there

one stock exchange for trading stock of listed commercial banks, development banks,

financial companies, some hotels and other few manufacturing companies. In the exchange

investors can trade stock, bonds, preferred stocks and other securities. To meet the necessity

in the investment sector the concept of commodities trading and its market has been

established with the establishment of Commodities and Metal Exchange Nepal Ltd.

(COMEN). It is just that commodities market has been enter in the financial hub of Nepal but

there is not any further development in the commodities market.

The study is conducted to explore the trend of derivative market in Nepal. To identify the

future prospects, the study considers current development of capital market, investors’

awareness, and present performance of existing derivative companies in Nepal.

To know the future prospects of derivative market in Nepal, the dependent and independent

variables are taken into consideration. The dependent variables consist of the Average Daily

Volume of Trading and the independent variables consist of price volatility, investor

awareness, alternatives available for trading, and size of cash market etc.


Conceptual Framework

Average Daily Volume of Trading

Investor Awareness

Alternatives Available for Trading

Size of Cash Market

Price Volatility

Figure: 1, Schematic Diagram of Dependent and Independent Variables

In the above schematic diagram, the dependent variable is Average Daily Volume of Trading

in Derivative market and independent variables are price volatility, investor awareness,

alternatives available for trading and size of cash market.

Variable definition

a. Average Daily Volume of Trading(ADVT)

It is measured as the average volume of trading in a day. The trading volume is measured

in rupees. Higher the trading volume per day, greater will be the possibility of future

growth of derivative market and vice-versa.

b. Price volatility

The price volatility measures the fluctuation in price of underlying assets in the market.

The proxy variable of price volatility is simply the standard deviation of price of

underlying assets. Higher price volatility indicates that the market growth is uncertain.


Generally, investors prefer less price volatility. There is negative relationship between

price volatility and average volume of trading per day.

c. Investor awareness

Investor awareness is measures in terms of number of investors participated in trading of

derivative securities. Higher the number of people involve in trading shows they deserve

the derivative knowledge and aware of market mechanism. Higher the investor awareness

shows higher will be the average volume of trading per day, indicating the future

prospects of derivative market and vice-versa.

d. Alternatives available for trading

This is the pool of choice available to investor for derivative trading. Various alternatives

such as future, forward, swaps etc. provides choice to investors. Higher the availability of

alternatives, higher will be the average daily volume of trading and vice-versa.

e. Size of cash market

It is measured in term of market value capitalization of underlying assets. Higher the size

of cash market, higher will be the average trading volume and vice-versa. The higher cash

market shows there will be the better prospects of derivative market in days to come.


Chapter 3

METHODOLOGY

3.1. Research Plan and Design

A research design is the "blue print" of the study. Research design is the determination and

statement of the general research approach or strategy adopted for the particular project.

Research designs help researchers to lay out their research questions, methodologies,

implementation procedures, and data collection and analysis to conduct a research project.

Research design is a road map for the researcher. If the design adheres to the research

objective, it will ensure that the client needs will be served. Research is the plan, structure

and strategy of investigation conceived so as to obtain answers to research questions and to

control variance. It is the specification of methods and procedures for acquiring the

information needed. It is the overall operational pattern or framework of the project that

stipulates what information is to be collected from which source by what procedure. In this

research we have two type of research design.

3.1.1. Descriptive Research Design

Descriptive research is used to describe characteristics of a population or phenomenon being

studied. It does not answer questions about how/when/why the characteristics occurred

(Wikipedia.org, 2012). The characteristics used to describe the situation or population is

usually some kind of categorical scheme also known as descriptive categories. Descriptive

research is a fact –finding operation searching for adequate information. It is a type of study,

which generally is conducted to assess the characteristics of given population or phenomenon

being studied. Descriptive research is a process of accumulating facts. It does not necessarily

seek to explain relationship, test hypothesis, make predictions, and get at implication of

study. It involves gathering data that describes events and then organizes, tabulates, depicts

and describe the data collection. Descriptive statistics is used to reduce the data to

manageable form.

3.1.2. Comparative Research Design

Comparative research, simply put, is the act of comparing two or more things with a view to

discovering something about one or all of the things being compared. This technique often

utilizes multiple disciplines in one study. When it comes to method, the majority agreement is

that there is no methodology peculiar to comparative research. It aims to show cause-and-

effect relationships between two or more variables. One variable is considered as the cause

(independent variable) and the other variable is considered as the effect (dependent variable).

In this research Average daily volume of trading is taken as dependent variables and price

volatility, Investor awareness, alternatives available for trading, and size of cash market, are

taken as independent variables.

http://en.wikipedia.org/wiki/Statistical_population


3.1.2.1. Causal-comparative Research

A causal-comparative design is a research design that seeks to find relationships between

independent and dependent variables after an action or event has already occurred. The

researcher's goal is to determine whether the independent variable affected the outcome, or

dependent variable, by comparing two or more groups of individuals. It aims to establish the

direction, magnitude and form of observed relationships. It permits investigation of variables

that cannot or should not be investigated experimentally, facilitate decision making, provide

guidance for experimental studies, and are less costly on all dimensions. In causal

comparative research the random sample is selected from two already existing populations,

not from a single population as in experimental research. The impact is tested by designing

multiple regression models and analyzing the model with the help of SPSS. For the study

purpose, quantitative data are collected from the secondary source. In this study following

regression model is used:

Average Daily Trading = β0 + β1 PV+ β2 IWR + β3 AVT + β4 SCM + ℮

Where,

PV = Price Volatility

IWR = Investors Awareness

AVT = Alternatives Available for Trading

SCM = Size of Cash Market

3.2. Description of Sample

In the theory of finite population sampling, a sampling design specifies for every

possible sample its probability of being drawn( (Wikipedia.org, 2014). Sampling is a method

of selecting experimental units from a population so that we can make decision about the

population. In large population it is very difficult to study whole sample hence a random

selected sample are tested to generalize conclusion of whole population. Out of 12 derivative

exchanges, six derivative exchanges are chosen as representative sample for conducting the

analysis using observations from 2012 to 2014.

The samples taken for study are as follows:

Table: 1, Sample derivative exchanges

S.N. Derivative Exchanges

1. Mercantile Exchange Nepal Ltd. (MEX)

2. Commodity & Metal Exchange Nepal Ltd. (COMEN)

3. Nepal Derivative Exchange Ltd. (NDEX)

4. Wealth Derivative Exchange Ltd. (WEX)

5. Commodity Future Exchange(CFX)

6. National Spot Exchange(NSE)

http://en.wikipedia.org/wiki/Population

http://en.wikipedia.org/wiki/Sampling_(statistics)

http://en.wikipedia.org/wiki/Sample_(statistics)

http://en.wikipedia.org/wiki/Probability


3.3. Data Collection Procedure and Time Frame

Data collection is the process of gathering and measuring information on variables of interest,

in an established systematic fashion that enables one to answer stated research questions, test

hypotheses, and evaluate outcomes. Data are collected through the reports of derivative

exchanges (monthly, quarterly and annually). The study use secondary data for analysis of

current performance of derivative exchanges. The secondary data are collected through

reports, newspapers, exchange websites etc. Last 2 years data are collected for the study. This

is short-term research work which is estimated to take two to three months. Data collection

for derivative exchanges is a challenging job due to the raw stage of derivative market in

Nepal.

3.4. Analysis Plan

Every dissertation methodology requires a data analysis plan. The plan is critical because it

tells the reader what analysis will be conducted to examine each of the research hypotheses.

In the data plan, data cleaning, transformations, and assumptions of the analyses should be

addressed, in addition to the actual analytic strategy selected. In this study, descriptive

statistical tools such as min, max, average, standard deviation, goodness of fit and standard

error are used to find out results. Price volatility is measured in terms of standard deviation of

market price of underlying assets. Similarly, investors awareness is measures in terms of

number of investors participated in trading of underlying assets. Availability of derivative

alternatives is measured in terms of number of alternatives. Likewise, size of cash market is

measured in terms of market capitalization (amount). Regression model is used to analyze the

effect of independent variables on dependent variables.

http://en.wikipedia.org/wiki/Measuring

http://en.wikipedia.org/wiki/Hypothesis_testing

http://en.wikipedia.org/wiki/Hypothesis_testing


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ANNEX

MEX Futures Products

02 APR 2015

Item Open High Low Close

BRCMAY15 4571 4590 4319 4386

CCOMAY15 219.8 223 219.7 220.9

COFMAY15 236.5 249.5 236.3 249.1

CONMAY15 12 12.24 11.9 12.12

COPMAY15 484.7 487.7 479 481.6

COTMAY15 110.32 112.68 110.32 112.1

CRUMAY15 3995 4024 3847 3902

GOLJUN15 30987.5 31052.5 30725 30897.5

HEAMAY15 36.98 37.09 35.18 35.58

MCOPMAY15 485.2 488.2 479.5 482.1

MCOTMAY15 110.42 112.78 110.42 112.2

MGOLJUN15 30992.5 31057.5 30730 30900

MNAGMAY15 209.4 218 207.6 216.1

MRGOLJUN15 31002.5 31067.5 30740 30910

MRSILMAY15 437.7 438.8 427.6 431.6

MSILMAY15 436.7 437.8 426.6 430.6

NAGMAY15 208.9 217.5 207.1 215.6

PALJUN15 19258 19416 19038 19212

PLTJUN15 30012.5 30025 29587.5 29747.5

SBOMAY15 53.94 54.76 53.94 54.66

SGOLJUN15 30997.5 31062.5 30735 30905

SILMAY15 436.2 437.3 426.1 430.1

SOYMAY15 29.04 29.18 28.82 28.97

SSILMAY15 437.2 438.3 427.1 431.1

SUGMAY15 21.76 22.48 21.7 22.4

WHTMAY15 15.5 16 15.35 15.72

(Source: http://www.mexnepal.com)


Local Agro Commodities (Daily Wholesale Selling Price Bulletin)

S.No. Name of Commodity Unit नेपालीनाम Minimum Maximum Average

1 Apple Kg स्याउ 100.00 110.00 105.00

2 Chili Dry Kg सुकेको खुसाानी 200.00 200.00 200.00

3 Garlic Dry Chinese Kg लसुन सुकेको चाइननज 130.00 135.00 132.33

4 Garlic Dry Nepali Kg लसुन सुकेको नेपाली 80.00 90.00 85.00

5 Garlic Green Kg लसुन हरियो 40.00 45.00 42.50

6 Ginger Kg अदवुा 85.00 95.00 90.00

7 Green Peas Kg हरियो मटि 32.00 42.00 37.25

8 Mushroom Kg च्याउ 110.00 130.00 120.00

9 Onion Dry Kg सुकेको प्याज 31.00 33.00 32.20

10 Potato Red Kg िातो आलु 15.00 18.00 16.80

11 Potato White Kg सेतो आलु 10.00 12.00 11.20

12 Sweet Orange Kg गुललयो सुन्तला 50.00 60.00 55.00

(Source: http://www.mexnepal.com)

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Challenges and Prospects of Derivative Market in Nepal

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