research on uses of derivative in pakistan by saifullah

8/10/2019 research on uses of derivative in pakistan by saifullah

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EXPLORING DEVELOPMENT OFFINANCIAL DERIVATIVE IN

PAKISTAN

Prepared By

SAIFULLAH : Roll No. 8309

afzaal : Roll No. 8306

Mazhar bajwa : Roll No. 8318

Zuhaib : Roll No.8292

Discussion member saifullah


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Karachi Stock Exchange (KSE) shows a better

growth rate in financial derivatives but KSE

also faces high degree of volatility


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history

Royal exchange of London is first and modern marketwhich permits the use of derivative

In beginning derivatives used mostly for commodities but

with the passage of time it focus on financial derivative thatmay be cash settle or offset though taking different positionIn 1637 first forward agreement was made.

The first "futures" contracts are generally tread

to the rice market in Osaka, Japan around 1650.

The history of U. S. futures markets, was the creation of theChicago Board of Trade in 1848


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Derivative

It is an financial instrument which value isderived from some underlying assets

Example:

you can enter into an agreement with afriend. Whose says that, I will pay to you $100 ifshahid afridi scored 40 runs in 30 balls in a t20match .

Otherwise you have to pay meThis is derivative b/c value(100) depend uponscore


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Types of derivative

There are 3 types of derivatives

Option

forward / future Swap


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Option

Right to buy & sell the security

transaction upon the discretion of buyer

Premium have to be paid

Trade over the counter (OTC)

Premium is minimum amount as contract sizeamount

Most of the option is traded on over the market butnow a day the trend of option traded

on stock exchanges is increasing.


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Continue..

There is two types of option

Call option: give the right to buyer to buy

underlying assets

Put option: gives the right to seller to sell the

underlying assets


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forward / future

contract to buy & sell the security

Both parties have to honor their contract even

one party face sever loss.

Trade in organized exchange

It is zero sum game, means the gain of one

party is the exact loss of other party


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Continue

Short position: commitment to sell a product or instrumentLong position: commitment to buy a product or instrumentSelling short: to sell a security even you have not purchasedit (selling of borrowed)Short selling is also allowed in standardized and regulatedderivatives

You have to maintain a margin account in future exchange

The a/c is credited if you gain & debited if you face loss

if your margin account needs some

liquidity then you must have to reimburse that amount inyour account.


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Continue

Mark to market concept is prevailing in KSE100

profit and loss recognition is done on daily basis

gain may be withdrawn and loss must be

reimburse


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Distinct between forward & future

contract

forward customized

No guarantee

Marked to market only onsettlement date

More risky

OTC

no cash flows until delivery

future Standardized

guaranteed by clearing

house Marked to market daily

Less risky

Organized exchange

margin requirements


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swap

Simultaneously buying & selling the securities


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Continue..

There are major 2 types of swap

Cross currency swap

Interest rate swap


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Cross currency swaps CCS

An agreement between two parties to

exchange interest payments and principal on

loans denominated in two different

currencies. In a cross currency swap, a loan'sinterest payments and principal in one

currency would be exchanged for an equally

valued loan and interest payments in adifferent currency


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Interest rate swap

An agreement between two parties (known ascounterparties) where one stream of futureinterest payments is exchanged for another basedon a specified principal amount. Interest rate

swaps often exchange a fixed payment for afloating payment that is linked to an interest rate(most often the LIBOR). A company will typicallyuse interest rate swaps to limit or manage

exposure to fluctuations in interest rates, or toobtain a marginally lower interest rate than itwould have been able to get without the swap


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Swaption (Swap Option)

There is no obligation to enter into a specified

swap agreement with the issuer on a specified

future date


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Swap option

Call Swaption

A type of option between

two parties that can be

exercised on a swap wherethe buyer of the swap has

the right, but not obligation

to, receive an agreed upon

fixed interest rate

Put Swaption An option on an interest

rate swap that gives the

option buyer the right topay a fixed rate of interest,

and receive a floating rate

of interest from the option

seller / swap counterparty


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EVOLUTION OF DERIVATIVE

Evolution of derivative according to regulation

Forward------ Futures ------- options -------

Swaps


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KEY PLAYER OF DERIVATIVE

MARKET


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Hedgers

Hedger is that person who avoid from price

fluctuation


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Speculator

By using the own expertise they earn profit

Example:

if the speculator estimate that price ofa specific commodity would raise in future

then he purchase in bulk sum quantity in

same market and vice versa.


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Arbitrager

These are individuals and organizations that

have better understanding of different market

and take the advantage of two different prices

in different market.


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DERIVATIVE IN PAKISTAN

introduced in Pakistan in 2001

36% of total trading volume of the stock exchange

in 2007-2008 it has 26% volume of total market Up to 2011 only 42 companies has permission to launch the

stock futures which is now increase in numbers

In Pakistan KSE30 index is available at 30, 60 and 90 day of

settlement Major user or forward contracts are multinational companies,

different type of investment funds, cement sector, textile and

farming sector


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Continue..

Major Player is cement sector because of their

expansion in capacity which requires high

investment and high degree of risk

Cement sector tried to overcome risk by using

60% of forward contract


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GRAPHICAL ANALYSIS OF DERIVATIVE

IN PAKISTAN


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Cross currency swaps CCSdropped by 9%

Interest rate swap dropped26%


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SECTOR WISE CCS


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SECTOR WISE DISTIBUTION

Telecom = 33%

MAJOR USER OF DERIVATIVES IN


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MAJOR USER OF DERIVATIVES IN

PAKISTAN

Lucy Cement Ltd Kohinoor Textile Ltd

Attock Cement

National Bank of Pakistan

Standard Charter Bank

AKD ltd

Foreign investor also invests in Pakistani derivatives


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BENEFIT OF DERIVATIVES

try to stabilize the market though its rational

and optimal usage.

Low transaction cost

Lock the risk

Zero sum game

Source of fund


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THREATS OF DERIVATIVES TO STOCK

EXCHANGES AND FINANCIAL SYSTEM

many investors do not use such instrumentowing to their inherent complexity

Derivative promote leverage tendency whichmay hamper the profitability and increase risk

Increase excessive speculation and arbitragewhich is not good for efficient markets


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MAJOR LOSSES IN DERIVATIVE AROUND THEWORLD


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REASONS of LOW INTEREST LEVEL OF INSTITUTION IN

DERIVATIVES IN

PAKISTAN

Lack of knowledge about the derivative

Statutory restriction on different institution

like mutual fund only may use only 10% of

assets in derivatives

Fragile economy


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Recommendation

create investor awareness about existing

products

Try to minimize the complexity of mechanism


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