Introduction to the Industry

Conceptual Background
Derivatives are financial contracts, which derive their value from the underlying asset. Common underlying asset are equity, commodity, foreign exchange, real estate or any other asset. In commodity derivative the underlying asset is the spot price of the commodity. A financial derivative is a legally binding financial contract. Both contingent parties to the financial derivatives have the legal obligation to perform the terms and conditions of a contract. It is a zero sum game in which one partys gain is always equal to the loss of the other party. And a market where exchange of derivative takes place is known as Derivatives market.

Types of derivatives
Broadly the derivatives can be classified as forwards, futures, options and swaps. 1. Option 2. Forward Contract 3. Future Contract 4. SWAP

Forward: A tailored contract between two parties, where payment takes place at a specific time in the future at todays pre-determined price is known as Forward Contract. The long position on the contract agrees to buy the security on the date. They are betting the price will go up. The short position on the contract agrees to sell the security on the date. They are betting the price will go down. Forwards also represent the obligation to make a transaction at a set point in time in the future. Once you enter into a forward-based contract, you are obligated to make the transaction (unless both parties agree to cancel or otherwise modify the agreement which is rare).

Future Contract
Future Contract is contracts to buy or sell an asset on or before a future date at a price specified today. A futures contract differs from a forward contract in that the futures contract is a standardized contract written by a clearing house that operates an exchange where the contract can be bought and sold; the forward contract is a non-standardized contract written by the parties themselves. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price.

There are mainly two types of futures trading contracts. They are futures contracts which are traded for physical delivery, known as commodities and futures contract which are end with a cash settlement, known as financial instruments. Both types of futures contracts are traded electronically and directly.

1.1.1.1 Commodity Futures

The underlying asset however would be a commodity like gold or silver. The term commodity is a very broad term and it includes 2. Bullion gold and silver 3. Metals Aluminum , copper, lead, iron, steel, nickel, tin, zinc 4. Energy-crude oil, gasoline, heating oil, electricity, natural gas 5. Weather- carbon 6. Oil and oil seeds crude palm oil, kapsica khali,refined Soya oil, Soya bean 7. Cereals- barley, wheat, maize 8. Fiber- cotton, kapas 9. Species-cardamom, coriander, termuric etc 10. Pluses chana 11. Others- like potatoes, sugar, almonds, gaur
11.1.1.1 Commodities futures, or futures contracts, are an agreement to buy or sell a commodity at a specific date in the future at a specific price. Just like the price of bananas at the grocery store, the prices of commodities can change on a weekly or even daily basis. If the price goes up, the buyer of the futures contract makes money, because he gets the product at the lower, agreed-upon price and can now sell it at the higher, market price. If the price goes down, the seller makes money, because he can buy the commodity at the lower market price, and sell it to the buyer at the higher, agreedupon price. Buyers use these to avoid the risks associated with the price fluctuations of the product or raw material, while sellers try to lock in a price for their products. Like in all financial markets, others use such contracts to gamble on price movements. In another words, the futures contract based on commodities, such as wheat, corn, copper, gold etc are termed as commodity futures.

11.1.1.2

Financial Futures

In many cases, the underlying asset to a futures contract may not be traditional commodities at all that is, for financial futures the underlying asset or item can be currencies, securities or financial instruments and intangible assets or referenced items such as stock indexes and interest rates. Financial Futures are futures contract based on a financial instrument. Such contracts usually move under the influence of interest rates. As rates rise, contracts fall in value; as rates fall, contracts gain in value. Examples of instruments underlying financial futures contracts: Treasury bills, Treasury notes, foreign currencies, and certificates of deposit. Traders use these futures to speculate on the direction of interest rates. Financial institutions (banks, insurance companies, brokerage firms) use them to hedge financial portfolios against adverse fluctuations in interest rates.

Option

SWAP

Number of Firms in Nepal

S.No 1. 2. 3. 6. Name
Commodity and Metal Exchange Nepal Ltd (COMEN) Merchantile Exchange Nepal Ltd (MEX) Nepal Derivative Exchange Ltd (NDEX) Commodity Future Exchange Nepal Ltd. (CFX) Everest commodity Exchange (ECX)

ESTD.

Describe about the exchange

1.1.1 Components of Futures Exchange A future exchange is a corporate entity composed of clearing house, non- clearing house, account executives and clients. These firms elect board of directors, which in turn selects individuals to manage the exchange. The exchange establishes rules for its trading members.

Future Exchange Clearing House

Non-Clearing Member

change Account Executives

Clients

Describe something about each

Fig 2.2: Organizational Hierarchy of Future Exchange

S.NO 1 2 3

Product Name Brent Crude Oil Cocoa Coffee

COMEN

MEX

NDEX

CFX

4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Corn Copper Mini Copper Cotton Mini Cotton Crude Oil Mini Crude Oil Gold Mini Gold Small Gold Heating Oil Natural Gas Mini Natural Gas Platinum Palladium Silver Mini Silver Small Silver Soyabean Soyabean Oil Sugar

25 26 27 28 29 30 31 32 33 33

Wheat Intraday Exposure Nepal Gold/Silver Zinc Lead Nickle Heating Oil Spot Gold / Silver

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