CHAPTER - I

INTRODUCTION

1.1 General Background

Economic sector plays a vital role for developing the nations. Nepal is one of the least
developed countries in the world. Nepal is practicing the development program by
launching various capital formation activities in different sectors. Nepal launched
planned economic policy more than forty-five years ago. Now it is actively trying to
achieve the rapid pace of development through liberalization. To attain the rapid pace
of economic development of the country, there should be good environment for
potential investors in investment activities in the different sectors of the economy.

Development and expansion of the capital market as an institutional base is essential

for the mobilization of resources from small savers, and for the supply of long-term
capital at a minimal cost, to the productive sector of the economy. In this context, the
program initiated in the Tenth Plan will be continued. With a new vision and review
of the capital market's needs, qualitative changes will be brought about in the capital
market through market regulation and additional infrastructure development. With a
view to strengthen the derivative exchange and to develop it to the international
standard, Nepal government declared to make required rule & regulations regarding
derivative exchange to the related body.

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 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, warrants and swaps.

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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 every
one and every sector like growers, traders, exporters, importers, financial institutions,
industrialists, investors and end users.

Despite a long history of derivative futures trading in the world, futures markets are
still viewed with suspicion by many in both the academic and official circles. The
recent deflation in the values of various assets underlying the different derivatives,
including commodity derivatives, following the global meltdown, have provoked
even more doubts about the much acclaimed economic utility of futures trading for
price discovery and risk management. As a result, its support for futures business in
many commodities notwithstanding, the authorities have still not permitted such
trading in several food grains like rice and millets, and some major pulses, too. Even
in USA, which has the most active commodity exchanges in the world, the new
administration of President Obama is not merely rewriting the rules of regulation, but
even investigating the role of commodity futures trading in the steep rise in prices of
wheat and crude oil in 2007-08, regardless of the fact that commodities as an asset
class have revealed the resoluteness and resilience in the face of global financial
crisis.

1.2 History of Derivatives

The history of derivatives is quite colorful and surprisingly a lot longer than most
people think. To start talking about derivative we need to go back to the Bible. In
Genesis Chapter 29, believed to be about the year 1700 B.C., Jacob purchased an
option costing him seven years of labor that granted him the right to marry Laban's
daughter Rachel. His prospective father-in-law, however, reneged, perhaps making
this not only the first derivative but the first default on a derivative. Laban required
Jacob to marry his older daughter Leah. Jacob married Leah, but because he preferred
Rachel, he purchased another option, requiring seven more years of labor, and finally
married Rachel, bigamy being allowed in those days. Jacob ended up with two wives,
twelve sons, who became the patriarchs of the twelve tribes of Israel, and a lot of
domestic friction, which is not surprising. Some argue that Jacob really had forward

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contracts, which obligated him to the marriages but that does not matter. Jacob did
derivatives, one way or the other. Around 580 B.C., Thales the Milesian purchased
options on olive presses and made a fortune off of a bumper crop in olives. So
derivatives were around before the time of Christ.
The first exchange for trading derivatives appeared to be the Royal Exchange in
London, which permitted forward contracting. The celebrated Dutch Tulip bulb
mania, which you can read about in Extraordinary Popular Delusions and the
Madness of Crowds by Charles Mackay, published 1841 but still in print, was
characterized by forward contracting on tulip bulbs around 1637. The first futures
contracts are generally traced to the Yodoya rice market in Osaka, Japan around 1650.
These were evidently standardized contracts, which made them much like today's
futures, although it is not known if the contracts were marked to market daily and/or
had credit guarantees.

Probably the next major event, and the most significant as far as the history of U. S.
futures markets, was the creation of the Chicago Board of Trade in 1848. Due to its
prime location on Lake Michigan, Chicago was developing as a major center for the
storage, sale, and distribution of Midwestern grain. Due to the seasonality of grain,
however, Chicago's storage facilities were unable to accommodate the enormous
increase in supply that occurred following the harvest. Similarly, its facilities were
underutilized in the spring. Chicago spot prices rose and fell drastically. A group of
grain traders created the ‘to-arrive’ contract, which permitted farmers to lock in the
price and deliver the grain later. This allowed the farmer to store the grain either on
the farm or at a storage facility nearby and deliver it to Chicago months later. These
to-arrive contracts proved useful as a device for hedging and speculating on price
changes. Farmers and traders soon realized that the sale and delivery of the grain itself
was not nearly as important as the ability to transfer the price risk associated with the
grain. The grain could always be sold and delivered anywhere else at any time. These
contracts were eventually standardized around 1865, and in 1925 the first futures
clearinghouse was formed. From that point on, futures contracts were pretty much of
the form we know them today.

In the mid-1800s, famed New York financier Russell Sage began creating synthetic
loans using the principle of put-call parity. Sage would buy the stock and a put from

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his customer and sell the customer a call. By fixing the put, call, and strike prices,
Sage was creating a synthetic loan with an interest rate significantly higher than usury
laws allowed.

One of the first examples of financial engineering was by none other than the
beleaguered government of the Confederate States of America, which is sued a dual
currency optionable bond. This permitted the Confederate States to borrow money in
sterling with an option to pay back in French francs. The holder of the bond had the
option to convert the claim into cotton, the south's primary cash crop.
Interestingly, futures/options/derivatives trading were banned numerous times in
Europe and Japan and even in the United States in the state of Illinois in 1867 though
the law was quickly repealed. In 1874 the Chicago Mercantile Exchange's
predecessor, the Chicago Produce Exchange, was formed. It became the modern day
Merc in 1919. Other exchanges had been popping up around the country and
continued to do so.

The early twentieth century was a dark period for derivatives trading as bucket shops
were rampant. Bucket shops are small operators in options and securities that
typically lure customers into transactions and then flee with the money, setting up
shop elsewhere.

In 1922 the federal government made its first effort to regulate the futures market with
the Grain Futures Act. In 1936 options on futures were banned in the United States.
All the while options, futures and various derivatives continued to be banned from
time to time in other countries.

The 1950s marked the era of two significant events in the futures markets. In 1955 the
Supreme Court ruled in the case of Corn Products Refining Company that profits
from hedging are treated as ordinary income. This ruling stood until it was challenged
by the 1988 ruling in the Arkansas Best case. The Best decision denied the
deductibility of capital losses against ordinary income and effectively gave hedging a
tax disadvantage. Fortunately, this interpretation was overturned in 1993.
Another significant event of the 1950s was the ban on onion futures. Onion futures do
not seem particularly important, though that is probably because they were banned,
and we do not hear much about them. But the significance is that a group of Michigan

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onion farmers, reportedly enlisting the aid of their congressman, a young Gerald Ford,
succeeded in banning a specific commodity from futures trading. To this day, the law
in effect says, ‘you can create futures contracts on anything but onions.’

In 1972 the Chicago Mercantile Exchange, responding to the now-freely floating

international currencies, created the International Monetary Market, which allowed
trading in currency futures. These were the first futures contracts that were not on
physical commodities. In 1975 the Chicago Board of Trade created the first interest
rate futures contract, one based on Ginnie Mae (GNMA) mortgages. While the
contract met with initial success, it eventually died. The CBOT resuscitated it several
times, changing its structure, but it never became viable. In 1975 the Merc responded
with the Treasury bill futures contract. This contract was the first successful pure
interest rate futures. It was held up as an example, either good or bad depending on
your perspective, of the enormous leverage in futures. For only about $1,000, and
now less than that, you controlled $1 million of T -bills. In 1977, the CBOT created
the T -bond futures contract, which went on to be the highest volume contract. In
1982 the CME created the Eurodollar contract, which has now surpassed the T -bond
contract to become the most actively traded of all futures contracts. In 1982, the
Kansas City Board of Trade launched the first stock index futures, a contract on the
Value Line Index. The Chicago Mercantile Exchange quickly followed with their
highly successful contract on the S&P 500 index.

1973 marked the creation of both the Chicago Board Options Exchange and the
publication of perhaps the most famous formula in finance, the option pricing model
of Fischer Black and Myron Scholes. These events revolutionized the investment
world in ways no one could imagine at that time. The Black-Scholes model, as it came
to be known, set up a mathematical framework that formed the basis for an explosive
revolution in the use of derivatives. In 1983, the Chicago Board Options Exchange
decided to create an option on an index of stocks. Though originally known as the
CBOE 100 Index, it was soon turned over to Standard and Poor's and became known
as the S&P 100, which remains the most actively traded exchange-listed option.

The 1980s marked the beginning of the era of swaps and other over-the-counter
derivatives. Although over-the-counter options and forwards had previously existed,

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the generation of corporate financial managers of that decade was the first to come out
of business schools with exposure to derivatives. Soon virtually every large
corporation, and even some that were not so large, were using derivatives to hedge,
and in some cases, speculate on interest rate, exchange rate and commodity risk. New
products were rapidly created to hedge the now-recognized wide varieties of risks. As
the problems became more complex, Wall Street turned increasingly to the talents of
mathematicians and physicists, offering them new and quite different career paths and
unheard-of money. The instruments became more complex and were sometimes even
referred to as ‘exotic.’

In 1994 the derivatives world was hit with a series of large losses on derivatives
trading announced by some well-known and highly experienced firms, such as Procter
and Gamble and Metallgesellschaft. One of America's wealthiest localities, Orange
County, California, declared bankruptcy, allegedly due to derivatives trading, but
more accurately, due to the use of leverage in a portfolio of short- term Treasury
securities. England's venerable Barings Bank declared bankruptcy due to speculative
trading in futures contracts by a 28- year old clerk in its Singapore office. These and
other large losses led to a huge outcry, sometimes against the instruments and
sometimes against the firms that sold them. While some minor changes occurred in
the way in which derivatives were sold, most firms simply instituted tighter controls
and continued to use derivatives.

1.3 Derivative Market in Nepal

Markets for futures trading were developed initially to help agricultural producers and
consumers manage the price risks they faced in harvesting, marketing and processing
food crops each year. Today, futures exist not only on agricultural products, but also a
wide array of financial, stock and forex markets. In the 21st century, online commodity
trading has become increasingly popular, and commodity brokers offer front-end
interfaces to trade these electronic-based markets. A commodities broker may also
continue to offer access to the traditional pit-traded, or open-outcry, markets that
established the commodity exchanges.

Derivative market is expanding rapidly in Nepal since last three years. In Nepal,
derivative market is introduced by Commodities & Metal Exchange Nepal Ltd

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(COMEN). It is the first derivative exchange of Nepal established on 2006 which has
been providing trade services in agriculture goods. It built warehouses to improve
services. Though there is no commodity market regulator, five commodity exchanges
are currently operating on the market and it is also heard that 36 commodity
exchanges have been registered on Company Registrar's Office and three exchanges is
going to operate soon.

On the occasion of 2nd anniversary program of Mercantile Exchange Ltd (MEX)

organized in Soaltee Hotel held on 5 th Jan 2011, Dr Surbir Paudel, Chief guest of the
program told that there is absence of regulating body in commodity at present, and
Securities Board of Nepal (SEBON) is going to regulate it in near future since
Securities Act is being amended by incorporating provisions for regulating
commodity exchange. With the enactment of amended provisions of Securities Act as
per the draft, the responsibility of commodity market regulation will be of SEBON
which will be most challenging given the existing Structure and manpower of
SEBON. Under SEBON's regulation there will be expansion of commodity market
along with professional development of Commodity Exchanges. Senior Economic
advisor of Ministry of Finance was also present as a guest at the event.

On 8th July 2011, Securities Board of Nepal (SEBON) successfully conducted a

dissemination seminar on the formulation of five years capital market development
master plan. It had taken the initiation to formulate the master plan since October 25,
2010 under the technical assistance of World Bank. On the basis of the market
assessment report submitted by international capital market expert, the World Bank
Consultant, Mr. Richard Pratt and the suggestions made by different advisory groups
of SEBON, master plan is about to bring in to the final stage. Seminar was organized
for the purpose of ingesting the suggestions from stakeholders on the master plan.

On 19th July, 2011 Commodity market stakeholders took part in the discussion
program held in SEBON. In the context of commodity market regulation being as the
emerging issue and commodity market stakeholders being interested on its regulation
expecting to address the issues of commodity market in the five-year capital market
development master plan which is to be finalized in SEBON within a couple of days,
SEBON gave the space for the commodity market to discuss on its issues. In the

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discussion program, authorities from commodity exchanges and commodity market
makers shared their problems and experiences jointly with SEBON and Mr. Richard
Pratt, an international capital market expert, who has been involved in providing
technical inputs in formulating five-year capital market development master plan.
This is the early initiation of SEBON whereby the commodity derivative market
stakeholders put their issues to make SEBON understand on the real situation of
commodity market. Then after SEBON is being involved in drafting commodity
market regulation and amending securities Act to incorporate commodity market
regulatory provisions and is also approaching to it and getting preliminary
information. The discussion revealed the following major issues:
 Absence of commodity derivative market regulator
 Lack of proper warehouse
 Lack of central counter party
 Lack of proper settlement guarantee fund
 High concentration on speculation and less emphasis on hedging and arbitrage
 Low concentration on local products
 Lack of proper education and awareness
In connection with this, Mr. Richard Pratt is expected to submit a supplementary
report on commodity derivative market assessment and regulatory approach.
On 22nd July 2011 SEBON organized a discussion program with Commodity Brokers.
The initiative was made in the context of commodity derivative market being major
element of the financial market in the economy and stakeholders being immensely
interested with the capital market development master plan, SEBON took the
initiation to discuss with commodity market participants. In the discussion program,
about 30 commodity market brokers took part and informed about the status and
loopholes of the market. According to them, many of the investors are losing from the
commodity market due to unhealthy and non-transparent practices flourished in
absence of regulating agency. Commodity Brokers put forth their remarks along with
written advices to SEBON suggesting to build up the regulatory framework and
institutional strength as soon as possible to address the existing problems like high
capital gain tax, incompatible trading software, lack of fit and proper entry/exist
criteria for the brokers and market makers, absence of settlement guarantee fund, low
level of public awareness etc. Further, they opined that SEBON, being a responsible

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agency of the financial market, should take initiative to address the gaps between the
commodity derivative market performance and Government understanding on
commodity derivative market development in the country.

Then a team of SEBON observed Commodity and Metal Exchange Nepal (COMEN)
Ltd., Hattisar on September 29, 2011. As SEBON has forwarded the draft of
commodity market regulation and Securities Act amendment, SEBON is attentive for
its prerequisites and collecting information from the market. On this Context, SEBON
officials visited COMEN and obtained the information regarding the current situation
and trading mechanism of the commodity market. With the leadership of Dr Nabaraj
Adhikari, Head of Planning and Development Department, comprising with other
members Mr Gopal Krishna Acharya, Officer, Mr Jeeban Amgain, Officer, Mr Nabin
Man Baidya, Officer and Mr Raju Bdr. G.C., Assistant observed the exchange. At the
time, different queries made by the team were addressed by the Chief Executive
Officer of COMEN, Mr Anand Benani. Finally, a five year master plan has been
prepared and amendment in the Securities Act has been recommended for the
regulation of commodity market.

1.4 Statement of the Problems

The problem of the study is directed on Nepalese investment practice towards
Derivative Market: An Enquiry. Brokering services in Derivative Exchange play vital
role for determining the prices of commodity, motivating the potential investors in
investing activities and developing the derivative market of the nations. Brokering
services are major issues for the development and improvement of the trading
commodities in exchange. It is known that investors are the major sources of capital
and the backbone of the derivative market. Unless, investors begin analyze the good
or bad broker before making investment decisions, the market cannot develop
smoothly. The provisional behaviors of the investors also play vital role for setting the
price of the commodity in the market.

Investment in the past was done in whim. And that investment is made more on an
impulse, rather than through market study and credit rating. It is frequently heard that
the majority of the investors are not satisfied with the services presently provided by
the brokers. Investors frequently complain about the inadequacy of required

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information about the trading of commodities from brokers. Investors are not able to
identify the right trading position due to lack of proper information. The limited
numbers of brokers are doing business only on part time basis. Some brokers do not
have enough derivative education and adequate knowledge and expertise in brokering
services. The brokers are not able to provide various education services related to the
trading of the derivative as compared to brokers of the derivative market in other
countries. Hence, this does not represent the practical situation in a reliable way.

Brokers are also supposed to assist in the maintenance of a fair market but they may
not be able to do this job in their capacity successfully because of the various
obstacles presented in the economic environment. So, the necessity to analyze
practical situation of brokering services in derivative exchange in the present
situation. Though the price of the trading software and commission structure differs
from one broker to another, some have fixed the actual cost & commission which play
the vital role to retain the investor loyal to the market.
Followings are some of the serious problems that play vital role for brokering services
in Derivative exchange:
i. There is no rule and regulation to regulate derivative market in Nepal
though there is five derivative exchanges operating nowadays.
ii. The actual clearing and settlement process takes long time than the
mentioned time. This affects price determination and also the image of the
brokers in regard to their services in the derivative exchange.
iii. There is a lack of professional brokers and they do not provide full
time service.
iv. Most of the brokers are doing it as a part time. So the investors are
unable to make investment in proper time due to lack of proper
information of trading system.
v. The market is totally captured by amateur who buy very little quantity
of commodity. These investors hold the commodity in view of making
profit also affects in brokering services.
vi. There were various problems to the investors regarding the services of
the brokers.
vii. Investors just use derivative as speculation but not hedge.

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Due to the fluctuating trend of the price of underlying goods or assets, the researcher
is interested to find out what actually is the situation in the derivative market in
respect to brokering services in derivative exchange.

1.5 Objectives of the Study

This study has five main objectives:
i. To study the contribution of Derivative Market in Nepal.
ii. To analyze the performance and effectiveness of Derivative Market in Nepal.
iii. To study the opinions of investors on Derivative Market.

1.6 Significant of the Study

Investors invest their money with the hope of getting good return in their invested
fund. But due to many reasons they lose their hard earning, while investment is made
without required information about trading of derivatives. Many times investors
blindly invest their funds by just using technical tools not fundamental, but with the
hope of getting good return only. The role of intermediaries (i.e. NCMs and market
markers) in derivative market is essential in providing reliable and adequacy of the
information to the investors about trading of commodities. But the majority of the
investors are unsatisfied with the presently available services from NCMs.

While investing in derivatives, the investors should receive the benefits from his
investment more than the opportunity income that could be received investing
elsewhere. But the lack of adequate knowledge, inability in using modern
technologies and insufficient use of communication technologies to spread the
information about the price-earning relationship of the company enforces people to
invest the amount by analyzing the trend of the market. It indicates that is extreme
necessity to establish clear conception about the price-value relationship to secure the
invested amount.

Hence, this study targets to explore and assist derivative investments by imparting the
knowledge about the different aspects related to the Non Clearing Members (NCMs)
in derivative exchange. So, the study will be beneficial for the people interested in
investments in derivative and prevailing investors. This study will also be helpful for

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other researchers in the similar field as it provides suggestions on the related field to
some extent.

1.7 Limitations of the Study

The research will have some limitation, which weaken the heart of study. Basically,
the study is done for the partial fulfillment of the requirement of the degree of Masters
of Business Studies. Inadequate coverage of NCMs, Time constraints, Lack of
research experience asymmetry, reliability of financial and statistical tools used and
financial problems are the main limitations. Other limitations are:
i. Though the study is based on primary and secondary data its accuracy
depends upon the information given by the respondents.
ii. The data duration of research is short because of new market to Nepal.
iii. In this study only limited financial and statistical tools and techniques
is used for analysis. So it doesn’t cover all scenarios.
iv. This study is the sample study regarding the services of brokers and its
investors.

1.8 Organization of the Study

This study is organized on the following five chapters:

Chapter I : Introduction
This chapter deals with subject matters of the study consisting background of the
study, focus on the study, statement of the problem, objective of the study, limitation
of the study and significance of the study.

Chapter II : Review of Literature

This chapter deals with review of the different literature of the study field. It is
important tasks for thesis writing. Therefore it includes conceptual framework along
with the review of major books, journal, research works, website, discussed with
friends and past thesis etc.

Chapter III : Research Methodology

This chapter deals with research methodology and it includes research design,
population and sample, source and technique of data collection, data analysis
tools and limitation of the methodology. It is an important chapter because in

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the financial analysis of a firm, we should need the various data and different
statistical tools. Research methodology is directed in the area, limitation, tools
and techniques of research analysis for preparing and comparing of the thesis.

Chapter IV : Presentation and Analysis of Data

This chapter deals with analysis and interpretation of the data using financial
and statistical tools describe in chapter three. It is a body of report. Similarly
this chapter also includes the major findings of the study. At last part of this
chapter, an explanation of the interview and major findings of the whole study
have been presented.

Chapter V : Summary, Conclusion and Recommendations

This chapter deals with summary of the study held, the conclusion made ultimately
and the possible suggestion. It includes Summary conclusion and recommendations,
which shows the success or failure of the research done. Moreover, it draws the
conclusion and recommendation for the improvement of derivative market in Nepal.

Apart from above, a bibliography and appendices are also included in this study.

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 CHAPTER - II
REVIEW OF LITERATURE

2.1 Conceptual Review

2.1.1 Nepalese Financial System
Financial system is a set of institutional arrangements through which financial surplus
in the economy are mobilized from surplus units and transferred to deficit units. The
institutional arrangements include a conditions and mechanism governing the
production, distribution, exchange and holding financial assets or instruments of all
kinds and organizations as well as the manner of operation of financial markets and
institutions of all descriptions. In concrete terms, there are three main constituents of
any financial system, they are:
i. financial assets
ii. financial markets
iii. financial institutions

2.1.1.1 Financial Assets

“A financial asset (or security) simply is a piece of paper that represents the investor’s
rights to certain property and the conditions under which he or she may exercise those
rights.” (Sharpe, Alexander and Bailey; 2000: 2)

In other words, it represents the holder’s claim against real sector economic units.
Further, financial assets are also divided into two types – primary securities and
secondary securities. Claims against real sector are known as primary securities and
claims against financial institutions are known as secondary securities. Following are
the securities that represent claims against real sector are called primary securities-
i. Equities
ii. Bonds
iii. Bills
iv. Book-debts
And following are the securities that represent claims against financial institutions and
are called secondary securities-
i. Currencies

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 ii. Bank deposits
iii. Life insurance policies
iv. Units (like NCM mutual fund and CIT units)
“The volume of equities and corporate bonds is insignificant as compared to
government bonds.” (Shrestha, Paudel and Bhandari; 2005: 37)

2.1.1.2 Financial Markets

“Financial markets are the mechanisms created to facilitate the exchange of financial
assets. The major participants of the financial markets are the savers / investors and
borrowers / users of funds. They are involved in the purchase and sale of securities in
this financial market and are supposed by mediators and facilitators. Individuals,
corporate bodies, non-profit organizations and the government are the participants in
these transactions of buy and sale of financial assets. This mismatch between the
saving and investment of these participants is the central reason for the existence of
the financial markets itself.” (Shrestha, Paudel and Bhandari, 2005: 40-41)

2.1.1.2.1 Money Market and Capital Market

Financial markets can be categorized in mainly two bases; they are on life span of the
securities and economic function.
On the basis of life span, they are of two types-
i. Money Market
ii. Capital Market
The money market deals on short term and the capital market on long term securities.

This division of financial market is based on the life span of the security. Money
market refers to that financial market in which securities with a short term (one year
or less) and highly liquid debt securities are traded. Thus, money market comprises
the securities that have short maturity period (life span), easy marketability, liquidity
and even lower risk in comparison to other securities. Money market facilitates flow
of short fund. The participants of money market are short term deficit units and
surplus units (government, business entity and individuals). Instrument traded in the
money market are Treasury bills, commercial paper, certificate of deposits etc.

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In contrast to money market, capital market refers to the financial market in which
long- term securities are traded. Specifically, securities having life spans of more than
one year are traded in the capital market. Long-term financial instruments such as
stocks issued by corporations are basically traded in a capital market. Capital market
facilitates flow of long term fund. The participants of market are long term surplus
units and deficit units (government, business entity and individuals). Instrument
traded in the capital market are common stock, Treasury bonds, corporate bonds etc.

Capital Market includes:

i. Activities relating to the organization, distribution and trading of securities.
ii. Organization, which facilities this activities.
iii. Individuals and institutions, which buy and sell securities.
iv. Rule and regulations, customs and practices that control; the organization
and conduct of business in the market.
Securities are marketable financial instruments that bestow on their owners the right
to make specific claims on particular assets. An individual security provides evidence
of either creditor ship or ownership depending on whether it is a bond or a stock
respectively. “A bond is a loan that is paid off interest, the investors lends money to
the borrowing company that issued to the bond. In contrast, stockownership
represents a cash investment in the future of a corporation; the investor owns a part of
the corporation and shares in the profits.” (Franci; 1998: 21)

Financial Market is the market for the exchange of capital and credit, including the
money markets and the capital markets. While money market is the market for short-
term debt securities, such as banker's acceptances, commercial paper, repos (a
contract in which the seller of securities, such as Treasury Bills, agrees to buy them
back at a specified time and price. also called repurchase agreement or buyback.),
negotiable certificates of deposit, and Treasury Bills with a maturity of one year or
less and often 30 days or less. Money market securities are generally very safe
investments which return a relatively low interest rate that is most appropriate for
temporary cash storage or short-term time horizons. Bid and ask spreads are relatively
small due to the large size and high liquidity of the market where as Capital Market is
the market where debt or equity securities are traded.

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2.1.1.2.2 Primary and Secondary Market
On the basis of economic function market can be categorized into following two
types-
i. Primary market
ii. Secondary market
The market through which the funds are transferred from savers to investors is called
primary market. Hence, the transaction of securities issued for the first time takes
place in the primary market. Primary market facilitates direct transfer of funds. The
participants of primary market are the issuing company, investment bankers and
investors. The institutions that perform the role of an expert in issuing new securities
are called investment bankers (issue managers). These bankers make available advice
to the business firms regarding the nature of security, maturity, interest rate and
underwrite the issue of securities.

And the market where the existing and pre-developed securities are bought and sold is
called secondary market. A secondary market provides liquidity to purchases of the
securities. High liquidity of the secondary market encourages the investors to invest in
the primary market as well. The secondary market can be regarded as the center to
convert stocks, bonds and other securities into cash immediately.

2.1.2 Securities Board of Nepal (SEBON)

Since its establishment SEBON has continuously concentrated its efforts to improve
the legal and statutory frameworks, which are the bases for healthy development of
the stock market and to enhance the degree of investor’s protection. After the second
amendment of Securities Exchange Act on January 1993 AD, SEBON is acting as an
apex regulatory body by bringing market intermediaries directly under its jurisdiction
and made it mandatory for the corporate bodies to report annually as well as semi-
annually regarding their performance. It also established direct relationship with
market intermediaries and listed companies SEBON’s regulatory interventions were
targeted to discipline the market and to consolidate its position as central securities
market regulator. On the other hand, a five year capital market development master
plan 2010 recommend to prepare the amendment for regulating the derivative market
in Nepal under SEBON’s regulation. Thus SEBON is going to regulate it in near
future since Securities Act is being amended by incorporating provisions for

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regulating derivative exchange. With the enactment of amended provisions of
Securities Act as per the draft, the responsibility of derivative market regulation will
be of SEBON. Under SEBON's regulation there will be expansion of derivative
market along with professional development of derivative Exchanges.

2.1.3 Present Situation of Derivative Market in Nepal

There is no regulating body in the Nepalese derivative market. The Ministry of
Finance and SEBON are doing homework to revise the existing Securities Act 2007 to
allow regulation of the commodities and futures exchanges. The government has told
SEBON, the capital market regulator, to supervise the commodities and futures
markets too. “The Securities Act has not defined commodities and futures contracts as
securities, and an amendment will put them under the parameter of securities. The act
only considers stocks, bonds, debentures or collective investment schemes by
corporate bodies and treasury bonds and other government bonds as securities. The
budget for the current fiscal year has also made a provision that an act would be
formulated to regulate and supervise transactions in commodities. According to Mr
Paristha Nath Poudel, director of SEBON, they have already identified the clauses in
the act to be amended but only after the parliament endorse the amendment to the
Securities Act, the commodities and futures markets will come under the supervision
of SEBON and they formulate rules for these markets to regulate and supervise it.
They have no right to regulate these new markets without the act in place. Given the
many other important bills remaining stuck in parliament, there is a doubt the
amendment to the Securities Act will be endorsed soon. A committee has been formed
under the coordination of undersecretary at the Finance Ministry Janak Raj Pant to
formulate regulations for these markets. People involved with the commodities and
future markets have been demanding early formulation of the act and regulations to
regulate them.” (Sukla; 2011:15)

“Nepal Rastra Bank has permitted the banks and financial institutions for derivative
transaction. However, organized market for financial derivative has not been started in
Nepal.” (Bhattarai; 2010: 29)

In today's dynamic and complex global financial markets, traders and investors are
looking for various innovative ways to generate returns. Commodities and derivatives

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trading offer exciting opportunities. The history of professional Trading started from
"Hat Bazaar" and the current financial exchanges are the modern and advanced
concept of the same "Hat Bazaar" trading. Nepalese Derivative Market is very young.
Investors have not been able to analyze the situation properly. They are not smart
enough to study the situation and take good judgments. 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.

So there comes a question like what is the difference between a speculator and a
gambler. Speculators are not gamblers, since they do not create risk, but merely accept
the risk, which already exists in the market. The speculators are the persons who try to
assimilate all the possible price-sensitive information, on the basis of which they can
expect to make profit. The speculators therefore contribute in improving the
efficiency of price discovery function of the futures market.

But it doesn’t mean that the speculation is always good for the economy of a country.
Over-speculation needs to be curbed because it can lead to distortion of price signals.
For this in case of the Nepalese Derivative Market, the positions held by speculators
are subject to certain margins. In the Nepal’s economy, there are various factors that
are having a real negative impact on the overall performance of the Nepalese markets.
First comes is the power supply problem. With the increasing temperature and
drought in the country, the power supply is getting poor. Till the month of Magh, the

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country is facing 11 hours of load shedding. Because of this, the manufacturing and
other industries are suffering a heavy loss every day. Also, the global economic crisis
has forced the industries to cut off the number of employees and thus prevent them
from the probable future crisis. The continuous political instability has also hit hard to
the market.

In Nepal, five commodities exchanges are working which provides investment

opportunities to around 10000-12000 people. The majority of transactions of
commodity exchange are in gold, silver, copper and crude oil, which are the products
not produced in Nepal.

2.1.3.1 Derivative Exchanges Working in Nepal

2.1.3.1.1 Commodities & Metal Exchange Nepal Ltd (COMEN)
COMEN is a state-of the-art; professionally organized, structured and managed online
commodity exchange marketplace established in 2006. It has commenced its
operations and has plans to encompass the entire spectrum of commodities across the
country to bring home the advantages of an electronic commodity trading platform to
all market participants in the commodity and metal segments. The BOD of the
company consists of eminent professionals and businessmen from diverse fields well
versed with the working of online exchanges. The Board is committed to provide a
world class exchange platform for market participants to trade in a wide spectrum of
commodity market products driven by global practices, professionalism and
transparency.

2.1.3.1.2 Mercantile Exchange Nepal Ltd (MEX)

MEX is the largest online commodity futures exchange in Nepal. It is located at
Alliance Tower, Fourth Floor, Charkhal, Dillibazar, Kathmandu, Nepal. MEX trades
futures in various commodities such as cash crops, food grains, vegetables, spices, oil
seeds, metals & bullion. It commenced its operations on 5 January, 2009. It is a
regulated company subject to various laws of Nepal and is a fully automated
electronic exchange, where there is no physical trading floor. The exchange is
controlled through a centralized platform which is connected with different ‘client’
front-ends called MEXNTrader.

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MEX is the leading commodity exchange company in Nepal which is established in
2007 and started its operations in the market in 2009 with the highest number of
members and clients base. Within three years of its operations, it has successfully
endorsed three clearing members as market makers and 82 non- clearing members.
MEX has generated an approximate of 700 million Rupees worth new investments in
Nepal as on May 2011and is also the highest tax payer among the exchange
companies in the country.

2.1.3.1.3 Nepal Derivative Exchange (NDEX)

Nepal Derivative Exchange (NDEX) is a state of art online commodity and derivative
exchange operating in Nepal. In the world of increasing volatility, NDEX is the best
platform to manage risk across the major commodities from precious metals to base
metals, from agro commodities to energies. It is one of the best and most diverse
derivative exchanges encompassing the widest range of benchmarked product
available.

NDEX, professionally managed by a team of young Nepal based entrepreneurs, was

incorporated on November 20, 2008 under the Company Act, 2063 of Nepal. It is
committed towards revolutionizing the commodity derivative market in Nepal. Its aim
is to empower the market participants, stakeholders, investors through innovative
product offering, technology and risk assessment, forecasting and managing tools. We
are here to transform Nepalese economy to more vibrant, transparent and accessible
marketplace to farmers, producers, traders, financers and government.

2.1.3.1.4 Wealth Exchange (WEX)

WEX is the first Spot Exchange in Nepal specializing in Gold and Silver. It serves the
risk management needs of customers around the globe. It provides the benchmark
products of Spot Commodities available on any Exchange. Its vision is one of
ongoing global growth, innovative product development, continually enhanced
technology and the highest level of service available on any Exchange.

WEX is a national level spot exchange promoted by prominent and reputed business
individual of the country. It serves customers around the country with a global product
line, virtually around-the-clock electronic trading and strategic alliances with other

21
Exchanges. It also offers a number of programs and products designed specifically to
appeal to a global audience.

2.1.3.1.5 Nepal Spot Exchange (NSE)

NSE is a state-of the-art; professionally organized, structured and managed online
commodity spot exchange marketplace established in 2010. It has commenced
operations and has plans to encompass the entire spectrum of commodities across the
country to bring home the advantages of an electronic spot trading platform to all
market participants in the agricultural and non-agricultural segments.

In the agricultural side, the Exchange will enable the farmers to trade seamlessly on
the platform so that they receive the best possible price. The real time availability of
information and simple delivery process will ensure that the farmers are the direct
beneficiaries of this trading platform. In the non-agricultural segment, both producers
and consumers of commodities would have real time access to price information
which will enable them to transact their business and lower cost through effective raw
material and finished goods inventory management.
The Board of Directors of the company consists of eminent professionals and
businessmen from diverse fields well versed with the working of online exchanges.
The Board is committed to provide a world class exchange platform for market
participants to trade in a wide spectrum of spot market products driven by global
practices, professionalism and transparency.

2.1.3.1.6 Asian Derivative Exchange (ADX)

It is heard that, ADX is trying to come into Nepalese Derivative market soon with
new vision and technology.

2.1.3.1.7 Everest Commodity Exchange (ECX)

It is heard that, ECX is trying to come into Nepalese commodity market soon with
new vision and technology.

2.1.3.1.8 Commodity Futures Exchange (CFX)

It is heard that, CFX is trying to come into Nepalese commodity market soon with
new vision and technology.

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2.1.3.2 Organizational Structure of Derivative Market
Derivative Exchange Regulatory Board
Derivative Exchange
Clearing Member
Non Clearing Member/Trading Member/Broker
Sub-Broker/AE
Investor/Clients

2.1.3.3 Derivatives Available for Trading in Nepal:

 Agricultural products
(Grain, Food & Fiber)
 Energy
 Precious metals
 Industrial metals
: Wheat, Corn, Soybeans, Coffee,
Soybeans oil, Cocoa, Sugar, Cotton
: Natural Gas, Heating oil, Crude oil, Brent crude
: Gold, Silver, Platinum, Palladium
: Copper

2.1.3.4 Settlement of Derivative Transactions:

Settlement of derivatives can be done in two ways depending upon the products;
physical settlement and cash settlement. In Nepal, cash settlement is in practice to
settle the contracts till date.
 Physical Settlement: Traditionally, Commodity Futures contracts are settled by
physical delivery upon expiration. If trader is short, a Futures contract (seller of
Futures) on the contract expiration date, he is obligated to deliver the underlying
Commodity to a pre-determined location. In addition, he will also be responsible
for any transaction costs that could include transportation, storage, inspections and
insurance. By trying the futures contract to an actual, physically deliverable
product, the integrity of the contract was backed up by underlying physical goods,
ensuring that the market universally agreed to the fairness of the price. This
allowed hedgers and speculators to more realistically take on and lay off the risk
of production and purchase because the price of the futures contract would closely
track the price of the physical commodity.

 Cash Settlement: Most commodity futures contracts are settled by delivery of the
underlying assets. Some, however, are cash settled. In cash settled contract, the

23
 settlement price at expiration is set equal to the value of some reference price or
index value. If a Commodity cannot be stored for a long period of time due to
spoilage or other logistics, the contract resorts to a cash settlement. The first cash
settled contract was the Eurodollar futures contract, which was launched in 1981.
The Eurodollar, which is a futures contract based on the interest rate paid on U.S.
dollars held outside the United States, was revolutionary because there simply is
no delivery mechanism for an interest rate. Then after the concept of cash
settlement was applied to traditional commodities and it proved to be a liberating
development for the exchanges.

2.1.3.5 Types of Derivatives

2.1.3.5.1 Future Derivative
Futures derivative means a legally binding agreement to buy or sell the underlying
assets on a future date. Future derivatives are standardized derivatives that specify the
quantity, quality (in case of commodities), delivery time and place for settlement on
any date in the future. The derivative expires on a pre-specified date which is called
the expiry date. On expiry, futures can be settled by delivery of the underlying asset or
cash.

2.1.3.5.2 Forward Derivative

“A forward derivative is an agreement between two parties to buy or sell an assets or
commodity at a fixed time in the future for a certain price agreed at the time of
contract. The present fixed price is known as the forward price. Forward contracts are
traded in OTC market and they are not standardized. The specification of the contract
can be changed many times within the contract period.” (Bhattarai; 2010: 29)

2.1.3.5.3 Options
An option is an investment alternative among various alternatives available in the
world of investment. It is a contract between two people wherein one person grants
the other person the right, but not the obligation, to pay or sell a specified asset at a
specified (predetermined) price on or before a set expiration date. Between any two
parties involved in the contract, the party receiving the right to buy or sell a specified
asset is called an option buyer and the person giving the right to sell or buy the asset is
called an option seller or option writer.

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“An option is a contract between two parties – a buyer and a seller – that gives the
buyer the right, but not obligation, to purchase or sell something at a later date, at a
price agreed upon today.” (Thapa & Pokharel; 2010: 6 )

In the options market there has developed some terminology that is somewhat
intimidating to the uninitiated. A call option is the right to buy a share of a stock, the
underlying security, at a specified price, called the exercise price or the strike price. A
put option is the right to sell a share of a stock at a specified price, the exercise price
or the strike price.

There is a limited time for the exercise of the call option. An American option can be
exercised at any time up to and including the expiration date. A European option can
only be exercised on the expiration date. The value of a call option at any time
depends upon:
 The current market price of the underlying security
 The exercise price
 The interest rate
 Time remaining until expiration
 The volatility of the price of the underlying security.
When any of these change the value of the option will change.

2.1.3.5.4 Swaps
Swap is a derivative in which counterparties exchange certain benefits of one party’s
financial instrument for those of the other party’s financial instrument. It can be used
to hedge certain risks such as interest rate risk, or to speculate on changes in the
expected direction of underlying prices. Derivative markets involve more than just put
and call options. There are also contracts involving swapping fixed interest rate
payment streams for adjustable or floating interest rate payment streams. A company
may have borrowed money under an adjustable interest rate security such as a
mortgage and is now fearful that the interest rate is going to rise. It wants to protect
itself against rises in the interest rates without going through the refinancing of the
mortgages. The company or individual liable for an adjustable rate looks for someone
who will pay the adjustable interest payments in return for receipt of fixed rate
payments. This is called a swap. The origin of swaps can be identified as a deal made
between IBM and the World Bank.

25
“A swap is a financial derivative in which two parties agree to make a series of
payments to each other at specific intervals over a specified period of time. The swap
payments are based on an agrees principal amount what is known as notional
principal simply because it is a base for calculating payments rather than the actual
amount to be exchanged between parties.” (Manandhar, Dahal & Dahal; 2009: 382)

2.1.3.5.5 Warrants
A derivative security which gives the holder the right to purchase securities (usually
equity) from the issuer at a specific price within a certain time frame is warrant.
Warrants are often included in a new debt issue as a "sweetener" to entice investors. A
company uses warrants in debt instruments to lower the interest rate, to make its
security more saleable as well as to reduce the cost of issue etc.

The main difference between warrants and call options is that warrants are issued and
guaranteed by the company, whereas options are exchange instruments and are not
issued by the company. Also, the lifetime of a warrant is often measured in years,
while the lifetime of a typical option is measured in months.

2.1.3.6 Types of Underlying Assets

2.1.3.6.1 Interest Rate Derivative
An interest rate derivative is a derivative where the underlying asset is the right to pay
or receive a notional amount of money at a given interest rate. These structures are
popular for investors with customized cash flow needs or specific views on the
interest rate movements (such as volatility movements or simple directional
movements) and are therefore usually traded OTC.

The interest rate derivatives market is the largest derivatives market in the world. The
Bank for International Settlements estimates that the notional amount outstanding in
June 2009 were US$437 trillion for OTC interest rate contracts, and US$342 trillion
for OTC interest rate swaps. According to the International Swaps and Derivatives
Association, 80% of the world's top 500 companies as of April 2003 used interest rate
derivatives to control their cash flows. This compares with 75% for foreign exchange
options, 25% for commodity options and 10% for stock options.

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2.1.3.6.2 Foreign Rate Derivative
Foreign rate Derivative is a derivative financial instrument that gives the owner the
right but not the obligation to exchange money denominated in one currency into
another currency at a pre-agreed exchange rate on a specified date

2.1.3.6.3 Commodity Derivative

Commodity derivatives are investment tools that allow investors to profit from certain
items without possessing them. This type of investing dates back to 1848 when the
Chicago Board of Trade was established. Initially, the idea behind commodity
derivatives was to provide a means of risk protection for farmers. They could promise
to sell crops in the future for a pre-arranged price.
Modern commodity derivative trading is most popular with people outside of the
commodities industry. The majority of people who use this investment tool tend to be
price speculators. These people usually focus on supply and demand and try to predict
whether prices will go up or down. When the prices of a certain commodity move in
their favor, they make money. If price moves in the opposite direction, then they lose
money.

2.1.3.6.4 Credit Derivative

Credit derivative is a securitized derivative whose value is derived from the credit risk
on an underlying bond, loan or any other financial asset. In this way, the credit risk is
on an entity other than the counterparties to the transaction itself. This entity is known
as the reference entity and may be a corporate, a sovereign or any other form of legal
entity which has incurred debt. Credit derivatives are bilateral contracts between a
buyer and seller under which the seller sells protection against the credit risk of the
reference entity.
There are two types of credit derivative, such as:
 Unfunded credit derivative
 Funded credit derivative

2.1.3.6.5 Equity Derivative

An equity derivative is a class of derivatives whose value is at least partly derived
from one or more underlying equity securities. Options and futures are by far the most

27
common equity derivatives; however there are many other types of equity derivatives
that are actively traded.

2.1.3.7 Usage of Derivative

Derivatives are broadly categorized by the relationship between the underlying asset
and the derivative (e.g., future, forward, option, warrant, swap); the type of
underlying asset (e.g., equity derivatives, foreign exchange derivatives, interest rate
derivatives, commodity derivatives, or credit derivatives); the market in which they
trade (e.g., exchange-traded or over-the-counter); and their pay-off profile.
Derivatives can be used for speculating purposes (bets) or to hedge (insurance).

Derivatives are used by investors to:

 Provide leverage (or gearing), such that a small movement in the underlying
value can cause a large difference in the value of the derivative.
 Speculate and make a profit if the value of the underlying asset moves the way
they expect.
 Hedge or mitigate risk in the underlying, by entering into a derivative contract
whose value moves in the opposite direction to their underlying position and
cancels part or all of it out.
 Obtain exposure to the underlying where it is not possible to trade in the
underlying (e.g., weather derivatives).
 Create option ability where the value of the derivative is linked to a specific
condition or event (e.g. the underlying reaching a specific price level).

2.1.3.7.1 Speculation & Arbitrage

Derivatives can be used to acquire risk, rather than to insure or hedge against risk.
Thus, some individuals and institutions will enter into a derivative contract to
speculate on the value of the underlying asset, betting that the party seeking insurance
will be wrong about the future value of the underlying asset. Speculators look to buy
an asset in the future at a low price according to a derivative contract when the future
market price is high, or to sell an asset in the future at a high price according to a
derivative contract when the future market price is low.

28
Attempting to make profit by exploiting price differences of identical or similar
financial instruments on different markets or in different forms is arbitrage.
Individuals and institutions may also look for arbitrage opportunities, as when the
current buying price of an asset falls below the price specified in a futures contract to
sell the asset. In derivative market arbitragers watch the spot and futures markets and
whenever they spot a mismatch in the prices of the two markets they enter to get the
extra profit in a risk-free transaction.

2.1.3.7.2 Hedge
A hedge is an investment position intended to offset potential losses that may be
incurred by a companion investment. An investment made in order to reduce the risk
of adverse price movements in a security, by taking an offsetting position in a related
security, such as an option or a short sale.

2.1.3.7.3 Hedge Vs Speculation

Hedging and speculating are the two primary ways in which derivatives are used.
Hedgers use futures to reduce or eliminate risk by insulating themselves against any
future price movements. Speculators, on the other hand, want to incur risk in order to
make a profit.

2.1.3.8 Analysis of Derivative

Derivative Analysis gives a clear and accessible approach to the analytical techniques
of underlying assets valuation.

2.1.3.8.1 Technical Analysis

Technical analysis is the framework in which traders study price movement. Trader
can look historical price movements and determine the current trading conditions and
potential price movement.
“Technical analysis is a method of evaluating commodities by analyzing statistics
generated by market activity, past price, indicators and volume. It does not attempt to
measure a commodity’s intrinsic value; instead they look for patterns and indicators
on the charts that will determine a future performance.” (Jeffrey; 2000: 4)

2.1.3.8.1.1 Indicators

29
Indicators are essentially calculations based on the price and the volume of a security
and measures factors such as money flow, trends, volatility and momentum. Within
technical analysis, indicators are used as a measure to gain further insight into to the
supply and demand of securities. Indicators, such as volume, are used to confirm price
movement and the probability that the given move will continue. Along with using
indicators as secondary confirmation tools, they can also be used as a basis for trading
as they can form buy-and-sell signals. “Technical indicators are those fancy
computerized studies that you frequently see at the bottom of price charts that are
supposed to tell you what the market is going to do next (as if they really could). The
most common studies include MACD, Stochastic, RSI etc.” (Jeffrey; 2009: 8)

For the best chart analysis, use a group of indicators based on your trading style and
the current Market Condition. Common indicator types include:
 Trend, direction of trend, and strength of trend indicators.
 Oscillator Indicators for Overbought and oversold which expose weakening
sideways action before price breaks out of the sideways trend.
 Accumulation and Distribution indicators which expose the buying and selling
habits of large lot institutional investors and institutional traders. Each leaves a
different ‘footprint’ on the chart.
 Convergences and divergences of price or volume, indicating a change of trend
direction.
 Compression or expansion of patterns of price and/or volume in cyclical patterns.

2.1.3.8.1.1.1 Trend
Trend analysis tries to predict a trend like a bull market run and ride that trend until
data suggests a trend reversal (e.g. bull to bear market). Trend analysis is helpful
because moving with trends, and not against them, will lead to profit for an investor.
Although trend analysis is often used to predict future events, it could be used to
estimate uncertain events in the past also.
2.1.3.8.1.1.1.1 Bollinger Band
Bollinger bands are probably one of the most important indicators ever developed for
measuring price action volatility. You can use Bollinger bands as a very accurate

30
indicator within any time frame. The indicator has many uses and can provide the
smart trader with some extremely profitable entry and exit signals.

2.1.3.8.1.1.1.2 Moving Average

An indicator frequently used in technical analysis showing the average value of a
security's price over a set period. Moving averages are generally used to measure
momentum and define areas of possible support and resistance and also used with
time series data to smooth out short-term fluctuations and highlight longer-term trends
or cycles. “The shorter the length of a moving average, the more sensitive it will be to
short-term fluctuations. The longer the length of a moving average, the less sensitive
it will be to abrupt price fluctuations. Therefore, short moving averages lag the market
less than long moving average, but are less effective than long moving averages at
smoothing or fattening out the noise.” (Louis; 2000: 60)

2.1.3.8.1.1.1.3 Parabolic SAR

Parabolic SAR refers to a price and time based trading system which is used by many
traders to determine the direction of an asset's momentum and the point in time when
this momentum has a higher-than-normal probability of switching directions. It is a
fairly good tool for traders looking for a strategic method of gauging a stock's
direction or for portioning a stop-loss order. As illustrated above, this indicator proves
to be extremely valuable in trending environments, but it can often lead to many
false signals during periods of consolidation. “It stresses a logical use of the trailing
stop-loss concept makes it a valuable tool for any technical trader.” (James; 2010:146)

2.1.3.8.1.1.1.4 Volume
The On-Balance Volume (OBV) indicator, introduced by Joseph Granville in 1963,
shows graphically the flow of volume in a stock. The OBV line is a running
cumulative total of the daily volume numbers, adding volume on days the
price goes up, subtracting on down-days. A volume bar chart and the
resulting OBV are shown below, green bars for volume when the price
increased that day, red bars signifying a drop in price.
2.1.3.8.1.1.2 Oscillator
Oscillator is banded between two extreme values and built with the results from a
trend indicator for discovering short-term overbought or oversold conditions. As the

31
value of the oscillator approaches the upper extreme value the asset is deemed to be
overbought, and as it approaches the lower extreme it is deemed to be oversold. It is
the repetitive variation, typically in time, of some measure about a central value (often
a point of equilibrium) or between two or more different states.

2.1.3.8.1.1.2.1 RSI
RSI is a momentum oscillator that measures the speed and change of price
movements. It oscillates between zero and 100. Traditionally, RSI is considered
overbought when above 70 and oversold when below 30. Signals can also be
generated by looking for divergences, failure swings and centerline crossovers. It is
based upon closing price which is used to identify the general trend.

2.1.3.8.1.1.2.2 Ichimoku Kinko Hyo

Ichimoku Kinko Hyo Technical Indicator is predefined to characterize the market
Trend, Support and Resistance Levels, and to generate signals of buying and selling.
It is comprised of five lines called the tenkan-sen, kijun-sen, senkou span A, senkou
span B and chickou span. This indicator was developed so that a trader can gauge an
asset's trend, momentum and support and resistance points without the need of any
other technical indicator. This indicator works best at weekly and daily charts.

2.1.3.8.1.1.2.3 Moving Average Convergence-Divergence (MACD)

It is one of the simplest and most effective momentum indicators. It turns two trend-
following indicators, moving averages, into a momentum oscillator by subtracting the
longer moving average from the shorter moving average. It fluctuates above and
below the zero line. As the moving averages converge, cross and diverge, traders can
look for signal. It is not particularly useful for identifying overbought and oversold
levels.
2.1.3.8.1.1.2.4 Momentum
The Momentum indicator compares the current price with respect to the past price. If
the current price is higher than the price in the past (momentum crosses above the
zero line), then the Momentum indicator is positive i.e., bullish signal. In contrast,
when the current price is lower than the price in the past (momentum crosses below
the zero line), then the Momentum indicator is negative i.e., bearish signal.

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2.1.3.8.1.2 Chart Patterns
In technical analysis, the distinctive formation created by the movement of security
prices on a chart. It is identified by a line connecting common price points (closing
prices, highs, lows) over a period of time. Chartists try to identify patterns to try to
anticipate the future price direction also known as trading pattern.

Charts do not predict the future. However, when used properly, charts do tell us a
great deal about how to trade, when to trade, and what to trade.
Chart tells about:
 When to buy or sell, based on your trading style and risk tolerance.
 What is a reasonable price to pay for a stock, option etc., based on your
trading style and trading parameters?
 Which stocks are forming Trend line Patterns that fit your trading style;
this tells you what trading strategies will work best at that time.
 Where to place your stop loss based on price patterns rather than the
outdated ‘percentage stop loss’.
 The angle of ascent or descent which tells you whether the current price
action is sustainable, how long the trend is likely to move in that direction,
if a change of trend is imminent, and where you are in the trend cycle.
 When to exit a stock based on your trading style, hold time, and financial
goals.
 Which of the 8 levels of Market Participants are actively trading?
 Which of the 4 positions currently dominate the price action: buyers,
sellers, sell shorter, or buy to cover traders.
 Whether small lots or large lots are in control of price.
 The direction of the long term, intermediate term, and short term trend and
whether the 3 trends are in harmony or opposition to each other. This
defines the overall cycle

2.1.3.8.1.2.1 Bar Chart

It shows the opening and closing prices, as well as the highs and lows.
2.1.3.8.1.2.2 Line Chart

33
It draws a line from one closing price to the next closing price. When strung together
with a line, investor can see the general price movement of a derivative over a period
of time.

2.1.3.8.1.2.3 Candle Chart

Candle charts are Japan’s most popular, and oldest, form of technical analysis. They
are older than point and figure and bar charts.

2.1.3.8.2 Fundamental Analysis

Fundamental analysis is a way of looking at the market by analyzing economic,
social, and political forces that affects the supply and demand of an asset. Simply, it is
a way of analyzing a currency through the strength or weakness of that country's
economy.

2.1.3.8.3 Sentimental Analysis

Sentiment analysis, analyze the attitude of investor with respect to market psychology.
The attitude may be his or her judgment or evaluation, affective state or the intended
emotional communication.

2.1.3.9 Traders Type in Derivative

2.1.3.9.1 Jobbing
The buying and selling of securities with the intent of generating quick profits is
jobbing. While most investors seek value through long-term investments, security
jobbing takes on a more speculative short-term tone.

2.1.3.9.2 Scalping
A trading strategy that attempts to make many profits on small price changes. Traders
who implement this strategy will place anywhere from 10 to 200 trades in a single
day in the belief that small moves in price are easier to catch than large ones.
Traders who implement this strategy are known as scalpers.

2.1.3.9.3 Intraday Trading/Day Trading

Day trading refers to the practice of buying and selling financial instruments within
the same trading day such that all positions are usually closed before the market close
for the trading day. Traders that participate in day trading are called active traders or
day traders (intra-day trading). Day trading used to be activity exclusive to financial

34
firms and professional investors and speculators. Indeed, many day traders are bank or
investment firm employees working as specialists in equity investment and fund
management. However, with the advent of electronic trading and margin trading, day
trading has become increasingly popular among at-home traders.

2.1.3.9.4 Swing
Swing trading is commonly defined as a speculative activity in financial markets
whereby instruments such as stocks, indexes, bonds, currencies, or commodities are
repeatedly bought or sold at or near the end of up or down price swings caused by
price volatility. A swing trading position is typically held longer than a day but shorter
than trend following trades, or buy and hold investment strategies that can be held for
months or years. Profits can be sought by engaging in either long or short trading.

Utilizing a set of objective rules for buying and selling is a very common method used
by swing traders because the rules eliminate the subjectivity, emotional aspects, and
labor-intensive analysis of swing trading. The trading rules can be used to create a
predictive market trading algorithm or "trading system" which can be further defined
as a calculable set of trading rules that uses either technical analysis and/or
fundamental analysis and results in entry, exit, and stop loss trade price points.

2.1.3.9.5 Position Trader

Commodities trader who, unlike most traders, takes a long-term, buy and hold
approach. In commodities trading, long-term refers to holding until the delivery date
is close, usually 5-7 months.

2.1.4 Trading & Market Timings of Derivative Exchanges

Trading timing of Derivative market takes place on all week days i.e., except
weekends and holidays declared by exchange in advance. And the market timing of
derivative market is normally 04:45 am to 03:45 am i.e., 23 hours per day.

2.1.5 Brokerage Commission

Brokerage commission is the service charge paid by the investors to the broker for a
complete transaction i.e. buy and sell or vice versa. This commission is divided
between Exchange, CM, NCM/TM/Brokers and AEs/RUs/Sub-Brokers. Investors pay

35
the commission on the basis of size and quantity of the product as specified by the
exchange. (See Appendix V)

2.1.6 Margin
In finance, a margin is collateral that the holder of a financial instrument has to
deposit to cover some or all of the credit risk of their counterparty (most often their
broker or an exchange). This risk can arise if the holder has done any of the
following:
 borrowed cash from the counterparty to buy financial instruments,
 sold financial instruments short, or
 enter into a derivative contract.

The collateral can be in the form of cash or securities, and it is deposited in a margin
account. On United States futures exchanges, margin was formerly called
performance bond. Most of the exchanges today use SPAN (Standard Portfolio
Analysis of Risk) methodology for calculation of margin in Options and Futures.
SPAN was developed by the Chicago Mercantile Exchange in 1988.

2.1.6.1 Initial Margin

The initial margin is the amount required to be collateralized in order to open a future
position. It varies upon the underlying asset that is covered. Some assets require high
amount of initial margin while some assets require only a few. It is calculated based
on a certain percentage of the total value of the assets covered.

2.1.6.2 Maintenance Margin

The amount required to be kept in collateral until the position is closed is the
maintenance requirement. The maintenance margin is the minimum amount to be
collateralized in order to keep an open position. It is generally lower than the initial
requirement. This allows the price to move against the margin without forcing a
margin call immediately after the initial transaction. On instruments determined to be
especially risky, however, the regulators, the exchange, or the broker may set the
maintenance requirement higher than normal or equal to the initial requirement to
reduce their exposure to the risk accepted by the trader.
2.1.6.3 Margin call

36
When the margin posted in the margin account is below the minimum margin
requirement, the broker or exchange issues a margin call. The investors now either
have to increase the margin that they have deposited or close out their position. They
can do this by selling the securities, options or futures if they are long and by buying
them back if they are short. But if they do none of these, then the broker can sell their
securities to meet the margin call. If a margin call occurs unexpectedly, it can cause a
domino effect of selling which will lead to other margin calls and so forth….
effectively crashing an asset class or group of asset classes.

This situation most frequently happens as a result of an adverse change in the market
value of the leveraged asset or contract. It could also happen when the margin
requirement is raised, either due to increased volatility or due to legislation. In
extreme cases, certain securities may cease to qualify for margin trading; in such a
case, the brokerage will require the trader to either fully fund their position, or to
liquidate it.

2.1.7 Type of Derivative Market

2.1.7.1 Over-the-counter (OTC) Market
Over-the-counter (OTC) derivatives are contracts that are traded (and privately
negotiated) directly between two parties, without going through an exchange or other
intermediary. Swaps, Options and Forward Contracts are traded OTC market. The
OTC derivative market is the largest market for derivatives, and is largely unregulated
with respect to disclosure of information between the parties, since the OTC market is
made up of banks and other highly sophisticated parties, such as hedge funds.
Reporting of OTC amounts are difficult because trades can occur in private, without
activity being visible on any exchange.

2.1.7.2 Exchange Traded Market

Exchange-traded derivative contracts (ETD) are those derivatives instruments that are
traded via specialized derivatives exchanges or other exchanges. A derivatives
exchange is a market where individual trade standardized contracts that have been
defined by the exchange. A derivatives exchange acts as an intermediary to all related
transactions, and takes initial margin from both sides of the trade to act as a guarantee.
The world's largest derivatives exchanges (by number of transactions) are the Korea

37
Exchange (which lists KOSPI Index Futures & Options), Eurex (which lists a wide
range of European products such as interest rate & index products), and CME Group
(made up of the 2007 merger of the Chicago Mercantile Exchange and the Chicago
Board of Trade and the 2008 acquisition of the New York Mercantile Exchange).

2.1.8 Features of Derivative Exchange

 Derivatives are essential tools to determine both current and future prices of
underlying assets.
 The derivatives market relocates risk from the people who prefer risk aversion
to the people who have an appetite for risk.
 It establishes the organized form of market to the sellers and buyers.
 The derivatives market has a history of alluring many optimistic, imaginative
and well educated people with an entrepreneurial outlook, the benefits of
which are colossal. Thus it acts as a facilitator for new entrepreneurs.
 In a nutshell, there is a substantial increase in savings and investment in the
long run due to augmented activities by derivative Market participant.

2.1.8.1 Balance of Payment

Balance of payments (BOP) accounts are an accounting record of all monetary
transactions between a country and the rest of the world. These transactions include
payments for the country's exports and imports of goods, services, financial capital,
and financial transfers. The BOP accounts summarize international transactions for a
specific period, usually a year, and are prepared in a single currency, typically the
domestic currency for the country concerned. Sources of funds for a nation, such as
exports or the receipts of loans and investments, are recorded as positive or surplus
items. Uses of funds, such as for imports or to invest in foreign countries, are recorded
as negative or deficit items.

2.1.8.2 Trade Balance

The balance of trade (or net exports, sometimes symbolized as NX) is the difference
between the monetary value of exports and imports of output in an economy over a
certain period. It is the relationship between a nation's imports and exports. A
favorable balance of trade is known as a trade surplus and consists of exporting more
than is imported; an unfavorable balance of trade is known as a trade deficit or,

38
informally, a trade gap. The balance of trade is sometimes divided into a goods and a
services balance.

2.1.8.3 Spread
A spread is a difference obtained from a long and a short position held on the same
security. Therefore, it can be defined as being composed of both long positions and
similar short options on the same underlying length’s security. The spread is possible
if the exercise price or the expiration time is differ or both. The spread having
different exercise price but the same expiration time is vertical spreads, and in
contrast, horizontal spreads (time spreads, calendar spreads) and if both differs, is
diagonal spreads.

2.1.8.4 Straddles
Straddles is a strategy used in options trading which would be employed by someone
who expects the price of the underlying shares to be volatile. Investors simultaneously
buy a call option and a put option in a share which have the same exercise price and
expiration date. Thus the investor can make a profit if the share’s price rises or falls.
However, for them to profit, the share price has to move further in at least one
direction than if they were just buying a call or a put. A long or short straddles is
established by buying or selling both a call and a put on a stock, each with the same
exercise price and the same expiration date.

“A straddle is the purchase of a call and put that have the same exercise price and
expiration date. By holding both a call and a put, the trader can capitalize on stock
price movement in either direction.” (Don; 2004: 257)

2.1.8.5 Regulation
There is no regulator in Nepal to regulate derivative market. Exchanges are being self-
regulated, though they are asking government to bring them under Securities Board of
Nepal’s (SEBON) regulation or any other regulatory body. (Bhattarai; 2010: 30)

2.1.8.6 Confidence & Sentiment Report

Confidence & sentiment reports give insight into business and consumer sentiment.
Central banks, analysts and traders use these reports to suggest futures trends in
spending, employment, production, economic growth and inflation.

39
Any true insight into these economic aspects is valued by market participants. Many
of the reports below are released by central banks and governments to help determine
their actions and have a history of moving markets upon release, making them all the
more valued.

2.1.8.7 Impact of Economic News over Derivative Market

Financial news is full of stories about how markets were surprised or anticipated an
economic statistic and how the markets moved in response to this news. It analyzes
the difference between economic announcements and what was anticipated, on
financial markets.

As long as markets have existed, savvy traders have paid attention to the market’s
reaction to significant (potentially market-moving) news. This was true in the days of
the ticker tape and is still true in today’s electronic age. Significant news should, by
definition, result in a significant market reaction. But it doesn’t always happen and
many times the reaction is opposite of what commonly expected.

No matters what the news be, but how the market reacts to the news is the main thing.
Obviously, the news sets the public perception, but you must be alert for divergences
between the news and market action. It’s expectation versus reality. Look for the
divergence between what’s happening and what people think is supposed to happen.
When the big turn comes, the general public will always be looking the wrong way.

2.1.8.8 News Rules

 If bad news is announced and the market starts to sell off in large volume, it’s a
good bet that the market’s going lower.
 If the market fails to react to good news, it probably already has been discounted
in the price.
 Moves of importance invariably tend to begin before any news justifies the initial
price move. When the move is underway, the emerging fundamentals will slowly
come to light. A big rally (decline) on no news is usually very bullish (bearish).

40
 It is generally not a good practice to buy after very bullish news or sell after an
extremely bearish report, because both good and bad news can already be
discounted in the price.
 Always consider whether the trend is down or up when the news is made known
because a well-established trend will generally continue regardless of the news.
 When unexpected news occurs (news that the market has not had time to prepare
for) and the market opens in a wide range or “gaps” lower or higher, sell out your
longs or cover your shorts and wait. Watch the market for 30 minutes to an hour.
If the market opened sharply lower with heavy selling and was not able to trade
much lower than that, it’s into support, and you can buy it with a tight risk point.
Watch the market closely at this point and note the tone of the rally. If it’s small
and the market is able to again fall under the levels made when the bad news came
out (or rise above the levels made when the good news came out), it’s safe to
assume the market is going lower (higher).

2.1.8.9 Risk Disclosures

 Commodity futures trading is speculative, involves substantial risks, so one should
invest only risk capital.
 One should lose a substantial amount or all his/her investment, and therefore s/he
should carefully consider whether such trading is suitable for him/her in light of
his/her financial condition.
 The high degree of leverage that is obtainable in commodity trading can work
against him/her as well as for him/her — the use of leverage can lead to large
losses as well as large gains.
 No matters what the news be, but how the market reacts to the news is the main
thing. Obviously, the news sets the public perception, but you must be alert for
divergences between the news and market action. It’s expectation versus reality.
Look for the divergence between what’s happening and what people think is
supposed to happen. When the big turn comes, the general public will always be
looking the wrong way.
 If the market moves against your position, to maintain the position run one should
have back up money to overcome the margin call.

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2.1.9 Global Market
Markets such as equities or interest rates tend to be traded locally during the business
day in their own time zone. For example, Japanese traders focus on Japanese stocks,
European traders on European stocks and U.S. traders on U.S. stocks. All of these
traders certainly should be aware of what is happening elsewhere as the global
integration of financial markets continues, but an event in Japan that directly affects
Japanese stocks may not have the same effect in Europe, and traders of European
stocks may not pay as much attention to what happens in the U.S. or Japanese stock
markets.

Forex, on the other hand, has become an asset class that is truly a global investment
reflecting every economic development on earth. Whatever has an influence on
currencies in Japan has an effect on what happens to currencies in London or Chicago.
It is clear that intermarket relationships among currencies are extremely important in
today's world.

2.1.9.1 24-Hour Trading

Forex trading begins Monday morning in Sydney, Australia (Sunday afternoon in the
United States) and moves around the globe as business days begin in financial centers
from Tokyo to London to New York, ending with the close of trading Friday afternoon
in New York. Anything that happens anywhere in the world at any time of the day or
night affects the Forex market immediately without waiting for an exchange to open
before the effects can be seen. The Forex market is always open for trading.

2.1.9.2 Electronically Traded

With the advances of technology – specifically, the Internet and online trading – and
electronic trade-matching platforms, most Forex trade executions are instantaneous,
getting you into and out of positions with the click of a mouse once you have made a
trading decision. All of the benefits of electronic trading and updates of your positions
and current status are available to today's Forex trader.

2.1.9.3 Liquidity
With the size of the Forex market, around-the-clock trading, and electronic trade
execution mentioned above, illiquidity is not much of an issue in most venues of
Forex trading. There is almost always a party to take the other side of a position you

42
want to establish, no matter when you place your order. Forex bids and asks tend to be
tight and slippage minimal.
2.1.9.4 Leverage
Leverage is the ratio of the amount of capital used in a transaction to the required
security deposit (margin). It is the ability to control large amounts of a security with a
relatively small amount of capital. Leveraging varies dramatically with different
brokers, ranging from 2:1 to 500:1. A small move in your favor can produce a big
return on your investment. However, whenever you talk about the benefits of
leverage, you also have to remember that leverage works both ways. A small move
that is against your position can eat up the money in your account quickly if you are
not a nimble trader who takes quick action to cut losses before they become too large.
What leverage gives, it can also take away.

2.1.9.5 Plenty of Information

Governments issue dozens of reports every month that influence the Forex market.
Information is widely disseminated by the financial media. With advances in the
Internet and financial news services, prices and economic data are delivered within
moments of being released and are available to Forex traders of all types throughout
the world. If anything, there may even be too much information for traders to sort out
at times, which has its own negative consequences.

2.1.9.6 Simplicity
You don't have to watch or analyze reports and price movements of hundreds of
companies or mutual funds, trying to figure out which to buy or sell. With all of the
fundamental information coming at you from many sources every day, you can make
your trading life easier by concentrating on the Forex market because you could easily
limit yourself to monitoring movements of a half dozen Forex pairs. In addition, you
don't have to worry about going short or selling on a downtick as you do with equities
because it's as easy to sell as it is to buy in the Forex market.

2.1.9.7 Good Technical Market

Once you understand the basics of technical analysis and how you can apply a
software program to your trading, you can extend that knowledge to all your Forex
markets without having to learn and understand a whole new set of market factors.
Because currencies are influenced by government policies and economic

43
developments that usually stretch over longer periods of time, Forex markets are good
for trend-following techniques. As a result, if you keep an eye on economic conditions
and charts as they evolve, you may find that Forex market moves are easier to follow
and predict than are movements in other markets. A glance at a currency chart such as
euro futures is enough to show clear longer-term trends, which often have enough
movement within them to also satisfy the trader looking for shorter-term swing
moves.

2.1.9.8 Active Price Movement

Whether looking at price movements intraday or over a number of days, currencies
tend to have trading ranges that are wide enough to produce attractive trading
opportunities. Volatility is necessary for a trader to make money in any market, and
the Forex market usually provides more than enough volatility because there are new
developments that affect the Forex market every day.

2.2 Review of Journals and Articles

The research articles, published in various well known journals which are relevant to
this study, have been reviewed here such as articles, journals etc. There are limited
journals available in the field of management in Nepal and hard to find any research
article relevant to this study. Despite the situation, some articles published both
nationally and internationally are taken into consideration.

Surendran (2011) has published an article on “Gaining Confidence from the Market”
explaining the urgent needs and requirements of regulatory system and policy before
any rumor and mismanagement happens in the derivative market of Nepal. He
highlighted some important aspects in this article.

Commodity market in Nepal is attracting investors looking for newer investment

areas than the conventional stock market. Commodity is regarded as a means of
investment, capturing an important portion of the financial market in the present
world. But in Nepal, the commodity market is running without any proper regulatory
mechanism from the government. And without inclusion of domestic product
valuation in commodity market, the exchange can’t be applicable in real time.

44
Current taxation provision of the Nepalese government in commodity trading is not
practical and does not exist anywhere else in the world. Government should take tax
on annual basis from the profit so that the investors’ risk can be managed.
To develop commodity market, the level of awareness needs to increment in Nepal.
Thus exchange companies should collaborate with various business schools and
colleges to educate more about this market and should conduct various business
seminars, Expos, Trade shows, awareness campaigns etc. within & outside the valley
soon.

Poudel (2011) has published an article on “SEBON Readies Draft” explaining about
the first draft of the Commodities Market Operation Regulation 2011. SEBON plans
to bring the regulation into effect after the securities act bill is endorsed by the
Cabinet. It is only the first draft. The regulation will be implemented effectively by
making some adjustments in accordance with the act.

The proposed draft of the regulation has made it mandatory for companies to acquire
operating license to start a commodities exchange which should be renewed at the end
of every fiscal year. According to Poudel, the draft has provisioned that commodities
exchanges will be public limited with a minimum paid-up capital of NRs. 100 million
which might be increase as per requirement based upon the volume of transaction
carried out by the commodities market. He added that the draft has also set criteria for
the appointment of the board members and CEO of commodities exchanges, clearing
members, commodities brokers and commodities that can be traded in the market.

Kunwar (2010) has published an article on “Commodity Exchanges: An Emerging

Career in Nepal” explaining the derivative market as major contributor to
the Nepalese economy. Derivative market is growing enormously over the
last few years which have created massive employment opportunities to the
general people with finance students benefitting the most. In a short span of
time, commodity market has not only limited to futures trading but has also
spread its faction to spot trading and option trading in the country.

This increasing number of commodity exchanges in the country proved two things.
Firstly; the local investors have welcomed this new area of investment with

45
 open arms. Consequently, more and more investors participate in this market
on a regular basis. Secondly; the setting up of a regulatory body and the
soon to be introduced regulations by the government further shows that this
market has a huge potential in the country. Likewise, participation of
different sectors such as banks further drives home the point that commodity
marker is here to stay.

Sapkota (2010) has published an article on “Commodity Trade and Its Benefits in
Context of Nepal” explaining derivative market as innovative investment
alternatives which provides novel platform to those investors who wants to
diversify their portfolio. It is one of a few investment areas where an
individual with limited capital can make extraordinary profits in a relatively
short period of time.

Commodity market in Nepal is in very early stages but is an emerging market, with a
vast growth potential and can become one of the prominent markets in
Nepal. In recent years commodity trading has shown substantial growth.
People from the various fields have started investing in the commodity trade
which also created employment opportunities to the general public and the
government as well by paying huge amount of tax.

The real benefit of commodity market is that it will assist the country to improve and
upgrade its economic condition without any help from other countries. And it
is possible through introducing wide range of agro products in commodity
market, in which Nepal has potential to meet the global demand. For e.g.
Ginger, it can be introduced in a trading list, as Nepal has potential to meet
the global demand as for being fourth largest ginger producing country.
Inclusion of such agro product in commodity trading platforms will help
producers to hedge against price risk. And if the government seriously
invests some of its time and gives a clear picture to commodity exchanges, it
can justify the most prominent sector of the country, which is non-other than
the "Agriculture". On the same hand, farmers can capitalize their agricultural
investments by defining correct price for their product in the commodity

46
 derivative market as it will provide them a platform to hedge their price
risks.

Lamsal (2010), has published an article on “Challenges of Nepalese Commodity

Market” explaining the challenges faced by commodity market which need
to be addressed for the country to derive benefit from this market.
 Commodity market is facing some structural as well as institutional
bottlenecks such as weak and poor infrastructures including roads, power,
irrigation and warehouse.
 Lack of skilled manpower.
 Lack of clear and suitable government policy.
 Stakeholders of the organized commodity market such as farmers,
wholesalers, manufacturers, processors, consumers etc. are not aware & are
not confident about the operation of the market; and its favorable impact to
them.
 Nepalese commodity exchanges are highly concentrated in trading of foreign
market-based metals, fuels and agro product only but not exercise in domestic
product.
 Due to the volatility of the market, small investors may not survive in this
market.

2.3 Review of Independent Research

In this section, an attempt has been made to review some theses related to this study.

Kuprianov (2009) has conducted a study on “ISDA Derivatives Usage Survey”. His
research objectives are as follows:
1. New survey shows that 94 percent of the world's largest corporations report
using derivatives to manage business and macroeconomic risks
2. Foreign exchange and interest rate derivatives are the most widely used
instruments among large global corporations
3. Reported derivatives usage was uniformly high among companies based in
developed economies

The main findings of his research are as follows:

47
 1. ISDA published the results of its first survey of derivatives usage by the
world’s major companies in 2003. The 2003 ISDA Derivatives Usage Survey
found that 92 percent of the world’s 500 largest companies, a broad-
ranging sample covering industries that included banking, mining,
manufacturing, aerospace, wholesalers of office and electronic equipment,
and retail, used derivative instruments to manage and hedge their business and
financial risks.
2. The global scale of the companies surveyed by ISDA, the largest number of
companies (441) report using foreign exchange derivatives, followed by
interest rate derivatives (416), commodity derivatives (240), equity
derivatives (143), and credit derivatives (101).
3. ISDA recently updated this survey for companies in the Fortune Global 500.
The results show that the use of derivatives by businesses continues to grow.
According to the most recent results, just over 94 percent of the sample—471
out of 500 companies—report using derivatives.

Curtis (2011) has conducted a study on “The Importance of Trading Psychology and
Discipline”. His research objectives are as follows:
1. To study the psychological aspect of trading in derivative market.
2. To study about the investors greediness in trade.
3. To know importance of trading rules before starting trade.

The conclusion of his study was;

1. A trader is often darting in and out of stocks on short notice, and is forced to
make quick decisions. To accomplish this, they need a certain presence of
mind and discipline, so that they stick with previously established trading
plans and know when to book profits and losses.
2. Greed is not easy to overcome. That's because within many of us there seems
to be an instinct to always try to do better, to try to get just a little more. A
trader should recognize this instinct if it is present, and develop trade plans
based upon rational business decisions, not on what amounts to an emotional
whim or potentially harmful instinct.

48
 3. To get their heads in the right place before they feel the emotional or
psychological crunch, investors can look at creating trading rules ahead of
time. Traders might establish limits on the amount they win or lose.

Research Gap
Derivative market has always become significant to its stakeholders as well as
relevant to the economy of nation. Its main objective is to minimize the risk. Till date
I could not find any research thesis related to this topic in Nepal so I take some
foreign independent research as reference. I think, this research may be the pioneer
research in the field of derivative market in Nepal.
CHAPTER – III
RESEARCH METHODOLOGY
Research methodology is the way to solve systematically about the research problem.
Methodology states the method with which data have been extracted and discuss the
tool of that have been used in interpretation of such data to fulfill the stipulated
objectives.

3.1 Research Design

The research study attempts to analyze the derivative practice in Nepal. Hence,
descriptive as well as analytical research designs have been employed.

Descriptive research is essentially a fact finding approach relative largely to present

and abstracting generalization by the cross-sectional study of the current situation.

Analytical approach is followed to parametric and non-parametric test of data.

3.2 Population and Sample

Among the universe of 251 brokers (approximately) and 12000 investors or clients
(approximately), 22 brokers and 120 clients are taken as the sample size of the study.

3.3 Data Collection Procedure

This study mainly depends upon the primary sources of data. The secondary is used
for supporting primary data. Secondary data had been collected from published

49
materials of different organizations such as: COMEN, MEX, NDEX, WEX, NSE,
SEBON, National Planning Commission etc. Some data were taken from trading
reports of exchange. A questionnaire was distributed to Exchange, CM, NCM and
individual investors to collect their opinion and views. The informal discussion and
interviews were also performed to collect the views from different sources.

3.4 Data Processing Procedure

The uses of statistical tools, such as percentage analysis, range are used to analyze the
primary data.

3.5 Analyses and Presentation of Data

The collected data are presented in tabular form and interpreted accordingly. Detailed
calculations are presented in appendices.

3.6 Analytical Tools

On the basis of primary data collected from questionnaires and informal discussion
with different investors, brokers, NCM, CM, Exchange and staff as well as officers of
SEBON, statistical tools were used to perform the detail analysis as required by the
study.

3.6.1 Statistical Tools

3.6.1.1 Percentage Analysis
The percentage analysis is done to compare the two or more data for general
information. It is used as a method to divide the options of the related sectors into two
or more sectors.

3.6.1.2 Arithmetic Mean

Arithmetic mean is the sum of all the observations divided by the number of
observations. The arithmetic mean is denoted by ( X ). It is computed as:

(X ) = �fx
N

3.6.1.3 Median

50
Median divides the whole observations into two halves. The first half comprises all
the values greater and the second half comprises all the values smaller than median.
Median is denoted by Md. The formula used for computing the median is as under:
th
�n+1 �
Md = � � item
�2 �

3.6.1.4 Research Hypothesis

The following hypotheses are set about the different aspects related to the
effectiveness of Broker in derivative market. These hypotheses have been tested by
analyzing the data primarily received from three sectors investors and brokers and
exchange. These data have been collected by using the questionnaire and tested by
using chi-square test.

The null hypotheses were set as under:

i. There is no significant difference between the opinions of Investors
and brokers so far as adequacy and reliability of information provided by the
brokers.
ii. There is no significant different between option of investor and brokers
so far as the education and training provided by NCMs.
iii. There is no significant different between option of investor and brokers
so far as the service provided by related banks.
iv. There is no significant different between option of investor and brokers
so far as the reliability of report provided by NCMs.
v. There is no significant different between option of investor and NCMs
so far as the handling of margin call.
vi. There is no significant different between option of investor and NCMs
so far as the clearing of liquidity.

The alternative hypotheses were set as under:

i. There is significant difference between the opinions of Investors and
brokers so far as adequacy and reliability of information provided by the
brokers.
ii. There is significant different between option of investor and brokers so
far as the education and training provided by NCMs.

51
 iii. There is significant different between option of investor and brokers so
far as the service provided by related banks.
iv. There is significant different between option of investor and brokers so
far as the reliability of report provided by NCMs.
v. There is significant different between option of investor and NCMs so
far as the handling of margin call.
vi. There is significant different between option of investor and NCMs so
far as the clearing of liquidity.

3.6.1.5 Chi-Square Test

Among many methods of testing hypothesis, chi-square test is used which is
popularly known as non-parametric test. It is very helpful when it is not possible to
make the dependable assumptions about the parent population from which the sample
is drawn. Chi-square is denoted by (χ2). This test does not require any assumption
about the parameter. For testing chi-square, the total number of items must be as large
as 50 and the expected frequency of any item or cell must not be less than 5. If it is
less than 5, the frequencies of adjacent item or cells should be pooled together in
order to make it 5 or more than 5. Chi-square test is broadly used as a test of goodness
of fit and as a test of independence of attributes. In this study chi-square is used to test
the independence of the responses found from different sectors.

The procedures followed to perform the chi-square test are described as under:
i. The first stage is to set the null and alternative hypothesis. Null hypothesis,
which is denoted by Ho. Ho, is set to suggest that there is no association
between two attributes, i.e., respondent sectors and the response whereas
alternative hypothesis which is denoted by H1 is set to suggest that there is
association between the sectors and responses.
ii. The second stage is to make the contingency table for testing the independence
of the responses in regards to the sectors. The rows of the table occupy the
responses, whereas the column will occupy the respondent sectors. Then the
expected cell, Frequencies under Ho are calculated by using the relation as
under:
Expected frequency of a cell of ith row and jth column
Row total X Column total
Total number of observation

52
 =
iii. The third stage is to compute the test statistic under Ho. This is computed as:

( O-E )
2

c =�
2

E
iv. The fourth stage is to write down the tabulated value of chi-square at a certain
level of significance, which is assumed to be of 5% in the calculation for (r-1)
X (c-1) for degrees of freedom.
v. The fifth stage is to make the decision. If the computed value of chi-square is
less than the tabulated value, Ho is accepted at the level of significance 5%. If
the computed value of chi-square is greater than its tabulated value, Ho is
rejected.

53
 CHAPTER – IV
PRESENTATION AND ANALYSIS OF DATA
In this chapter the relevant data and information had been taken from the distribution
of Questionnaire and Personal Interview from the related sectors under this study,
investor NCM, CM and Exchange were taken as the sources to gather the relevant
information by distributing the questionnaires. Appropriate statistical tools had been
used to perform the analysis, which is described in Chapter III.

4.1 Analysis of Data

A total of 150 questionnaires were distributed to investors, NCM, CM and Exchange
as 120, 22, 3and 5 respectively. Among them 70 questionnaires from investors, 15
questionnaires from NCMs, and 5 questionnaires from exchanges were returned and
rest of questionnaires were not returned respectively. (See Appendix-I)

Table: 4.1
No. of Questionnaire Distributed to,
Returned and Not Returned from Investors, NCM, CM and Exchange
Description Investor NCM CM Exchang Total
No. of Questionnaire distributed 120 22 3 5 150
s e
Questionnaire returned 70 15 0 5 90
to
Questionnaire not returned 50 7 3 0 60
(Source: Appendix II.1)

Figure: 4.1
No. of Questionnaire Distributed to,
No. of Questionnaire distributed

Returned and Not Returned from Investors, NCM, CM and Exchange

4.1.1 Tenure of Investors

54
Questionnaire distributed to
Investors are requested to fill the registration date to know that how long he/she was
involved with the investing activities in derivative market. 70 investors responded this
question. From the acquired data it was known that the investors involving period was
different. 41 investors were involving from one year, 10 investors were involving
from two years, 14 investors were involving from three years and 5 investors were
involving from four years. The average involving year per investors was 1.76 years.

Table: 4.2
Tenure of Investors in Derivative Market
No. of years involved (X) 1 Year 2 Years 3 Years 4 Years Total
No. of investors (F) 41 10 14 5 70
(Source: Appendix II.2)
Figure: 4.2
Tenure of Investors in Derivative Market
No. of investors

4.1.2 Qualification of Investors

Investors were requested to fill up their qualification to know would they actually able
to understand the market mechanism or they just trade with others voice. Out of 70
investors, 6 investors have qualification up to SLC (i.e. 8.57%), 9 investors have done
Involving time
PCL (i.e. 12.86%) or intermediate, 39 investors have completed Bachelor (i.e.
55.71%), 16 investors have completed Master (i.e. 22.86%) and none of them have
more than Master Degree. From the acquired data most of the investors have
completed bachelor level education.

Table: 4.3
Investor’s Qualification
Qualification Up to SLC PCL Bachelor Master More Total
No. of Investor 6 9 39 16 0 70
Percentage 8.57% 12.86% 55.71% 22.86% 0% 100%
(Source: Appendix II.3)
Figure: 4.3

55
 Investor’s qualification

No. of investors

Investor’s qualification

4.1.3 Profession of Investors

Investors were requested to fill up their profession to know about their background.
Among 70 respondents, 1 investor was from agriculture sector, 12 investors were
from job, 45 investors were from business, 11 investors were from student and 1
investor from other sector, which is 1.43%, 17.14%, 64.29%, 15.71% and 1.43%
respectively. Most of the investors were found business person and only one
investor’s profession belongs to agriculture.

Table: 4.4
Investor’s profession
Profession Agriculture Job Business Student Other Total
No. of Investor 1 12 45 11 1 70
Percentage 1.43% 17.14% 64.29% 15.71% 1.43% 100%
(Source: Appendix II.4)
Figure: 4.4
Investor’s profession
No. of investors

4.1.4 Invested Amount

Investor’s profession

56
Investors were requested to quote their invested amount in derivative market to know
the general idea about investment. Among 70 respondents, 15 investors invested
below Rs.50000, 16 investors invested Rs.50000 to Rs.100000, 26 investors invested
Rs.100000 to Rs.200000, 12 investors invested Rs.200000 to Rs.500000 and one
investor invested more than Rs.500000. By calculating the primary data, median
invested amount per investor was found as Rs.115385.

Table: 4.5
Amount invested by investors in Derivative Market (in RS.000’)
Amount Frequency Cumulative Frequency
Below 50 15 15
500100 16 31
100-200 26 57
200-500 12 69
500 & more 1 70
(Source: Appendix II.5)
Figure: 4.5
Amount invested by investors in Derivative Market
No. of investors

4.1.5 Investors Involvement in Exchanges

Investors were requested to quote the name of exchanges where they have opened
their account for trading. 70 investors responded the answer in which 6 investors
opened an account in COMEN (i.e. 6.74%), 48 investors opened an account in MEX
(i.e. 53.93%), 19 investors opened an account in NDEX (i.e. 21.35%), 5 investors
Amount Invested in ‘000’
opened an account in WEX (i.e. 5.62%) and 11 investors opened an account in NSE
(i.e. 12.36%). From the acquired data it was found that 52 investors were involving in
only one exchange for trading, whereas 12 investors were involving in two exchange
and 6 investors were involving in more than two exchanges. Most of the multi
account holder investors opened their accounts in MEX, NDEX and NSE.

57
 Table: 4.6
Investor’s involvement in exchanges

Exchange COMEN MEX NDEX WEX NSE Total

No. of Investor 6 48 19 5 11 89
Percentage 6.74% 53.93% 21.35% 5.62% 12.36% 100%
(Source: Appendix II.6 &Appendix II. 7)

Figure: 4.6
Investor’s involvement in exchanges
No. of investors

4.1.6 Trading Style

Among the 70 respondents, they were requested to mark their trading style. In which
Account in exchange
1 investor was jobber, 2 investors were swing traders, 29 investors were intraday
traders, 26 investors were scalpers and 12 investors were position traders which were
1.43%, 2.86%, 41.43%, 37.14% and 17.14% respectively. From the acquired data it
was known that the highest percentage (i.e. 41.43%) of investors trading style was
intraday and the lowest percentage (i.e. 1.43%) of investors trading style was jobbing.

Table: 4.7
Investors trading style

Trading style Jobbing Swing Intraday Scalping Position Total

No. of Investor 1 2 29 26 12 70
Percentage 1.43% 2.86% 41.43% 37.14% 17.14% 100%
(Source: Appendix II.8)
Figure: 4.7
Investors trading style

58
 No. of investors

4.1.7 Reference Software Investor’s trading style

It was requested for all (i.e. for investors, NCM, CM and Exchange) to mark the
reference software they use. Among them, 90 respondents answered the questionnaire.
Out of 90 respondents 84.44% of the respondent refers GCI software, 28.89% of the
respondent refers CME Equote software, 32.22% of the respondent refers futures pros
software, 10% of the respondent refers Trade N Track (TNT) software and remaining
10% of the respondent refers other software.
Table: 4.8
Reference Software Used by Investors, NCMs, CMs and Exchanges
Software GCI CME Equote Futures Pros TNT Other
No. of user (out of 90 respondents) 76 26 29 9 9
User % (out of 90 respondents) 84.44% 28.89% 32.22% 10% 10%
(Source: Appendix II.9)

Figure: 4.8
Reference Software Used by Investors, NCMs, CMs and Exchanges
No. of user

4.1.8 Websites

59
Reference Software
It was requested for all (i.e. for investors, NCM, CM and Exchange) to mark the
websites they use. Among the questionnaire distributed, 90 respondents answered the
questionnaire. Out of 90 respondents 80% of them used Kitco and Forex Factory
websites, 62.22% of them used Oil N gold websites, 50% of them used Market watch
websites, 41.11% of them used Bloomberg websites and 23.33% of them use all
websites. Data presented in table shows that most of the respondents use more than
one websites.
Table: 4.9
Websites used by investors, NCMs, CMs and Exchanges
Website Kitco Oil N Gold Forex Factory Market Watch Bloomberg All user
User No. (out of
72 56 72 45 37 21
90 respondents)
User % (out of
80% 62.22% 80% 50% 41.11% 23.33%
90 respondents)
(Source: Appendix II.10)

Figure: 4.9
Websites used by investors, NCMs, CMs and Exchanges
No. of user

4.1.9 Purpose of Investment

To know the general ideas of investor’s investment purpose in Derivative market, four
options were provided to them which were: use of access money, portfolio
investment, capital gain and risk reduction. 70 investors responded the answer and 7
Websites
investors chose for use of excess money (i.e. 10%), 10 investors chose for the
portfolio investment (i.e. 14.29%), 48 investors choose for portfolio investment (i.e.
68.5%) and 5 investors choose for risk reduction (i.e. 7.14%). From the acquired data
it was known that the highest percentage (i.e. 68.57%) of investor’s purpose was to
make capital gain and the lowest percentage (i.e. 7.14%) of investor’s purpose was to
risk reduction.

60
 Table: 4.10
Purpose of investment in Derivative Market
Purpose of Use of access Portfolio Capital Risk
Total
investment money investment gain reduction
No. of Investor 7 10 48 5 70
Percentage 10% 14.29% 68.57% 7.14% 100%
(Source: Appendix II.11)

Figure: 4.10
Purpose of investment in Derivative Market
No. of investors

4.1.10 Service from Broker/TM/NMC and of

Purpose CMinvestment
Investors were requested to mark the types of services they were presently getting
from the Broker/TM/NCM and CM. Four options were put to mark which were:
trading service only, information service only, both service and other service if any. 70
investors responded the answer and 9 investors were getting only trading services
from brokers (i.e. 12.86%), 5 investors were getting only information services from
brokers (i.e. 7.14%), while 53 investors were getting both trading and information
services (i.e. 72.86%) and 5 investors were getting other services also (i.e. 7.14% ).
By analyzing the data most of the investors are getting both trading and information
services from the concerned Broker/TM/NCM and CM.
Table: 4.11
Response of Service from Broker/TM/NMC and CM
Trading Information Both Other
Service Total
service (TS) service (IS) services (if any)
Response of Investor 9 5 51 5 70
Percentage 12.86% 7.14% 72.86% 7.14% 100%
(Source: Appendix II.12)
Figure: 4.11
Response of Service from Broker/TM/NMC and CM
Response of investors

61
 Service from Broker/TM/NCM and CM

4.1.11 Present Situation

To know the investor’s profit loss situation till the date of questionnaire distributed,
70 investors and 15 brokers were requested to fill up the answer. Among the 70
investors, 11 investors were in profit (i.e. 15.714%), 12 investors were in balance (i.e.
17.143%) and rest 47 investors were in loss (i.e. 67.143%). Among the 15 brokers
having altogether 2056 investors, 379 investors were in profit (i.e. 18.44%), 320
investors were in balance (i.e. 15.56%) and 1357 investors were in loss (i.e. 66%).
From the above data highest percentage of the investors, investing in derivative
market was in loss and only a limited percentage of investors were in profit.
Table: 4.12
Investors Present Situation
Response Investors view Percentage Broker/TM/NCM view Percentage
Profit 11 Investors 15.714% 379 18.44%
Balance 12 Investors 17.143% 320 15.56%
Loss 47 Investors 67.143% 1357 66%
Total 70 Investors 100% 2056 100%
(Source: Appendix II.13)

Figure: 4.12
Investors Present Situation
Percentage of investors

4.1.12 Investor’s Opinion towards Derivative Market

Investors were requested to put their opinion towards Derivative market. 70 investors
responded the answer. Among the respondents 11 investors took it as hedge (i.e.

Investor’s situation
62
15.71%), 43 investors took it as speculation (i.e. 61.43%) and 16 investors took it as
gambling (i.e. 22.86%). From the above data, it came to know that most of the
Nepalese investors were risk seeker because high percentage (i.e. 61.43%) of
investor’s opinion towards derivative market was speculation and they did not hedge
to minimize risk because only 15.71% took derivative market as hedge.

Table: 4.13
Investor’s opinion towards Derivative Market
Derivative as a Hedge Speculation Gambling Total
Response of Investor 11 43 16 70
Percentage 15.71% 61.43% 22.86% 100%
(Source: Appendix II.14)

Figure: 4.13
Investor’s opinion towards Derivative Market
No. of investors

Investor’s opinion

4.1.13 Promotional Activities

20 brokers including exchanges were requested to mark the promotional tools they
used to promote derivative market in Nepal. Six options were put which were:
advertisement, trade show, awareness campaign, award distribution, press release and
feedback collection. Among 20 brokers including exchanges, 90% of them used
advertisement tools for promotion, 35% of them were involved in trade shows, 65%
of them organized awareness campaign, 20% of them organized award distribution
programs, 35% of them organized press release program and 70% of them collects
feedbacks from the related sectors.
Table: 4. 14
Promotional Activities of Exchange, CM and Broker/TM/NCM
Trade Awareness Award Press Feedback
Activities Advertisement
show campaign release collection
Involvement 18 7 13 4 7 14

63
% out of 20 90% 35% 65% 20% 35% 70%
(Source: Appendix II.15)
Figure: 4.14
Promotional Activities of Exchange, CM and Broker/TM/NCM
Involvement of Broker
& Exchange

Advertisement
Trade show
Awareness
Award distribution
4.1.14 Advertisement Tools Press release
Feedback collection
20 brokers including exchanges were requested to quote the advertisement media they
used for promotion and publicity of derivative market. Three options were put which
Promotional Activities
were: electronic media, paper media and outdoor media. Among 20 brokers including
exchanges, 40% of them used electronic media, 90% of them used paper media and
60% used outdoor media for advertisement. Brokers and exchanges used multi-media
to promote and publicized the market.
Table: 4.15
Advertisement tools used by Exchange and Broker/TM/NCM
Advertisement Electronic media Paper media Outdoor media
Involvement 8 18 12
% out of 20 40% 90% 60%
(Source: Appendix II.16)
Figure: 4.15
Advertisement tools used by Exchange and Broker/TM/NCM
No. of respondents

Media preferred by Brokers & Exchanges

4.1.15 Prefer Contract Size
In order to know the most traded product contract size of investors, 20 brokers
including exchanges were requested to fill up the questionnaire according to their
trading record. Among 20 brokers including exchanges, 25% of them put their views

64
on regular contract size, 45% of them put their views on mini contract size and rest
30% of them put their views on small or nano contract size.
Table: 4.16
Most traded contract size
Contract Size Regular Mini Small/Nano Total
Views of broker & exchange 5 9 6 20
Percentage 25% 45% 30% 100%
(Source: Appendix II.17)
Figure: 4.16
Most traded contract size
No. of respondents

Trading contract size

4.1.16 High Frequency Trading Product (HFTP)

It was requested for clients, NCM and Exchange to rank the HFTP in Nepalese
derivative market. Among 90 respondents, 87 clients responded for Gold, 79 clients
responded for silver, 63 clients responded for crude oil and 50 clients responded for
copper. Out of the respondents, 63 clients gave first priority for gold, 17 clients gave
first priority to silver, 6 clients gave first priority for crude oil and only one clients
gave first priority for copper. From above data, gold is the most traded product and
copper is least traded product among gold, silver, crude oil and copper in Nepal.
Table: 4.17
Investors Priority for Trading Product
Trading Product 1 Priority 2nd Priority 3rd Priority 4th Priority
st
Row Total
Gold 63 15 7 2 87
Silver 17 46 9 7 79
Crude oil 6 12 26 19 63
Copper 1 6 21 22 50
Column Total 87 79 63 50 279
(Source: Appendix II.18)
Figure: 4.17
Investors Priority for Trading Product

65
 No. of respondents

Priority for trading product

4.1.17 Reliability of Information
To know the performance of brokers/NCM/TM and to measure the investor’s
satisfaction level regarding reliable and adequate information provided by them for
trading in derivative assets, medians were calculated independently of these two
sectors. The medians of investors were found satisfactory and getting satisfactory
level of reliable and adequate information from brokers in trading of derivative assets.
While the broker’s median found to be very good and claims that they provides very
good level of reliable and adequate information to investors regarding trading of
derivative assets.

Table: 4.18
Reliability of information provided by NCMs
Sector Very Good Good Average Satisfactory Bad Row Total
Investors 7 27 24 12 0 70
Brokers 1 11 3 0 0 15
Column Total 8 38 27 12 0 85
(Source: Appendix III.1)

Figure: 4.18
Reliability of information provided by NCMs
No. of respondents

Range
4.1.18 Education and Training
To know the performance of brokers/NCMs/TMs regarding education and training
provided to investors about derivative market, medians were calculated independently

66
of these two sectors. The medians of investors and broker’s/NCM’s/TM’s were found
to be very good and average respectively. Investors were getting very good education
and training from brokers/NCMs/CMs while the broker’s/NCM’s/TM’s claimed that
they were providing average level of education and training.
Table: 4.19
Education and Training provided by NCMs
Sector Very Good Good Average Satisfactory Bad Row Total
Investors 12 30 19 8 1 70
Brokers 5 6 2 2 0 15
Column Total 17 36 21 10 1 85
(Source: Appendix III.2)

Figure: 4.19
Education and Training provided by NCMs
(Investors & NCM)
No. of respondents

4.1.19 Bank Service

To know the performance of banks regarding their service provided to derivative
investors, medians were calculated independently of these two sectors. The medians
of investors were found satisfactory and they were getting satisfactory level of service
Range
from banks. While the broker’s/NCM’s/TM’s median found to be average and they
claimed that they were providing average level of bank service to investors.
Table: 4.20
Bank Service
Sector Very Good Good Average Satisfactory Bad Row Total
Investors 5 29 8 12 16 70
Brokers 4 4 3 2 2 15
Column Total 9 33 11 14 18 85
(Source: Appendix III.3)

Figure: 4.20
Bank Service

67
(Investors & NCM)
No. of respondents

4.1.20 Reliability of Report

To know the performance of brokers/NCMs/TMs regarding the reliability of trading
report provided to investors, medians were calculated independently of these two
sectors. The median of both investors and brokers were found satisfactory and both
Range
claims that they were getting and providing satisfactory level of trading report.

Table: 4.21
Reliability of report provided by NCMs
Sector Very Good Good Average Satisfactory Bad Row Total
Investors 5 31 21 10 3 70
Brokers 1 9 4 1 0 15
Column Total 6 40 25 11 3 85
(Source: Appendix III.4)

Figure: 4.21
Reliability of report provided by NCMs
(Investors & NCM)
No. of respondents

4.1.21 Margin Call Update

To what extend the level of satisfaction of investors and brokers/NCMs/TMs/CMs
regarding the margin call in derivative market, their medians were calculated
independently. The medians of investors were found very good and they were getting
Range
very good service regarding margin call from brokers/NCMs/TMs/CMs. While the

68
broker’s/NCM’s/TM’s median found to be average and they claimed that they were
providing average level of service regarding margin call to investors.

Table: 4.22
Margin call update
Sector Very Good Good Average Satisfactory Bad Row Total
Investors 12 27 18 9 4 70
Brokers 5 5 4 0 1 15
Column Total 17 32 22 9 5 85
(Source: Appendix III.5)

Figure: 4.22
Margin call update
(Investors & NCM)
No. of respondents

4.1.22 Liquidity Clearing

To know the performance of brokers/NCMs/TMs and CM regarding the liquidity
clearing, medians were calculated independently of investors and
brokers/NCMs/TMs. The medians of investors were found average and they were
Range
getting average satisfaction level regarding liquidity clearing service from
brokers/NCMs/CMs. And also the broker’s/NCM’s/TM’s median found to be average
and they claimed that they were providing average level of satisfaction regarding
liquidity clearing service to investors.
Table: 4.23
Liquidity clearing
Sector Very Good Good Average Satisfactory Bad Row Total
Investors 21 24 15 9 1 70
Brokers 5 6 3 0 1 15
Column Total 26 30 18 9 2 85
(Source: Appendix III.6)
Figure: 4.23
Liquidity clearing

69
(Investors & NCM)
No. of respondents

Range
4.1.23 Contribution of Derivative Market:
Derivative market contributes in different sectors of Nepalese economy. It generates
employment opportunities, investment opportunities, revenue collection etc. From the
primary data collected, it is come to know that there are approximately 5547 people
directly working in this market where as more people are also indirectly involving in
this market and approximately 31,626 people are trading in this market which means
it can be taken as good investment alternatives.

Nepal government had already collected more than 10 corers rupees as investors’
capital gain tax from 3 major exchanges viz MEX, NDEX & COMEN as on FY
2067/068 which excludes the income tax of Exchanges, Clearing houses,
NCMs/TMs/Brokers and so on with VAT of the products. If there is regulatory body
in Nepal then the government can collect more and more revenue form this market
which definitely contributes in the development of Nepalese Economy.

Table: 4.24
Contribution of Derivative Market
Employment Opportunities
Derivative
Head Clearing NCM/TM/ AE/RU/Sub- Total Clients****
Exchange
Office Office* BM** Broker***
MEX 40 3x13 = 39 82x6 = 492 82x15x1 = 1230 82x126 =10332
NDEX 37 1x13 = 13 78x6 = 468 78x15x1 = 1170 78x126 = 9828
COMEN 25 3x13 = 39 66x6 = 396 66x15x1 = 990 66x126 = 8316
NSE 15 3x13 = 39 15x6 = 90 15x15x1 = 225 15x126 = 1890
WEX 16 1x13 = 13 10x6 = 60 10x15x1 = 150 10x126 = 1260
Total 133 143 1506 3765 31626

70
 (Source: Appendix II.19)
Figure: 4.24
Percentage of employment Contribution of Derivative Market

100% MEX

80% NDEX
& clients

60% COMEN

40% NSE

20% WEX

0%
Head Office Clearing Office NCM/TM/B AE/RU/SB Total Clients

4.2 Testing of Hypothesis

The chi-square test was performed to test whether the attributes or characteristics
(responses, in this case) manifest themselves independently or some related inner. For
Tentative employment at different sector of Exchanges & its clients
testing the independence of two attributes the contingency table of two rows and five
columns had been formulated. The row frequency included the level of response while
the column included the sectors. The responses of different sectors were put in the cell
frequencies while the totals of the frequencies in each of the rows and columns were
put in the marginal frequencies.

4.2.1 Reliability of Information

From the chi-square test it was found that the calculated value of chi-square was less
than the tabulated value of chi-square at five percent level of significance at four
degree of freedom, thus null hypothesis (Ho) was accepted. So, we may conclude that
there is no significant difference between the responses given by two sectors as far as
the adequacy and reliability of information provided by brokers to investors regarding
the derivative market.

4.2.2 Education and Training

From the chi-square test it was found that the calculated value of chi-square was less
than the tabulated value of chi-square at five percent level of significance at four
degree of freedom, thus null hypothesis (Ho) was accepted. So, we may conclude that

71
there is no significant difference between the responses given by two sectors as far as
the education and training provided by NCMs.

4.2.3 Bank Service

From the chi-square test it was found that the calculated value of chi-square was less
than the tabulated value of chi-square at five percent level of significance at four
degree of freedom, thus null hypothesis (Ho) was accepted. So, we may conclude that
there is no significant difference between the responses given by two sectors as far as
the service provided by their related banks.

4.2.4 Reliability of Report

From the chi-square test it was found that the calculated value of chi-square was less
than the tabulated value of chi-square at five percent level of significance at four
degree of freedom, thus null hypothesis (Ho) was accepted. So, we may conclude that
there is no significant difference between the responses given by two sectors as far as
the reliability of trading report provided by NCMs regarding derivative market.

4.2.5 Margin Call Update

From the chi-square test it was found that the calculated value of chi-square was less
than the tabulated value of chi-square at five percent level of significance at four
degree of freedom, thus null hypothesis (Ho) was accepted. So, we may conclude that
there is no significant difference between the responses given by two sectors so far as
the handling of margin call in derivative market.

4.2.6 Liquidity Clearing

From the chi-square test it was found that the calculated value of chi-square was less
than the tabulated value of chi-square at five percent level of significance at four
degree of freedom, thus null hypothesis (Ho) was accepted. So, we may conclude that
there is no significant difference between the responses given by two sectors so far as
the liquidity clearing of the exchanges.

4.3 Suggestions and Comments from Investors

Most of the investors, brokers/NCMs/TMs, CMs, Exchanges and other well-wisher of
derivative market said about the urgent need of regulation regarding derivative market

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in Nepal. Some of them comments on the taxation system, pricing mechanism and fix
exchange rate in this market. Investors said the activities and services of brokers and
other related bodies were not enough in this market regarding the distribution of
information, proper education, awareness campaign, and promotional activities and so
on. That is why the efficiency of derivative market was seriously hampering in Nepal.
So the concerned sectors should take necessary action to correct these
inconveniencies in derivative market.

4.4 Study Results

From the field survey and statistical analysis of collected data, the major findings of
the present study are briefly summarized as follows:
i. It was found from the data acquired by questionnaire that average years of
investor’s involvement in investing in derivative market were found to be 1.76
years which is regarded as an early stage of the market.
ii. The qualification of investors involved in derivative market were found as
8.57 percent up to SLC, 12.86 percent of intermediate level, 55.71 percent of
bachelor level and 22.86 percent of master level.
iii. Profession of investors were found as 17.14 percent from service sector, 64.29
percent from business sector, 15.71 percent from students, 1.43 percent from
agriculture sector and rest 1.43 percent from other sectors.
iv. The average investment amount of investors in derivative market was found to
be Rs.141429.
v. Most of the investors opened their account in one Exchange such as MEX and
NDEX for futures and NSE for spot whereas some investors have opened
multi accounts in multi exchanges.
vi. Most of the investors were found as intraday traders and scalpers while few of
them are position traders.
vii. It was found that 84.44% of the investors including brokers used GCI software
as reference softwares and some of them also used CME Eqoutes, Futures
Pros, Track N Trade and other reference softwares.
viii. Kitco, Oil N Gold and Forex Factory were found as commonly used websites.
Beside that Market watch, Bloomberg & other websites were also in use.

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 ix. The purpose of investment of the investors in derivative market were found to
be 68.57 percent for capital gain, 14.29 percent for portfolio investment, 10
percent for use of access money and 7.14 percent for risk reduction.
x. In comparison to the wide array of services most of the investors are getting
both trading and information services (72.86 percent), while few (7.14
percent) are getting other services also.
xi. It was found that more than 65 percent of the investors were in loss while only
below 20 percent of investors were in profit.
xii. It was found that most of the Nepalese investors were risk seeker. 61.43
percent investors takes derivative as speculation, 22.86 percent takes as
gambling and only 15.71 percent takes as hedging.
xiii. It was found that most of the Exchanges, CMs and NCMs spend promotional
budget in advertisement, awareness campaign and feedback collection while
few of them also spends on trade shows, award distribution, press release.
xiv. Most of the exchanges and their related sectors used paper media (i.e. 90
percent) for advertisement but low electronic and outdoor media.
xv. Most of the investor’s preferred product contract size was found as mini size
while few investors preferred regular size.
xvi. It was found that high frequency trading products were serially gold, silver,
crude oil and copper among the derivative products available for trading in
Nepal.
xvii. The median value of investors and brokers regarding adequacy and reliability
of information was found satisfactory and very good. The Chi-square test
showed that there was no any significant difference between the views of two
sectors regarding reliable and adequate information provided by brokers.
xviii. It was found from the data collected from the questionnaire that the median
value of investors and brokers regarding education and training was very good
and average. The Chi-square test showed that there was no any significant
difference between the views of two sectors regarding education and training
provided by brokers.
xix. The median value of investors and brokers regarding bank service was found
satisfactory and average. The Chi-square test showed that there was no any
significant difference between the views of two sectors regarding education
and training provided by brokers.

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 xx. It was found from the data collected from the questionnaire that the median
value of both investors and brokers regarding reliability of report was
satisfactory. The Chi-square test showed that there was no any significant
difference between the views of two sectors regarding reliability of report
provided by brokers.
xxi. The median value of investors and brokers regarding margin call was found
very good and average. The Chi-square test showed that there was no any
significant difference between the views of two sectors regarding education
and training provided by brokers.
xxii. It was found from the data collected from the questionnaire that the median
value of both investors and brokers regarding liquidity clearing was found
average. The Chi-square test showed that there was no any significant
difference between the views of two sectors regarding education and training
provided by brokers.
xxiii. It was found that approximately 5,547 employees were directly involved in
Derivative Exchanges and approximately 31,626 investors were investing in
this market as a good way of investment alternatives. And these exchanges
paid more than 10 corers rupees as investors’ capital gain tax to government.

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 CHAPTER – V
SUMMARY, CONCLUSIONS AND
RECOMMENDATIONS
5.1 Summary
It is very important to know weather the Nepalese Derivative market is serving an
important contribution to the development of different sectors of Nepalese economy
or not. Derivative market in Nepal is in initial stage and taken as a good way for
investment alternatives for the investors from all background. In this record, the study
has been based upon the objective to study about the Derivative Market.

This thesis deals with the study of Derivative Market in Nepal. It tries to know
weather the derivative Market operating in Nepal in order to take as an investment
alternative or not. This study gives emphasis on finding out the contribution,
performance and effectiveness of Derivative Market in Nepal with the opinion of
investors, brokers and exchange companies. Though this study is mostly based upon
primary data, various published materials are taken as secondary data as well. A
schedule of questionnaire has been used to collect the opinions of respondents. It has
distributed to three distinct groups of respondents i.e., Derivative Exchanges,
Derivative Brokers and Derivative investors. Total 150 sets of questionnaires were
distributed, among them 90 respondents returned the questionnaire.

The data acquired from different sources have been processed by various statistical
methods such as percentage, range, mean, median, chi-square test to achieve and
fulfill the objectives of the study.

In this way, this study has been completed with fulfillment of stated objectives.

5.2 Conclusions
1. In today’s unstable global financial market, traders and investors are
seeking for innovative investment alternatives for diversifying their portfolio.
Derivative market provides wide range of investment alternatives for Nepalese
investors. Nepalese derivatives market is still in a nascent stage of
development but offers tremendous growth potential.

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 2. Derivatives Exchanges of Nepal contributes in various sectors of
Nepalese economy. It provides different opportunities to the general people as
well as the government such as creating employment opportunities, investment
opportunities, and revenue collection through TDS and so on.
3. The performance of Derivative Exchanges and its related bodies seems
light in Nepal. They were promoting their market on person to person basis
but not involving in mass promotion. Trade shows, Mass media advertisement,
Awareness campaigns, research and development works are very necessary for
the growth of the market. They could not able to draw the attention to the
potential investors as derivative Market is one of the best and emerging
investment alternative in Nepal for their growth. However, they are working
hard to get the better result in near future.
4. The effectiveness of brokering service helps to increase investors as
well as trade volume. It also helps to retain the investors in the market. Most
of the investors investing in this market are of speculative nature and they are
losing from the market after capital loss saying the market as gamble.
5. Current taxation provision of the Nepalese government towards
Derivative market is not practical and does not exist anywhere else in the
world. Despite of unfair taxation system, Derivative Exchanges operating in
Nepal have paid more than 10 corers rupees as investors’ capital gain tax.
6. Derivative Exchanges in Nepal are operating in self regulation. Though
everyone directly or indirectly involving in this market urge for the
government regulation, there is no regulation system and regulatory bodies
yet. So, the government regulation is one of the major requirement for the
development of Derivative Market in Nepal.

5.3 Recommendations
The following recommendations are made to the different sectors to derivative
practice in Nepal:
1. Though commodity market in Nepal is growing at a rapid pace, the major
hurdle in its expansion is the absence of regulatory body for its proper
regulation. However, SEBON is initiatives to regulate this with the help of
existing exchanges. But the situation in other countries is different, because a
separate entity is set up for regulating and monitoring the commodity market.

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 As for Nepal, commodity market is like an orphan, which seriously needs a
guardian to look after. Traders, investors and exchanges are eagerly waiting
for a proper regulatory body to be established, so that commodity market can
become a major contributing sector in Nepalese economy.
2. People in Nepal, simply invest in Derivative Market because they have very
little alternatives for investment. They are not well aware of the fact that
investing in this market involves high risks. The rationality of Nepalese
investors was found to be at low level. They have very low knowledge of the
trading procedure. So, the concerned bodies should feel more responsible to
provide proper education and well training, sufficient and reliable information.
3. Brokers should open their offices in the place easily accessible to the present
and potential investors as it was seen during the observation period that almost
all of the brokerage offices are not opened in accessible place. They should
also focus in other activities apart from trading in this market.
4. The derivative market lacks the existence of rational investors. So, it is
recommended to the regulatory bodies to carry out programs using various
media and spot program to inform and attract the potential investors, both
individual and institutional.
5. The investors who live out of valley could not complain their grievances to the
concerned authorities because of the span of time and distance. So, exchanges
should increase its information dissemination activities to meet the
expectations of investors of different parts of the country so that the
involvement of the investors out of the Katmandu valley could be increased.
6. The pace of economic development should be accelerated in order to have its
positive impact on the development of derivative market.

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Surendran, Jitesh (2010). Gaining Confidence from the Market. MEX Year Book.
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Independent Researches:
Curtis, Glenn (2011). The Izmportance of Trading Psychology and Discipline. New
York: Prentice Hill.
Kuprianov,Anatoni (2009). ISDA Derivatives Usage Survey. Newyork: International
Swaps and Derivatives Association.

Websites:
http://www.investopedia.com 21th December 2011
http://www.investorwords.com 21th December 2011
http://www.babypips.com 21th December 2011
http://www.elliottwave.com 21th December 2011
Http://www.mexnepal.com 24th Janaury 2012
Http://www.comen.com.np 24th Janaury 2012
Http://www.ndex.com.np 24th Janaury 2012
http://www.wexnepal.com 24th Janaury 2012
http://www.nsenepal.com 24th Janaury 2012
http://www.isda.org 15th March 2012
http://sebon.gov.np 24th Aug 2012

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