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DERIVATIVES
MARKET
Objectives
Introduction
by far the most significant event in finance
during the past two decades has been the
extraordinary development and expansion of
financial derivatives.
These instruments
enhance the ability to differentiate risk and
allocate it to those investors most able and
willing to take it a process that has
undoubtedly improved national productivity
growth and standards of living.
(Alan Greenspan)
Introduction
Introduction
Derivatives are instruments created to
minimize risk
Their value are derived from something
From an asset
Example: share prices, prices of commodity,
Introduction
Definition:
Derivative instruments are simply financial
Participants in Derivative
markets
Question
History of Derivatives
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History of Derivatives
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Products (http://www.klse.com.my/website/bm/derivatives/products/)
BMD has the following products available to be traded on the CME Globex electronic trading
platform
Commodity Derivatives
Crude Palm Oil Futures (FCPO)
USD Crude Palm Oil Futures (FUPO)
Crude Palm Kernel Oil Futures (FPKO)
Equity Derivatives
FTSE Bursa Malaysia KLCI Futures (FKLI)
FTSE Bursa Malaysia KLCI Options (OKLI)
Single Stock Futures (SSFs)
Financial Derivatives
3 Month Kuala Lumpur Interbank Offered Rate Futures (FKB3)
3-Year Malaysian Government Securities Futures (FMG3)
5-Year Malaysian Government Securities Futures (FMG5)
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Questions
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Basic Terminologies
Forward Contract
A contract between two parties agreeing to carry
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For Example:
Futures Contract
To overcome 3 problems of forward contracts:
1. Multiple coincidence needs
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Futures contract
An exchange-traded form of forward contract
A commitment to buy or sell an underlying asset at a future
date
Contracts are standardized
Except for price - quantity, quality of the underlying asset,
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Hedging
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market
Try to make profit. Example: buy futures at a
low price, then sell it at a high price
An important role: provide the depth and
volume of trading that allows hedgers and
others to enter or exit the market easily
Provide liquidity and continuous trading
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2. Day traders
Do intraday trading and on small volumes of trade
3. Position traders
Look for long-term price trends and may hold on
their position over weeks, or months
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Options derivatives
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Some Terminologies
Options derivatives
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Options derivatives
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Options derivatives
Advantages of options:
Limited risk (applicable to buyers only)
Option sellers have unlimited risk similar to
future holders
Flexibility
Standard options provide flexibility to trade
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Options derivatives
Exchange-traded options
Originate and traded on a formal exchange
Most commonly are equity options
Traded using electronic trading systems
Settled through a clearing house (MDCH)
Novation
A process whereby it connects the two contracting parties
Over-the-counter options
Not traded through a formal exchange
Arrange deals through telephone or on face-to-face meetings
Able to negotiate as to quantity, quality maturity and delivery
Higher credit risk
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Classification of
Derivatives
Future Contracts
Forward Contracts
Options
Swaps
OTC
Exchange Traded
RM Interest Rate
Derivatives
Forward Rate
agreements, Interest
rate Swaps
Foreign Currency
Derivatives
Forwards, Swaps,
Options
Currency Futures
Equity Derivatives
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Uses of Options
1.
3.
Uses of Options
4.
Types of Options
Call Option
A call option gives the option buyer the right (but not the
obligation) to buy a specified asset at a specified price at
or before a specified date.
When the option buyer exercises the right, the option
seller is obliged to sell the asset to the option buyer.
Put Option
A put option gives the option buyer the right (but not the
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Underlying assets
Shares, an index, a particular futures
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as out-of-money?
For out-of-money, the option will not be exercised.
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date
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Premium
Cost or the price of an option
The price that the option buyer pays to the
option seller
Premiums are quoted as index points to one
decimal place
Example: 1 point for RM100, 0.1 for RM10. If the
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immediate exercise
Intrinsic value equals the amount where option is in-the-money
The option of at-the-money and out-of-money has zero
intrinsic value
Call intrinsic value and put intrinsic value?
Time value refers to the value that arises from the
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Swaps
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Swaps
Example:
Let say Fair Ltd borrows RM50 million at a floating
Swaps
Illustration of an Interest Rate Swap to
Reconfigure Bond Payments
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Swaps
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Spot
0
3 months
Forward
Futures
0
3 month
buyer pays forward
price, seller delivered bonds
month