derivatives instrument and nepal

Derivative Instruments and

Nepal

Kalpana K.C.Nitesh Khatiwada

Soni SahaniSeminar in Financial System in Nepal

Master of Business ManagementNepal Commerce Campus

Kathmandu

Good Morning!!

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Derivative Instruments

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“A security or contract designed in such a way that its

price is derived from the price of an underlying asset.

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Understanding Derivative Instruments

Consider that if your college reimburses 100%

of costs for an “A”, 75% of costs for a “B”, 50%

for a “C” and 0% for anything less.

Your “right” to claim this reimbursement, then is

tied to the grade you earn. The value of that

reimbursement plan, therefore, is derived from

the grade you earn.

A video: Understanding Derivatives

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Can be created by mutual agreement - types of

derivative products are limited only by

imagination and so there is no definitive list of

derivative products.

Types:

Options

Swaps

Warrants

Futures

Forwards6


In creating a financial derivative, the means for,

basis of, and rate of payment are specified

Payment may be in currency, securities,

physical entity such as gold or silver,

agricultural product such as wheat or pork, a

transitory (short lived) commodity such as

communication bandwidth or energy

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The amount of payment may be tied to

movement of interest rates, stock indexes, or

foreign currency

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Featured of Derivative

Instruments9

Features

Relates to the future contract between two parties

Value derived from underlying assets

Counter parties have specific obligation under the

derivative contract

Undertaken directly between two parties or

through the particular exchange

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Features

Underlying transactions are mostly settled by

taking offsetting positions

Mostly secondary market instruments, have little

usefulness in mobilization of fresh capital

Standardized exchange traded as well as

customized, OTC traded

Off-balance sheet item

Types of Traders

Hedgers

Use derivatives to reduce the risk that they face from potential

future movements in a market variable

Speculators

Use derivatives to bet on the future direction of a market

variable

Arbitrageurs

Take offsetting positions in two or more instruments to lock in

a profit 12

Critique of Derivatives

Speculative and gambling motives

Increase in risk

Instability of the financial system

Price instability

Displacement effect

Increased regulatory burden

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Derivative Exchanges

A derivative exchange is a market where

individuals trade standardized contracts that have

been defined by the exchange

The CBOT was established in 1848 to bring

farmers and merchants together

A rival futures exchange CME was established in

1919

CBOE started trading call option contracts on 16

stocks in 197314

OTC Market

The over the counter market is a telephone and

computer linked network of dealers who do not

physically meet.

Trading is done over the telephone.

Usually between two financial institutions (FIs) or

between a FI and its clients

FIs often act as a market maker for more

commonly traded instruments15

OTC Market

Telephone conversations in the OTC are usually

taped.

OTC trades are much larger than the exchange

traded market.

Market participants are free to negotiate any

mutually attractive deal.

Usually some credit risk is involved

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Myths about Derivatives

Derivatives are new, complex, high-tech

financial products created by Wall Street’s

rocket scientists.

Derivatives are purely speculative, highly

leveraged instrument.

The enormous size of the financial derivatives

market dwarfs bank capital, thereby making

derivatives trading an unsafe and unsound

banking practice.17

Myths about Derivatives

Only large multinational corporations and large

banks have a purpose for using derivatives.

Derivatives take money out of productive

processes and never put anything back.

Only risk seeking organizations should use

derivatives.

The risk associated with financial derivatives

are new and unknown18

Derivative Instruments

in Nepal19

Derivative Market in Nepal

• Est: 14 August, 2007

• Location: Dillibazar, Kathmandu

• Website: http://www.mexnepal.com/

Mercantile Exchange Nepal

Limited(MEX)

• Est: 20 November, 2008

• Location: Tinkune, Kathmandu

• Website: http://ndex.com.np/

Nepal Derivative Exchange

Limited(NDEX)

• Location: Tripureshwor, Kathmandu

• Website: http://www.wexnepal.com/

Wealth Exchange Limited (WEX)

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• Location: Putalisadak, Kathmandu

• Website: http://www.ezonenepal.com

E-zone Commodities

Market Pvt. Ltd

• Est: 7 June, 2007

• Website: http://www.nationalspotexchange.com/

National Spot Exchange

Limited(NSX)

• Website: http://wellnepal.com/organization/cfx-commodities-futures-exchange-pvt-ltd/

Commodity Future Exchange Nepal

Limited(CFX)

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Others

Axis Broking Solution Pvt Ltd

Nepal Spot Exchange

Commodities & Metal Exchange Nepal Ltd.

Himalayan Commodity Brokers Pvt. Ltd.

Kathmandu Commodity Exchange (P) Ltd.

Asia Commodities and Securities Pvt. Ltd.

Birat Commodity Market Pvt . Pld.

Easy Commodities Investment Pvt. Ltd. (ECI)

Himalayan Commodity Brokers Pvt. Ltd.

South Asia Commodities and Brokerage Pvt. Ltd.

Standard Commodities Pvt. Ltd.22


Instruments Traded in Nepal

Future

Forward

SWAPS

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Forward

Contract that gives the buyer and the seller the right

and the obligation to buy a specified asset on a

specified date at a specified price

Ownership of good is transferred and payment is

made

Traded Over the counter

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Future

Contract that gives the buyer and the seller the right

and the obligation to buy a specified asset on a

specified date at a specified price

No physical delivery of goods

Traded on organized exchange

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SWAPS

Practice seen in Banking Industry

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Challenges of Derivative Market in Nepal

Lack of sufficient penetration of internet in

urban areas

computer literacy with minimum number of

people

traditional method of agro-economy

non-commercialized agro production sector

lower literacy rate

Financial Literacy of educated people27

Challenges of Derivative Market in Nepal

Other challenges:

Contract sizes at international markets that can be too

large for developing country requirements.

Exchange rate controls or risk

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Prospect of Derivative Market in Nepal

Fluctuating Exchange Rate

Huge loss in agro products due to natural

calamities

Predicting future price

SWAP income flows

Devised to mitigate risk

Employment

Market for local commodity29

“Developing Derivative Market in

Nepal

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1🔑

Creating Derivative Market

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Creating Derivatives Market

Legal

Environment• Does and

Don'ts

Regulatory

Environment• Regulatory

Bodies

Economic

Environment• Interest Rates

• Taxes

• Inflation

• Market Size

• Suppliers

3

Political

Environment• Monetory Policy

• Fiscal Policy

1 2 4

2🔑

Creating Derivative Contract

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Creating

Derivatives

Contract

Large Spot Market

Maturity of Spot Market

Existance and

Involvement of Dealer

Community

3🔑

Creating Successful Derivative

Contract

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Creating Successful Derivative Contract

Exchange

Perseverance

Derivative

Market

Environment

Well Designed

Contract

Quotes for illustration purposes only

Creating Derivative Markets

Other Considerations

High level of investor’s sophistication and awareness

Information Symmetry

Availability of local commodity in large scale

Adequate risk management knowledge and practice

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Conclusions

There was considerable enthusiasm in the field

Speculative use of derivatives with intent to

earn more in a short span of time can de-

stabilize the financial market and ultimately

pose a real threat to financial stability

Considered as complex

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Conclusions

Unethical practices, manipulation of the real

rates

Potential for miscalculation, misuse and

unawareness had led to some highly publicized

losses has driven the sentiments of the public

against

Decreasing attraction

The misuse, compromised and speculative use

of derivatives39

References

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David Siegel. (2016, June 23). Derivative. Retrieved from Investopedia:

http://www.investopedia.com/terms/d/derivative.asp?layout=infini&v=5E&orig=1&adtest=5

E

Hull, J. C., & Basu, S. (2011). Options, Futures and Other Derivatives. Delhi: PEARSON.

Mahat, M. (2011). New Financial Products and Challenges for Central Bank: Nepal. 174-206.

Risal, N. (2016). Capital Market. Financial System in Nepal. Kathmandu: Nepal Commerce Campus.

Shrestha, R. (2010). Why to Invest in Derivative Market? New Business Age.

Sigdel, S. N. (2012). Basics of Derivatives. Options, Futures and Derivatives. Kathmandu: Apex

College.

Weber, E. J. (2008). A Short History of Derivative Security Markets. Economics.

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