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MALAYSIA DERIVATIVES EXCHANGE BHD. Introduction to Derivatives

MALAYSIA DERIVATIVES EXCHANGE BHD. Introduction to Derivatives. Presented by Dr. Zaha Rina Zahari. 6 September 2001. Historical Note. 1980 Establishment of the Kuala Lumpur Commodity Exchange (KLCE) with CPO Futures

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MALAYSIA DERIVATIVES EXCHANGE BHD. Introduction to Derivatives

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  1. MALAYSIA DERIVATIVES EXCHANGE BHD.Introduction to Derivatives Presented by Dr. Zaha Rina Zahari 6 September 2001

  2. Historical Note 1980 Establishment of the Kuala Lumpur Commodity Exchange (KLCE) with CPO Futures 1995 KLSE CI Futures contract launched on The Kuala Lumpur Options and Financial Futures Exchange (KLOFFE) 1996 Malaysia Monetary Exchange (MME) introduced the three-month KLIBOR Futures 1998 KLCE merged with MME to form COMMEX Malaysia 2001 KLSE CI Options contract was launched on KLOFFE 2001 Birth of MDEX -Merger of KLOFFE & COMMEX Introduction to Derivatives (6 September 2001) - 1

  3. KLSE Group of Companies Introduction to Derivatives (6 September 2001) - 2

  4. Regulatory Framework Introduction to Derivatives (6 September 2001) - 3

  5. Market Structure CORPORATETrading Member, Associate MemberFutures Broker RepresentativeClient INDIVIDUALLocal Introduction to Derivatives (6 September 2001) - 4

  6. Trading Member or Futures Broker can trade in futures and options contracts both for themselves and on behalf of their clients. The person who directly deals with the client in a futures broking company is a futures broker representative (FBR). A FBR essentially acts on behalf of a futures broker in connection with the broking business. A futures broker & its representatives must be licensed by the SC Trading Members Introduction to Derivatives (6 September 2001) - 5

  7. Local membership is only open to individuals who want to trade on their own behalf. Local Members have access only to the trading facility of MDEX. They do not have access to the clearing facility. Local Membership is not governed by the FIA and therefore, Local Members need not be licensed. Local Members Introduction to Derivatives (6 September 2001) - 6

  8. A derivative is a financial instrument whose value depends on the values of other, more basic underlying variables. Examples of derivatives are futures, options, swaps, forward. FX Forward Crude Palm Oil Futures KLSE CI Options Interest Rate Swaps What is Derivatives ? Introduction to Derivatives (6 September 2001) - 7

  9. An agreement in which an asset is purchased or sold at a price, delivery, and settlement set for a specified future date Example : Currency (FX) forward Credit, default and settlement risk involved What is a forward contract? Introduction to Derivatives (6 September 2001) - 8

  10. A futures contract fixes the price and conditions now for a transaction that will take place in the future. What is a futures contract? Introduction to Derivatives (6 September 2001) - 9

  11. Producers of Palm Oil need to lock in the selling price of their product now instead of waiting for harvest time when the price may drop. Manufacturers of cooking oil / margarine need to lock in the purchase price of palm oil now instead of waiting for harvest time when the price may rise Examples of commodity futures usage Introduction to Derivatives (6 September 2001) - 10

  12. Where the asset to be delivered in the future is a financial instrument rather than a commodity Financial instruments may be bonds, shares, indices or currency notes What are financial futures? Introduction to Derivatives (6 September 2001) - 11

  13. Insurance Companies need to lock in interest rate now instead of waiting for the insurance premium to be collected when the interest rate may drop. Hence, Long KLIBOR Futures Commercial Banks need to lock in the interest rate now instead of waiting to borrow out when the interest rate may rise Hence, Short KLIBOR Futures Examples of financial futures usage Introduction to Derivatives (6 September 2001) - 12

  14. A futures contract where the deliverable asset is the basket of stocks that make up a stock index So you can trade an ENTIRE MARKET What are stock index futures? Introduction to Derivatives (6 September 2001) - 13

  15. An option is a formal contract which gives the holder the right, without the obligation, to purchase or sella certain quantity of an underlying instrument at a stipulated price within a specific period of time. What is an option ? Introduction to Derivatives (6 September 2001) - 14

  16. Two types of options 1. Call Option 2. Put Option Types of Options Introduction to Derivatives (6 September 2001) - 15

  17. A Call option gives the holder the right, to purchase the underlying instrument at a stipulated exercise price at expiration Example "KLSE CI September 700 Call" gives the holder an option to purchase (if he exercised his options) the KLSE CI at 700 index points at expiration in September. The writer must sell the index to the holder at 700 index points. Call Option Introduction to Derivatives (6 September 2001) - 16

  18. Index =700 X1 = 680 (In-the-money), Premium = 24 X2 = 700 (At-the-money), Premium = 12 X3 = 720 (Out-of-the-money), Premium = 2 Therefore, investors are trading on the premium Call Option Premium Quotation Introduction to Derivatives (6 September 2001) - 17

  19. A Put option gives the holder the right, but not the obligation, to sell the underlying instrument at the stipulated exercise price at expiration. Example "KLSE CI September 700 Put" gives the holder an option to sell (if he exercised his options) the KLSE CI at 700 index points at expiration in September. The writer must buy the index from the holder at 700 index points. Put Option Introduction to Derivatives (6 September 2001) - 18

  20. Index =700 X1 = 680 (Out-of-the-money), Premium = 4 X2 = 700 (At-the-money), Premium = 12 X3 = 720 (In-the-money), Premium = 26 Therefore, investors are trading on the premium Put Option Premium Quotation Introduction to Derivatives (6 September 2001) - 19

  21. TRADING MEMBER Make order by Phone/Fax KATS Trading Terminal MDEX - KATS Options/Futures Dealer Orders Order entry Order Confirmation Online Trade Confirmation Order Slip Printed Trade Confirmation INVESTOR Trades Time stamp order slip MDCH (DCS - Derivatives Clearing system) Trading Process • KATS: • Timestamps order • Electronic Matching • Registers Trades Introduction to Derivatives (6 September 2001) - 20 Overview of KLOFFE (30 April 2001) - 8

  22. Bullish View Buy Futures Buy Call Options Sell Put Options Bearish View(short sell is legalized under the FIA 1993) Sell Futures Sell Call Options Buy Put Options Volatility trading (regardless of the market direction) Sell Call Options and Sell Put option when market is quiet Buy Call Options and Buy Put Options when market is volatile 3-Dimensional Trading Introduction to Derivatives (6 September 2001) - 21

  23. Trade Interest Risk Transfer - Hedging Arbitrage Portfolio Enhancement Portfolio Management Speculative Interest Trading Flexibility Introduction to Derivatives (6 September 2001) - 22

  24. To protect portfolio during turbulent market condition To ensure consistent return in portfolio management NOT about making money The Needs of Hedging Introduction to Derivatives (6 September 2001) - 23

  25. Margins are not down payments for the contracts. They are a form of 'good faith' deposit This sum of money is often referred to as the 'Initial Margin' Where the margin deposited by the trader is insufficient to settle the cash difference, the trader will have to pay the additional amount required. This is known as “Variation Margin” However, as long as the position is open (not closed out), the margin required must be maintained at all times. Margins Introduction to Derivatives (6 September 2001) - 24

  26. The brokers may however, require their clients to deposit a higher initial margin. The contract is for a transaction at a later date, therefore you do not have to pay the entire contract value now Initial Margin Introduction to Derivatives (6 September 2001) - 25

  27. Marked-to-market means that the positions that a trader holds are re-valued according to the most current market prices. For daily marking-to-market, the closing price (normally the last-traded price) of the contract is used 'Variation Margin' is to be settled daily based on the daily 'marked-to-market' value of the futures trades. Marked-to-market & Variation Margins Introduction to Derivatives (6 September 2001) - 26

  28. MDEX Products • KLSE CI Futures contract • KLSE CI Options contract • Crude Palm Oil Futures contract • Three-month KLIBOR Futures contract Introduction to Derivatives (6 September 2001) - 27 Overview of KLOFFE (30 April 2001) - 8

  29. Underlying SecurityKuala Lumpur Stock Exchange Composite Index Contract SizeFKLI X RM100.00 Minimum Price Fluctuation0.1 index point Trading Hours08.45 hours to 12:45 hours and 14:30 hours to 17:15 hours Final Trading DayThe last business day of the contract month Final Settlement DayThe business day following the Final Trading Day Final Settlement ValueThe average value rounded upwards or downwards to one decimal point, 0.05 being rounded upwards, of the Kuala Lumpur Composite Index for the last half hour of trading on the Kuala Lumpur Stock Exchange on the Final Trading Day excepting the highest and lowest values. KLSE Composite Index Futures Contract Specifications Introduction to Derivatives (6 September 2001) - 28

  30. KLSE Composite Index Options Contract Specifications • Underlying SecurityKuala Lumpur Stock Exchange Composite Index • Contract Code • Calls: C OKLI Puts:P OKLI • Contract SizeOKLI Exercise Price X RM100.00 • Minimum Price Fluctuation0.1 index point • Trading Hours08.45 hours to 12:45 hours and 14:30 hours to 17:15 hours • Final Trading DayThe last business day of the contract month • Final Settlement DayThe business day following the Final Trading Day • Final Settlement ValueThe average value rounded upwards or downwards to one decimal point, 0.05 being rounded upwards, of the Kuala Lumpur Composite Index for the last half hour of trading on the Kuala Lumpur Stock Exchange on the Final Trading Day excepting the highest and lowest values. Introduction to Derivatives (6 September 2001) - 29

  31. Crude Palm Oil Futures Contract Specifications • Underlying SecurityCrude Palm Oil • Contract Size25 Metric tons • Minimum Price FluctuationRM1.00 per metric tons • Trading Hours10:30 hours to 12:30 hours and 15:00 hours to 18:00 hours • Final Trading DayA contract month expires at noon on the 15th day of the month or, if the 15th is a non-market day, the preceding business day. • Deliverable Unit25 metric tons, +/- not more than 2% Settlement of weight differences shall be based on the simple average of Daily Settlement Prices of the delivery month from: a. 1st business day of the delivery month to the day of tender if tender is made before the last trading day of the delivery month b. 1st business day of the month to the business day immediately preceding the last day of trading if the tender is made on the last trading day and thereafter Introduction to Derivatives (6 September 2001) - 30

  32. Three-month KLIBOR Futures Futures Contract Specifications • Underlying SecurityThree Month Kuala Lumpur Interbank Offered Rate • Contract SizeRM 1,000,000 • Minimum Price FluctuationRM 25.00 • Price Quotationin index term: Price = 100 - implied yield (2 decimal points) • Trading Hours9:30 hours to 12:30 hours and 14:30 hours to 17:00 hours • Final Trading Day11:00am on 3rd Wednesday of the contract month • Final Settlement Cash settlement based on Final Settlement Value • Settlement by Clearing House (MDCH) at the cash settlement index (100 - cash settlement rate) Introduction to Derivatives (6 September 2001) - 31

  33. Development of MDEX Products • MGS Bond Futures • Individual Shares Futures • Islamic Index Futures • USD Denominated CPO Futures • Capitalised Index Derivatives • Other Commodity Derivatives • Strategic Alliances Introduction to Derivatives (6 September 2001) - 32 Overview of KLOFFE (30 April 2001) - 8

  34. Trading Performance Introduction to Derivatives (6 September 2001) - 33

  35. Trading Performance Introduction to Derivatives (6 September 2001) - 34

  36. Trading Performance Introduction to Derivatives (6 September 2001) - 35

  37. Market Demography Introduction to Derivatives (6 September 2001) - 36

  38. Market Demography Introduction to Derivatives (6 September 2001) - 37

  39. Market Demography *Others include Proprietary Account, Local Individual and Local Corporations ** Market Maker Scheme discontinued in Aug-98, reinstated in Aug-99 and discontinued in Apr-01 Introduction to Derivatives (6 September 2001) - 38

  40. Summary • Overview of the Derivatives Market • Advantage of trading derivatives • Flexible trading environment • Hedging ability • Can be used in all three market conditions • Derivatives Products listed at MDEX • Development of MDEX products Introduction to Derivatives (6 September 2001) - 39

  41. Thank You http://www.mdex.com.my Introduction to Derivatives (6 September 2001) - 40

  42. Question & Answer Introduction to Derivatives (6 September 2001) - 41

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