EXPLORING DEVELOPMENT OF

FINANCIAL DERIVATIVE IN
PAKISTAN


Prepared By

SAIFULLAH : Roll No. 8309
afzaal : Roll No. 8306
Mazhar bajwa : Roll No. 8318
Zuhaib : Roll No.8292
Discussion member saifullah
Karachi Stock Exchange (KSE) shows a better
growth rate in financial derivatives but KSE
also faces high degree of volatility


history
Royal exchange of London is first and modern market
which permits the use of derivative

In beginning derivatives used mostly for commodities but
with the passage of time it focus on financial derivative that
may be cash settle or offset though taking different position
In 1637 first forward agreement was made.

The first "futures" contracts are generally tread
to the rice market in Osaka, Japan around 1650.

The history of U. S. futures markets, was the creation of the
Chicago Board of Trade in 1848

Derivative
It is an financial instrument which value is
derived from some underlying assets
Example:
you can enter into an agreement with a
friend. Whose says that, I will pay to you $100 if
shahid afridi scored 40 runs in 30 balls in a t20
match .
Otherwise you have to pay me
This is derivative b/c value(100) depend upon
score
Types of derivative
There are 3 types of derivatives
Option
forward / future
Swap
Option
Right to buy & sell the security
transaction upon the discretion of buyer
Premium have to be paid
Trade over the counter (OTC)
Premium is minimum amount as contract size
amount
Most of the option is traded on over the market but
now a day the trend of option traded
on stock exchanges is increasing.




Continue..
There is two types of option
Call option: give the right to buyer to buy
underlying assets
Put option: gives the right to seller to sell the
underlying assets


forward / future
contract to buy & sell the security
Both parties have to honor their contract even
one party face sever loss.
Trade in organized exchange
It is zero sum game, means the gain of one
party is the exact loss of other party



Continue
Short position: commitment to sell a product or instrument
Long position: commitment to buy a product or instrument
Selling short: to sell a security even you have not purchased
it (selling of borrowed)
Short selling is also allowed in standardized and regulated
derivatives
You have to maintain a margin account in future exchange
The a/c is credited if you gain & debited if you face loss
if your margin account needs some
liquidity then you must have to reimburse that amount in
your account.


Continue
Mark to market concept is prevailing in KSE100
profit and loss recognition is done on daily basis

gain may be withdrawn and loss must be
reimburse




Distinct between forward & future
contract
forward
customized
No guarantee
Marked to market only on
settlement date
More risky
OTC
no cash flows until delivery
future
Standardized
guaranteed by clearing
house
Marked to market daily
Less risky
Organized exchange
margin requirements
swap
Simultaneously buying & selling the securities

Continue..
There are major 2 types of swap
Cross currency swap
Interest rate swap
Cross currency swaps CCS
An agreement between two parties to
exchange interest payments and principal on
loans denominated in two different
currencies. In a cross currency swap, a loan's
interest payments and principal in one
currency would be exchanged for an equally
valued loan and interest payments in a
different currency
Interest rate swap
An agreement between two parties (known as
counterparties) where one stream of future
interest payments is exchanged for another based
on a specified principal amount. Interest rate
swaps often exchange a fixed payment for a
floating payment that is linked to an interest rate
(most often the LIBOR). A company will typically
use interest rate swaps to limit or manage
exposure to fluctuations in interest rates, or to
obtain a marginally lower interest rate than it
would have been able to get without the swap
Swaption (Swap Option)
There is no obligation to enter into a specified
swap agreement with the issuer on a specified
future date

Swap option
Call Swaption
A type of option between
two parties that can be
exercised on a swap where
the buyer of the swap has
the right, but not obligation
to, receive an agreed upon
fixed interest rate
Put Swaption
An option on an interest
rate swap that gives the
option buyer the right to
pay a fixed rate of interest,
and receive a floating rate
of interest from the option
seller / swap counterparty
EVOLUTION OF DERIVATIVE
Evolution of derivative according to regulation
Forward------ Futures ------- options -------
Swaps


KEY PLAYER OF DERIVATIVE
MARKET
Hedgers
Hedger is that person who avoid from price
fluctuation


Speculator
By using the own expertise they earn profit
Example:
if the speculator estimate that price of
a specific commodity would raise in future
then he purchase in bulk sum quantity in
same market and vice versa.
Arbitrager

These are individuals and organizations that
have better understanding of different market
and take the advantage of two different prices
in different market.


DERIVATIVE IN PAKISTAN
introduced in Pakistan in 2001

36% of total trading volume of the stock exchange
in 2007-2008 it has 26% volume of total market
Up to 2011 only 42 companies has permission to launch the
stock futures which is now increase in numbers
In Pakistan KSE30 index is available at 30, 60 and 90 day of
settlement
Major user or forward contracts are multinational companies,
different type of investment funds, cement sector, textile and
farming sector


Continue..
Major Player is cement sector because of their
expansion in capacity which requires high
investment and high degree of risk
Cement sector tried to overcome risk by using
60% of forward contract


GRAPHICAL ANALYSIS OF DERIVATIVE
IN PAKISTAN
Cross currency swaps CCS
dropped by 9%
Interest rate swap dropped
26%


SECTOR WISE CCS
SECTOR WISE DISTIBUTION
Telecom = 33%
MAJOR USER OF DERIVATIVES IN
PAKISTAN

Lucy Cement Ltd
Kohinoor Textile Ltd
Attock Cement
National Bank of Pakistan
Standard Charter Bank
AKD ltd
Foreign investor also invests in Pakistani derivatives




BENEFIT OF DERIVATIVES
try to stabilize the market though its rational
and optimal usage.
Low transaction cost
Lock the risk
Zero sum game
Source of fund


THREATS OF DERIVATIVES TO STOCK
EXCHANGES AND FINANCIAL SYSTEM
many investors do not use such instrument
owing to their inherent complexity
Derivative promote leverage tendency which
may hamper the profitability and increase risk

Increase excessive speculation and arbitrage
which is not good for efficient markets




MAJOR LOSSES IN DERIVATIVE AROUND THE
WORLD
REASONS of LOW INTEREST LEVEL OF INSTITUTION IN
DERIVATIVES IN
PAKISTAN
Lack of knowledge about the derivative
Statutory restriction on different institution
like mutual fund only may use only 10% of
assets in derivatives
Fragile economy


Recommendation
create investor awareness about existing
products


Try to minimize the complexity of mechanism