WHAT ARE DERIVATIVES?

Derivatives are financial instruments whose value is

derived from an underlying physical commodity or

financial instrument
Example:
Price that is derived from the price of the instrument
on which they are based such as :
crude palm oil futures are based on the price of
palm oil traded in the commodities market, while
stock index options are based on the FTSE Bursa
Malaysia KLCI (FBMKLCI).

CONCEPT OF DERIVATIVES
A contract to buy and sell which is set today but will

be fulfilled at a stipulated date later.

Derivatives products are financial instruments
available to corporation and investor for the purpose
of managing their exposure to financial markets
volatility.
A derivative instruments value is derived from the
value of some other more basic underlying
instrument such as commodity prices, exchanges
rates, interest rates and share prices.

CASH MARKET VS. DERIVATIVES

MARKET
CASH MARKET
Is the market for immediate delivery of and payment

for commodity or financial instruments.

DERIVATIVES MARKET
Delivery of and payment for commodity of financial

instruments will be made in the future.

TYPES OF DERIVATIVE
MARKETS
1. FUTURES
A futures contract is an agreement between two

parties to buy or sell the underlying instrument at a

specific time in the future for a specific price
determined today.
Each contract specifies the commodity, the
quantity, quality and time of delivery or cash
settlement.

2. OPTIONS
An option provides the holder/buyer the right, but

not the obligation, to purchase or sell a certain

quantity of the underlying instrument at a stipulated
price within a specific time period by paying a
premium.
The seller of the options, has an obligation, which
is activated if the buyer exercises that right.

BENEFITS OF DERIVATIVES
Managing the risk associated with holding the

underlying asset position

Portfolio asset allocation purpose
Income generation through taking a position in

these products

THE EXCHANGE
An exchange is a specific market place where

derivatives are originated and traded.

Provides trading environment
Servers as communication centers, centralizing
orders from various buyers and sellers and
disseminating relevant information on price.
It is also self regulatory organization where it
establishes rules governing:

 Membership to the Exchange

The administration of the Exchange
Member & customer relationships
Trading practices

EXCHANGE TRADED VS.

OVER THE COUNTER (OTC) DERIVATIVES
Differences between exchange traded market & OTC
FEATURES

OTC

EXCHANGE TRADED

Market Place

Not Centralized

Centralized

Regulation

Self-regulated

Commission-regulated

Trading

Negotiated contract

Standardized contract

Margins payment

No legal
requirement

Legal requirement

Credit/ Default risk

High

Low

Transparency

No

Yes

Guarantee
performance

No

Guaranted by clearing house

Development of Derivative Market in Malaysia

(Find it by yourself & please submit )

CLEARING HOUSE
The clearing house that clears the contracts traded

in MDEX is known as the Malaysian Derivatives

Clearing House Bhd (MDCH) which is managed
independently from the exchange.
The primary function of a clearing house is to

provide financial stability by guaranteeing the

performance of all contracts traded.

Essentially, it acts as the counter party to all

contracts traded by assuming the obligation of a

buyer to the original seller and of a seller to the
original buyer.
Novation- Is the substitution of the clearing house

for the opposite contracting party in a futures or

options contract. Through novation, the clearing
house becomes the buyer to every seller and the
seller to every buyer.

Responsible for all settlement procedures arising

from options and futures trading.

The role of the clearing house can be summarized

as follows:
It provides central clearing-ensuring all members
fulfills their obligation.
It acts as a central bank to all exchange members
by matching all trades transacted on the exchange
It sets margin levels and handles movement in
margin requirement
It takes the responsibility of good delivery of each
contract, thereby guaranteeing trades.

INTERMEDIARIES IN BM
DERIVATIVES

i. FUTURE BROKERS
Conduct a futures broking business, act as

intermediaries between the clients and Exchange

in a marketplace
They can trade on behalf of clients.
Basic function:
Represent their customers in placing orders in the
market
Collecting margins from the customers

Providing basic accounting records

Advising customers in their trading programs
ii. FUTURE TRADING ADVISORS
Act as adviser to the investors on futures trading.
Can be companies or individuals.
Major difference between the futures trading

advisers & future brokers is that future trading

advisers cannot conduct business as a broker and
are not direct members of the Exchange. They play
an advisory role to the customers who are interested
in participating in the futures & options market.

FUTURE FUND
MANAGERS
A person who carry out a future fund

management business.
Specialize in managing funds that trades in
future & options
Employees of futures fund managers are called
futures fund manager representative

USERS OF FUTURES &

OPTIONS
i.

HEDGERS

Hedgers are investors or fund managers who will

trade future contracts to hedge their portfolio

exposure from any unexpected price movement in
the underlying or related market.
Their primary interest is to protect the value of
their portfolio

ii. SPECULATORS
Individuals who trade future contracts with the

primary interest of profiting from the future market

Willing to assume the risk of price fluctuations &
hope the profit.
The presence of speculators contribute
significantly to the liquidity of the market.

iii. Arbitragers
People who engage in arbitrage activities
Involves locking in a risk less profit by

simultaneously trading in two or more markets

Take advantage of relative price disparity between
two related markets.