Derivative market in nepal

Group B:
Ritu Joshi
Sarita Maharjan
Ankur Shrestha
Krishna Chalise
Dipika Shrestha
Pawan Kawan
Sona Shrestha

Introduction
 Derivatives are instruments which include:
a) Security derived from a debt instrument share, loan,
risk instrument or contract for differences of any
other form of security and,
b) A contract that derives its value from the price/index
of prices of underlying securities.

Types of Derivative Market
 Future contract : is an agreement between two
parties to buy or sell an asset at a certain time in the
future, at a certain price.
 Options : A contract that gives its buyer the right but
not obligation to buy or sell an asset at a fixed price
on or before a given date. An option to buy anything
is known as a CALL while an option to sell a thing is
called a PUT.

Cont..
 Swaps : are private agreements between
two parties to exchange cash flows in the
future.
 Forward : Customized contract between
two entities ,where settlement takes place
on a specific date in the future.

History of Derivative Market
 As early as the 1650s, dealings resembling
present day derivative market transactions were
seen in rise markets in Osaka, Japan.
 The first leap towards an organized derivatives
market came in 1848, when the Chicago Board
of Trade (CBOT), the largest derivative
exchange in the world, was established.

MAJOR COMMODITIES…….
 Gold
 Silver
 Crude oil
 Cotton
 Copper
 Corn
 Cocoa
 Sugar
 Coffee
 Platinum
 Palladium
 Heating oil
 Natural gas
 Soyabean
 Soyabean oil
 Wheat
 Brent crude

Parties involved….
 Client/Investor:
 Client or investor is the one who is ready to invest on
commodities of the derivative market and ready to bear the risk.
He is the person who needs to choose his broker carefully and
should have knowledge about the derivative market before having
entry in it.
 Broker:
 A derivatives broker is an investment professional who advises
individuals and corporations about how to buy, trade and sell
derivatives.
 Brokers negotiate deals between entities for derivative swaps,
research international investment opportunities, counsel individual
investors, and analyze corporate asset portfolios to calculate how
much a company should risk in the derivatives market. His main
job is to present options to a client, help the client make a
decision on how to proceed and execute the final choice.

Contd………….
 The broker's job is to work with a client to make an
appropriate investment plan and to provide investment tips.
 Because the derivatives broker acts for the client in many
aspects of the investment process, it is very important that a
client choose a derivatives broker that he or she trusts and
works well with.
 Clearing House:
 It is an agency or separate corporation of a future
exchange responsible for settling trading
accounts, clearing trades, collecting and maintaining
margin money, regulating delivery and reporting trading
data.

Contd….
 Clearing houses act as third parties to all futures
and option contracts - as a buyer to every clearing
member seller and a seller to every clearing
member buyer.
 Each futures exchange has its own clearing house.
 All members of an exchange are required to clear
their trades through the clearing house at the end of
each trading session and to deposit with the
clearing house a sum of money (based on
clearinghouse margin requirements) sufficient to
cover the member's debit balance.

TYPES OF DERIVATIVE CONTRACTS IN
NEPAL
 Over-the-counter (OTC) derivatives
 Exchange-traded derivatives
 Economic derivatives
 Energy derivatives
 Freight derivatives
 Insurance derivatives
 Weather derivatives
 Credit derivatives

BENEFITS OF THE DERIVATIVE
MARKET (OF NEPAL)
 Farmers, traders, exporters, importers can
insure their risk from the fluctuating product
prices by taking futures position in the derivative
market.
 Financial institutions can mitigate the interest
rate risk by locking their interest rate with
derivative exchange.
 Investors can invest in the products and can get
attractive returns.

 End users can buy the goods at a pre-
determined price.
 Investors have the advantage to determine the
conditions of the contract they wish to enter,
develop tailor-made contracts, while they
secure a certain degree of confidentiality in
respect to their transactions.

Trading process of Derivatives
Market

CLEARING MEMBER
Dual Role of Clearing & Settlement(C&S) and Market Making as a
Market Maker(MM)
•Clearing & Settlement Role
Can introduce market maker, brokers, clients, and responsible for
administrative works (provide margin/ commission leverage, creating
client profile, Broker and Sub-broker creation, margin call, fund
transfer, offline support etc).
•Market Making Role
Provide frequent bid and ask quotes simultaneously with quantity
within the parameter set by the exchange.
Role Perform By Parties In Trading

– Broker
Plays a role to introduce sub-brokers /clients or can trade
on their own account.
• Providing advisory services to clients, training and
customer support etc.

Parties involve in commodity trading
MEX
CLEARING MEMBERS
NON CLEARING MEMBERS (Broker) MEMBERS
CLIENTS
BANKS

How to start trading
Trading commodities online is a simple process to
get started, but it is not something that should be
entered into lightly. The traditional method of
calling your commodity broker to place orders and
waiting for a callback to give you a filled order
price is quickly ending. Therefore, if you want to
trade commodities online, we will cover the
process of how to start.

Matching Principles
When orders and quotes are entered into the central order
book, they are sorted by , price and entry time. Market orders
are always given the highest priority for matching purposes.
Orders and quotes in the central order book are anonymous: A
trader never knows the opposite side on a trade executed
through the exchange. Orders and quotes at a given price level
are aggregated, although the number of orders and quotes
making up the total remains unknown. Participants only see
the specific details of their own orders.
For all products, the best bid and ask prices, as well as their
respective aggregated bid and offer sizes, are always available
in real time.

Trading Method
Most of the derivatives markets are fully automated electronic
exchange, where there is no physical trading floor. The Exchange is
controlled through a centralized platform which is connected with
different ‘client’ front-ends called MEXN Trader.
Initial Margin
The initial margin (IM) is levied on all open positions (Buy or sell
positions) of the Members and their clients. The IM calculation
on each commodity varies depending upon its market volatility.
The margin so calculated is reduced from the total margin of
the Member available with the exchange and accordingly
further exposure is given on the balance amount.

•Daily Price Limit
Daily price limit is the maximum and minimum level that
a price of any contract can reach for that particular day. It
is the maximum amount of gain or loss that can occur on
a particular contract/s. If a price of the contracts reaches
the daily price limit, trading on that contract shall be
suspended for certain time period or may be for the
remainder of the day. This is also called locked market.
•Trading session
The trading session in MEX Nepal is of 23 hours daily from
Monday morning to Saturday morning. Market opens at
03:45 on Monday morning and closes at 02:45 Saturday
morning during summer and during winter, the market
opens and closes one hour later.

Important Papers
You need to open a saving account in Bank
You must fill up Client Registration Form and
Member Client Agreement
Read Risk Disclosure Document
Identity Certificate and Address Prove.
Bank Statement Certificate

Drawbacks
 Credit risk
Credit risk on account of default by counter party: This
is very low or almost zeros because the Exchange takes
on the responsibility for the performance of contracts
 Market risk
Market risk is the risk of loss on account of adverse
movement of price.
 Liquidity risk
Liquidity risks are the risk that unwinding of
transactions may be difficult, if the market is illiquid.

 Legal risk
Legal risk is that legal objections might be raised;
regulatory framework might not allow some
activities.
 Operational risk
Operational risk is the risk arising out of some
operational difficulties like, failure of electricity,
due to which it becomes difficult to operate in the
market.

Disadvantages
 Raises Volatility: Derivatives require a small initial
capital due to leveraging derivatives provide, therefore
a large no. of market participants can take part in
derivatives which leads to speculation and raises
volatility in the markets.
 Higher no. of Bankruptcies: Due to the existence of
leveraged in derivatives, participants assume positions
which do not match their financial capabilities and
eventually lead to bankruptcies.
 Increased need of regulation: There a Large no. of
participants who take speculative positions. It is
necessary to stop these activities and prevent people
from getting bankrupt and to stop the chain of defaults.

Regulations
 No regulatory body for derivative market.
 SEBON has authorized to control derivative market
but not able to regulate it.
 Due to lack of expert in Ministry of Finance and
other regulated bodies, there is no proper laws.
 Still derivative market is existed with huge
transaction

The Present Situation of Derivative
Market in Nepal
 The Nepalese Derivative Market is very young.
The investors haven’t been able to analyze the
situation properly.
 Nepal has only a recent history of derivative
market, which opened with COMEN at the end
of 2006
 MEX was established in 2007 and NDEX on
November 20, 2008.

 There is no regulating body in the Nepalese derivative
market.
 Over 90 percent people want to invest in gold and
crude oil
 Recently MEX and NSE has been merged to grab the
new opportunities in the market.
 After merger MEX has now 120 brokers from 90
brokers earlier.
 MEX is the leading derivative market in Nepal
according to trading volume and trading size.
 Software used are MT4, MT5, KAAP, Hybrid Solution,
etc.
 There are altogether 7 derivative exchange in Nepal.

List of Derivative Exchange in
Nepal
1) Commodity and Metal Exchange Nepal
Limited (COMEN) (2006)
2) Mercantile Exchange Nepal Limited(MEX)
(2007)
3) Nepal Derivative Exchange Limited(NDEX)
(2008)
4) Nepal Spot Exchange Limited(NSE) (2010)
5) Wealth Exchange Limited (WEX) (2011)
6) National Spot Exchange Limited(NSX)
7) Commodity Future Exchange Nepal

Problems in Nepal
 No experts to regulate derivative market.
 No regulatory authority.
 Lack of awareness among public.

Conclusion
• The derivatives market is very dynamic and quickly developed into
the most important segment of the financial market
• All in all the derivatives market in Nepal does not have a
longer history and thus seems to be still underdeveloped
• Derivatives play an important role in the economy but are
associated with certain risks.
• The crisis has highlighted that these risks are not sufficiently
mitigated in the over-the-counter (OTC) part of the market,
especially as regards credit default swaps (CDS). Since the
beginning of the financial crisis, the Commission has been
working to address these risks.

Cont………
 The derivatives market functions very well and is constantly
improving. The imperatives for a well functioning market are clear
fulfilled:
 The exchange segment in particular has put in place very effective
risk mitigation mechanisms mostly through the use of automation
 For its user, the derivatives market is highly effective transaction
costs for exchange traded derivatives are particular low.
 The derivatives market needs to focus on variety of commodities
that can manage the risks of that particular commodity
 Derivative trading is an excellent way to prove money earns money.
It will make our investment portfolio more attractive and secure. It
offers a wide range of alternatives, including international
opportunities. This is the best way to utilize our money

Derivative market in nepal

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