Impact on Derivatives

Page 3: Introduction to the Financial System Page 7: Commercial Banks Page 12: The Share Market and the Corporation Page 15: Corporations Issuing Equity into the Share Market Page 19: Investors in the Share Market Page 24: Short-term Debt Page 28: Medium- to Long-term Debt Page 32: Interest Rate Determination and Forecasting Page 37: The Foreign Exchange Market Page 40: Factors that Influence the Exchange Rate Page 42: Futures Contracts and Forward Rate Agreements Page 47: Options

FTSE Bursa Malaysia KLCI Futures (FKLI) is a capitalisation-weighted stock market index, composed of the 30 largest companies on the Bursa Malaysia by market capitalisation. Bursa Malaysia Derivatives (BMD) offers 3 categories of derivatives which are Commodity Derivatives, Equity Derivatives and Financial Derivatives. In our case study, KLCI May futures contract is under the equity derivatives.

Mr. Brown readily admitted that he was not at ease discussing the most recent approaches to risk reduction or hedging. He had received his MBA from Harvard in the 1960s and had spent most of his career working for a company that had little international exposure. Moreover, he was not familiar with derivatives such as currency options, which until recently were not widely traded. However, Mr. Brown had recently hired an assistant, Mr. Dan Pross, who had some knowledge of hedging and derivatives. As a student at UCLA, Mr. Pross had traded various types of derivatives for his own portfolio and was familiar with how they were traded. Although Mr. Pross did not have a finance background, he was, in Mr. Brown’s opinion, extremely intelligent and highly capable. Mr. Brown suggested that Mr. Pross make a presentation to the senior management on the use of derivatives to reduce risk.

By signing the Volcker Rule into law on July 21, 2010, I should declare in regard to this reform package that President Barack Obama has, effectively, released a complex, ambiguous document. In addition, it represents a package of 963 pages long with 2,826 footnotes and 1,347 questions. In effect, on December 10, 2013, five federal agencies have technically approved the Volcker Rule. Moreover, these agencies include the Commodity Futures Trading Commission, CFTC, the Securities and Exchange Commission, SEC, the Federal Reserve, the Office of the Comptroller of the Currency, OOC and the Federal Deposit Insurance Corporation, FDIC. Furthermore, the Volcker Rule has been strongly hindering the banking industry in regard to the risk-taking

In this project we first checked consistency and seasonality of S&P500 index stock performance by splitting its recent twenty years historical data into ten two year data and built ARIMA and GARCH models for each sub-period. We found that the models are considerably consistent before 2007-2008 sub-period, and there exists some minor seasonality in several subperiods, but no particular pattern can be identified for the whole period. We then tried to predict future return, volatility and VaR using the model we built for the last sub-period based on rolling forecast procedure. Though the fitted values of 10th sub-period model are

Analyze the derivatives market and determine the use of derivatives to efficiently manage investment risks in an investment portfolio.

For the purposes of this report, I analyzed the July corn futures market from a long position in contrast to my short position in the cash market. I took out one contract with a size of 5000 bushels of corn. I tracked this market since January 16th and collected futures and cash market prices throughout that whole period. In addition, I also analyzed hedging with futures and hedging futures with options dating back to February 21st. This report shall cover all aspects of this analysis including a compare and contrast section on each of the net prices from each hedging option.

Given the background of airline risk exposure and risk management practices, it is apparent that airlines have a variety of options available to minimise fuel price risk. Most of their hedging activity involves over the counter (OTC) instruments which are largely unregulated and difficult to study. Market activity in futures exchanges presents a safer option whose activity is monitored and regulated. The rest of the paper focuses on Southwest Airlines’ hedging activity for the years 2000 – 2014. We look at real life application of futures markets and their products as a risk management technique for a U.S. commercial airline and evaluate whether hedging adds value.

The real readers for Muhtaseb’s article align very well with his intended readers because of the location of the publication in the Journal of Derivatives and Hedge Funds which caters to financially savvy and hedge fund interested readers. In the second sentence of the abstract, Muhtaseb already begins to reference technical financial terms that his intended reader should understand. When elaborating on how his purpose is achieved, he says, “It is accomplished through identification and analysis of numerous activities normally associated with hedge funds that have become an integral part of capital market activities” (1). Even in the abstract when Muhtaseb attempts to summarize his argument in approachable and concise terms, he uses the phrase ‘capital market activities.’ The intended audience reading in the Journal of Derivatives and Hedge Funds would recognize capital markets as markets for buying and selling debt and equity instruments, but because I am not part of the intended audience for article, I rely on google searches to fill the gaps in my understanding. Because Muhtaseb published his article in a technical journal, though, his real readers are likely

With excessive trading, market became even more risky and volatile. Firstly, just because those derivatives can reduce risk, to some extent at least, it gave the banks and other financial institutions a perverse incentive of performing prudential risk control. Secondly, any risk-control instruments can easily become the profit-seeking tools for the greedy speculators. Like commodity futures contracts, they were originally designed to hedge risks in real commodity business. But very soon after, most such trading became for speculation purpose, which, on the contrary, increased the market volatility.

The idea of institutional herding has a striking implication for security price volatility. Estimations from the essay ‘Sending the Herd Off the Cliff Edge’suggests that the predominance of herding behavior may explain why the financial system in 1990s had been in crisis for 40 out of the 120 months or 33% of the time (Persaud, 2000). These concerns, along with the increasing stock market ownership of institution investor in comparison to individual investors, is often used as a basis for advocating for an increase in monitoring institutional trading in equity markets in hopes that it that would lead to a reduction in the dominance of institutional investors in the financial market. However such claims are not fully supported by empirical research in the literature. Two schools of thoughts emerge the first being that herding enhances pricing efficiency, and second ascertains that herding initiates short-term trend reversals.

Emmons et al. utilizes options contracts on federal funds futures to derive probability forecasts regarding Federal Open Market Committee (FOMC) monetary policy decisions. In particular, they use this information to assess how market expectations evolve over time surrounding five key events from 2003-2006. Additionally, they provide a general overview of the mathematics behind futures and options contracts as well as pricing methodology. While researchers have found that federal funds futures contracts provide useful information concerning market expectations (Carlson et al. 1995; Poole et al. 2002; Sack, 2004; and Piazzesi and Swanson, 2005), options-based forecasts are more useful when more than two federal funds target rates are

On January 5, 2000, Phoenix Research and Trading, a Toronto-based hedge fund management group, issued a hastily prepared press release. The firm stated that one of its traders, Stephen Duthie, had lost $7.4 million in unauthorized trading in its publicly traded Phoenix Hedge Fund LP, with the losses originating from a feeder fund called the Phoenix Fixed Income Arbitrage Limited Partnership.

The financial market volatility will affect the capital and returns of an investment. Price volatility in the financial market can be caused by various factors and consequently the market risk is relatively large for investors. For instance, during the 2008 financial crisis, the majority of investment and capital market related are suffering from different levels of loss because of the sharply fell of the global capital markets. Hence, it is not predictable whether the final index level of this plan will be higher than the initial FTSE 100 Index level due to the market change.

Among the most fundamental risks, associated with exchange-traded derivatives, is variable degree of risk. According to Ernst, Koziol, & Schweizer (2011), the transactions in