Chapter 5: Financial Markets

What is the opportunity that this is?

I believe the world is plotting to do me
good today. I cant wait to see what it is.
 Chapter Content
1. Money Market
2. Capital Market
3. Foreign Exchange Market
4. Derivatives Market
 The Malaysian Financial System
Malaysian
Financial System

Financial Banking Non-Bank

Financial
Markets System Intermediary

Securities Bank Negara Provident &

Commission Malaysia Pension Funds

Derivatives Commercial Development

Money Market Capital Market Offshore market Finance Institutions
market Bank

Finance
Money Market Equity markets Labuan Savings Institutions
Companies

Foreign
Insurance
Exchange Bond Markets Investment Bank Companies
Market

Other Financial
Others Intermediaries
 Financial Markets

Capital Derivatives
Market Market

Money &
Foreign Offshore
Exchange Market
Markets Financial
Markets
 Financial Market
An organization that is responsible for the
distribution of funds.
Involves the primary market (corporations and
investors), secondary markets (investors,
financial brokers, financial intermediaries, and
corporations) and the government.
Investment Sector
Business
Government
Household

Financial Broker Financial

Investment Banker Intermediaries
Mortgage Banker Commercial Bank
Savings Bank
Pension Funds
Secondary Market Finance Companies
Exchange

Savings Sector
Household
Businesses
Government
MONEY MARKETS
Money & Foreign Exchange Market
Provides financial institutions with the facilities
for adjusting their portfolio over the short-term.
For transmission of monetary policy actions by
Central Bank.
Function to reconcile interest of two groups:
Institutions and individuals who have temporary
surplus funds and want to lend and earn some return.
Institutions and individuals who need funds
immediately for short periods.
 Money & Foreign Exchange Market
Similarities & Differences
Both markets transact short-term liquid
financial assets with maturity of up to one
year.
Financial assets traded in domestic currency
for money market vs foreign currencies for
forex market.
Price quoted in terms of rate of interest for
money market and in terms of rate of
exchange for forex market.
 Money & Foreign Exchange Market -
Relationship
Both are closely related:
Conditions in the money market have a tendency
to be reflected in the exchange market and vice
versa.
Changes in the interest rates in money market
affect both the prices of financial assets and the
exchange rate in the forex.
 Money Market

Short-
Term Money
Interbank
Securities Market
Market
 Interbank Market
Largest money market
trading

Why banks need to borrow

interbank:
Insufficient deposit base. Trading of short-term funds
Meet statutory reserve
requirement

Important source of short Participants are banking

term funds for financial institutions, discount
institutions because of the houses, insurance
rising turnover in the companies, large
market and stable corporations, pension
interbank interest rate. funds and money brokers.

Transactions in terms of
Standard deals in short-term
borrowing and lending of
funds made for a fixed period
short-term funds in the
involving overnight money, 7-
secondary loans and deposits
day and 1,2,3 and 6 months.
market.
Short-term Securities Market
Sale and purchase of money
market instruments.

Commercial papers
Cagamas bonds and notes Involves discount houses,
Bankers Acceptances (BA) money brokers and other
Negotiable Instruments of intermediaries.
Deposits (NIDS)
Private Debt Securities

Government papers
Malaysian Govt. Securities (MGS)
Malaysian Treasury Bills (MTBs) Short-term money market
Bank Negara Bills (BNB) papers.
Government Investment
Certificates (GIC)
 Money Market
Primary Market
Participants are initial
suppliers of funds,
individuals and corporation,
international trading
companies, provident or
pension funds and
government and statutory
bodies.
New issues of securities.
Secondary Market
Existing securities are being
traded.
Center for secondary
activities of the loans and
deposit market.
Relates to the dealing
activities of the banks with
other financial institutions.
 Money Market Instruments
Repos
Negotiable Certificates of Deposits (NCDs)
Bankers Acceptances
Malaysian Government Securities
Malaysian Government Treasury Bills
 REPOs
An agreement whereby the bank sells its
valued papers to an investor with an
understanding to repurchase them at an
agreed price on a specified future date.
 Negotiable Certificate of Deposits
(NCDs)
A document which certifies that a certain sum
of Ringgit has been deposited with a financial
institution at a specified rate of interest with a
specified maturity period.
Is a negotiable instrument as an evidence of
deposit in a commercial bank.
 Negotiable Certificate of Deposits
(NCDs)
The amount (smallest RM100,000) and the
maturity (commonly 30 days) are dependant
on the investors (depositors) needs.)
Evaluation: High liquidity with strong
secondary market, moderate risk that
depends on the bank involved and high
return.
 Bankers Acceptance
Bills of exchange which are drawn on and
accepted by commercial or merchant banks in
Malaysia.
Created out of a bona fide trade transaction
such as to finance import and export of goods
to/from Malaysia and sale and purchase of
goods and services within Malaysia.
Similar to cashiers check payable in the future
with typical maturity of 30 days or 180 days.
 Bankers Acceptance
Arises from a short-term arrangement between a
purchaser and its bank for financing of certain
transactions.
The purchaser with its bank approval, issues a
draft, on which payment is contingent on some
events, to the seller for the amount purchased.
The seller who holds the BA may then sell it at a
discount in the secondary market to obtain
immediate funds.
 Malaysian Government Securities
(MGS)
Consist of government bonds and loan stock
which represents our government borrowings
from the private sector.
Issued on a tender basis from the Treasury via
BNM.
Can be traded in the secondary market and
price is determined by forces of supply and
demand.
 Malaysian Government Treasury Bills
(MGTB)
It is a Government Issue and represents the
obligation of the Treasury Department.
Maturities not exceeding one year; most of
the T-bills mature in 91 182 days, with
longer maturity such as 9 months and one
year.
The treasury holds weekly auction at a
discount with the smallest denomination of
RM1,000 and are considered as risk-free.
 Malaysian Government Treasury Bills
(MGTB)
Payable to order and entitle the holder the
payment of a fixed deposit sum on maturity.
Provides investment outlets for short term
surplus funds of commercial banks, merchant
banks, discount houses and finance
companies.
Evaluation: High liquidity with strong
secondary market, lowest risk, and low return.
FOREIGN EXCHANGE MARKET
 Foreign Exchange Market
Wholesale interbank market for the sale and
purchase of foreign currencies including
purchases by importers to pay their imports
and sale of ringgit by exporters arising from
receipt of export proceeds.
Deals transacted through money brokers via a
network of telex and Reuters Direct Dialing
screen for direct dealings with banks abroad.
24 hour market.
 Foreign Exchange Market
Participants are commercial banks, finance
companies, merchant banks, exporters,
importers, forex dealers, forex brokers.
All forex dealings transacted through institutions
authorized under the Exchange Control Act 1953
i.e. Commercial Banks and BIMB, Finance
Companies restricted to the sale of Travelers
cheques, Merchant banks handle fee-based
customers forex exposures and Money changers.
 Foreign Exchange Market
Spot-Market Currencies bought or sold for
immediate delivery (2 days).
Forward Market Currencies bought or sold
for future delivery.
Traditionally serving the needs of exporters
and importers in carrying out their financial
transactions and presently facilitate the
international trade and investment.
 Foreign Exchange Risks
Two main risks, foreign exchange exposure
and transaction risks.
Relates to the vulnerability of an institution to
changes in its profit or loss and shareholders
wealth due to fluctuations in exchange rates.
Foreign Exchange Exposure Risks

Translation Economic

Trading
Transaction Exposure
Exposure Risks
risks
 Foreign Exchange Exposure Risks
Transaction exposure risk/ business exposure
risk
When a company has a commitment to pay or
receive a foreign currency immediately or at a
future date.
Movement of the exchange rates will result in
company either profit or losses.
Businesses will buy and sell foreign currencies
spot and forward deliveries.
 Foreign Exchange Exposure Risks
Translation exposure risk/ Accounting
exposure risk
Arise when a company has assets and liabilities
which are denominated in foreign currencies.
Fluctuations in foreign currencies will alter
(positively or negatively) balance sheet of
company between two reporting periods.
Consolidation of group accounts involving foreign
subsidiaries and affiliated will result in losses due
to negative currency movements.
 Foreign Exchange Exposure Risks
Trading Exposure risk
Arise when an institution takes on a currency
exposure with the intention of profiting from it.
Company chooses not to hedge a foreign currency
receivable or payable until when the exchange
rates move in its favor.
If the rates move against its favor, the company
will make exchange losses.
 Foreign Exchange Transaction Risk
Relates to one of the counter parties to a
foreign exchange deal fails to honor its part of
the contract, causing the other party to suffer
financial losses.
Two main risks are settlement and pre-
settlement risks.
 Foreign Exchange Transaction Risk
Settlement risk/ delivery risk
One of the counter parties may default on delivery
date.
Pre-settlement risk
One of the counter parties defaults on an
outstanding forex contract before the delivery
date.
Occur in all forward forex deals and FX swaps.
 Role of Central Bank in FX Market
Floating exchange rate system whereby any
deviation from the desired equilibrium level
will result in central banks implementing
monetary policies to bring currencies back to
desired levels.
Competitive devaluation to bring the
exchange rate below equilibrium value to give
a competitive edge for exports.
 Role of Central Bank in FX Market
To curb inflationary pressures, exchange rates
kept above equilibrium.
Foreign exchange intervention
Consists of purchases or sales of one currency
against another in the spot or forward markets.
 Factors Affecting Foreign Exchange
Rates
Demand and supply
Market forces Fundamental & Technical
Economic factors
Government & Central Banks policies
Market psychology and sentiments
Political factors
International events
Market speculation & hedging
Market information
 Two Main Types of Foreign Exchange
Dealers
Corporate dealers
Service and look after the needs of the banks
corporate or commercial customers.
Normally do not take positions.
Inter-bank dealers (proprietary traders)
Deals and trade on behalf of the banks.
Also known as specialist who speculates on
currencies.
 Discussion Question
A Malaysian manufacturer is exporting its
products to another party in Japan. In a
foreign exchange transaction, would this
exported buy or sell Japanese yen to a bank?
Explain briefly.
CAPITAL MARKET
 Capital market
Market for raising long term funds i.e. long
term financial market.
Comprised of Conventional Market:
Equity market
Deal with corporate stocks and shares which have no
fixed maturity period
Bond market
Deal with Public and Private Debt Securities with
maturity more than one year.
 Purpose of Capital Market
Assist the process of economic development
by mobilizing medium and long term funds to
fund private investment and finance public
development programs and help banking
system in securitizing their assets.
 Purpose of Capital Market
Providing intermediary services promoting
private enterprises to raise funds for corporate
investment and expansion and changing the
ownership structure of companies.
 Role of Capital Market
K-economy equity funding through venture capital
and MESDAQ market.
Small-Medium Enterprises Equity funding through
Second Board & MESDAQ Market.
Privatization & Infrastructure Projects Bonds through
issue of Private Debt Securities Equity financing
through Bursa Malaysia.
Islamic Capital Market (ICM) Availability of Shariah-
compliant debt & securities, warrants & call warrants
Availability of Islamic investment products like unit
trusts, Islamic indices, and Crude Palm Oil Futures.
 Differences between money market
and capital market
Money Market Capital Market
Purpose Able to rapidly adjust Serve as link between
liquidity position surplus and deficit units
Secondary Market Very strong Rather weak when price
volatility is considered
Volume of Transaction High Low
Default risks Lower Higher
Importance of different Central Bank & Commercial Wide variety of Financial
financial institutions Bank Institutions
Volume of Financial Low High
Instruments
 Equity Market
Long term risk investments with potential for
capital growth.
Represents part ownership by the investor in a
particular company.
This ownership entitles the investor to a portion
of the companys profits through dividends and
also share the failure of the business.
Types of shares include ordinary shares and
preference shares.
 Background
KLSE traces its history to 1930s but the
present exchange was established in 1973
where Malaysia incorporated companies were
listed and traded in Stock Exchange of
Singapore (SES).
Privatization in late 1980s and 1990s resulted
in increased financing needs by private firms.
 Development of the Malaysian Stock
Market Msian Exchange for
Securities Dealing &
Automated
Delisting of Quotation
Msian Msian Monetary (MESDAQ)
companies from Exchange (MME) commenced trading
SES & Spore set up to provide of high-growth &
incorporated fixed income technology cos.
companies from derivatives i.e. KLOFFE became a MESDAQ joined
KLSE KLIBOR futures subsidiary of KLSE KLSE group.

1980 1990 1995 1996 1998 1999 2001 2002 2003

KL Commodity Introduction of KLCE & MME KLOFFE & Demutualization of
Exchange (KLCE) KL Options & merged as COMMEX merged the exchange.
established as Financial Futures Commodity & to become Name changed to
the first future Exchange Monetary Malaysian Bursa Malaysia.
exchange in (KLOFFE) to offer Exchange of Derivatives
South East Asia derivative Malaysia Exchange Berhad
products (COMMEX). (MDEX)
 Securities Commission (SC)
Establishment On March 1st 1993, as part of initiatives under the 6th Malaysia
Plan (1991 1995)
Accountability Reports to the Minister of Finance and tables accounts to the
Parliament annually
Membership Comprises 9 members, appointed by the Minister of Finance
consisting of:
Executive Chairman
Deputy Chief Executive
Representatives of the private sector
Representative of the government
Role To act as the single body that regulates and promotes the
development of the capital market
 Securities Commission (SC)
Promote and maintain fair, efficient, secure and transparent securities and
futures market and to facilitate the orderly development of an innovative and
competitive capital market.

Licensing and Supervising exchanges,

Development of the
supervising all clearing houses and
capital market
licensed persons; central depositories;

Regulating the take-over

Regulating all matters relating Regulating all matters relating to
and mergers of
to unit trust schemes; securities and futures contracts;
companies;
 Bursa Malaysia
Bursa Malaysia Securities Berhad is an
exchange that provides facilities for both retail
and institutional investors to buy and sell
securities.
Financial products may include shares of
public listed companies, loan stock, debenture
stocks, warrants and bonds.
 Functions of Bursa Malaysia

Strive towards highest standards

Regulate and maintain
Promote & develop capital to ensure transparent, fair &
facilities for conducting
market & protect interest & orderly market by instituting a
the business of a stock
welfare of members. policy of market surveillance &
exchange in Malaysia.
corp. disclosure.

Provide & enact listing Offer internationally

requirements & competitive securities &
enforcement of rules on derivatives products &
listed companies. services.
 Brokerage Firms
Intermediaries between the client and the
operations of the exchanges.
 Types of Market
Primary Market
A market where securities are
created.
A place where companies will
issue stocks or bonds to the
public for the first time.
The securities are being
offered by the issuer and the
issuer receives cash proceeds
from the new issues.
The process is called Initial
Public Offering (IPO).
Secondary Market
A market in which securities
traded are not issued by the
issuer but by another investor.
A market of previously issued
securities.
The issuer does not receive the
proceeds but goes to the current
owner.
Needs an organized securities
exchange that facilitates the
transactions of outstanding
securities and provides
continuous pricing of securities.
Risk of Investing in the Stock Market

Business Risk

Financial Risk

Purchasing Power Risk

Liquidity Risk

Interest Rate Risk

Market Risk
Risk of Investing in the Stock Market
Related to the nature of business.

Business Risk Different industry may have different level of

risk.

The level of risk that a company has due to high

level of financing/ borrowing.
Financial Risk Uncertainties due to the mixture of debt and
equity.

Purchasing Risk due to the effect of inflation.

The risk of losing purchasing power when the
investment return is unable to match the
Power Risk inflation rate.
Risk of Investing in the Stock Market
Risk that the stock may not be able to be converted into
cash at a reasonable price.
Liquidity Risk The more inconvenient it is to be liquidated; the higher is
the liquidity risk.

Interest Rate The chance that changes in interest rates will adversely
affect the value of securities.
Can affect the stock market as a decline in interest rate can

Risk lead to a better market because cheaper funds are

available for investment purposes.

The variability of returns to the changes in the market as a

whole and a result of a number of risks combined such as
Market Risk inflation, interest rate and tax risk.
Are due to changes in political situation, social events,
economic and changes in investors tastes and preferences.
 Common Stock
An instrument that represents ownership in a
company that issues the stock.
The stockholder has a claim on the earnings
and assets of the corporation.
They are also entitled to any incremental
profits of the company.
Advantages and Disadvantages of
Common Stock
Advantages Disadvantages
 Advantages of Common Stock

Shareholders has a right to vote on major decisions in

Voting and the company which can be made during the
shareholders meeting.
Pre-emptive A pre-emptive right is the ability to obtain a specific
rights number of shares, based on its current shareholding,
further issued by the company.

Easy to Trade Trading in shares in very easy. Find a stock broker, open
and Low a trading account and the CDS account and then you
are ready to trade.
Transaction The cost of transaction are stamp duties, brokerage
fees and clearing fees are relatively reasonable.
Costs
 Advantages of Common Stock

Variety of Many choices of shares in terms of types, price,

sector and level of risk.
Choices

Liquidity A stock order can be matched especially during

strong market where volume is high.

High Stock prices are volatile as compared to other types

of instruments and therefore give opportunities for
Returns investors to gain profits from the capital gain made.
 Disadvantages of Common Stock
Common stocks are sensitive to factors such as changes in
Fluctuation of domestic or foreign economic situation, uncertainties in a
political scenario, performance of foreign exchange,
Prices psychological factors and even manipulation.

Rapidly growing companies may declare small dividend or

Lower Current even not declare at all.
Income Companies not performing well may not pay a good
dividend too.

Determining the Difficulties in predicting the expected future earnings.

Intrinsic Value
 Types of Common Stocks

Blue-Chips Growth Income

Stocks Stocks Stocks

Cyclical Defensive Speculative

Stocks Stocks Stocks
 Types of Common Stocks
Blue-Chips Stocks
Stocks that belong to large, well-established and financially strong
companies.
Have a long and stable record of earnings and consistently paying
dividends.
Are also the industry leaders.

Growth Stocks
Those that have recorded a higher than average sales, earnings,
and dividends.
Normally pay small dividends due to the reinvestment of the
profits made for further growth.
 Types of Common Stocks
Income Stocks
Stocks that are known for its stable records of paying higher
than average dividends.
Suitable for investors seeking for high and reliable dividend
payment.

Cyclical Stocks
Stocks that are more responsive to the changes in the
economy.
Performance of the companies are closely linked to the
economic cycle.
 Types of Common Stocks
Defensive Stocks
The opposite of cyclical stocks.
It is less affected by the changes in the economy.
Speculative Stocks
Stocks that the prices move drastically due to both
fundamental and psychological factors.
These are stocks that move to a certain degree of
optimism, pessimism and even fear and hope of the
performance of that particular stock.
 Factors Affecting Stock Prices

Economic Industry Corporate

Factors Outlook Earnings

International
Crowd Political
Stock Market
Psychology Scenario
Condition
 Factors Affecting Stock Prices
Economic Factors
Refers to the interpretation of economic variables such as GDP,
interest rates, unemployment rate, money supply, industrial
production, currency value and trade balances.
Industry outlook
Looking at how competitive is the business, the regulatory condition,
the industry life cycle, labor condition and technological
developments.
Political Scenario
The political situation of a country has a direct impact on the
business climate in the country.
 Factors Affecting Stock Prices
Corporate Earnings
The earnings condition, sales level, dividends, and
other related decision such as mergers and
acquisition.
Crowd Psychology
The overall perception of investors to the economic
condition.
International Stock Market Condition
BOND MARKET
 Bond
An instrument that has a maturity date which
is the date that the bond matures and the
issuer will have to refund the principal to the
investor as promised.
A coupon rate is also stated the rate that
investors will receive periodically (6 months or
yearly) until its maturity date. The rate is fixed.
Yield to maturity the actual rate of return if
the bond is kept until maturity.
 Bond Market
Another avenue for efficient movement of
funds from surplus to deficit units.
Bond market creates the relationship of a
lender and borrower.
An instrument where the issuer promises to
pay a periodic interest to the investor and
repay the principal amount borrowed at
maturity.
Development of the Bond Market
Composition of MGS
46%, PDS 27%, & balance
are instruments issued by 50.7%
Khazanah Nasional, comprised of
Cagamas, Danaharta & private sector
Danamodal. bonds.

1987 1999 2005 2006

98% of bond market Islamic bonds
is dominated by raised was 25%
Msian Gov Securities (RM9.1b) of gross
issued mainly for issuance of PDS.
financing of
government
development needs.
 Regulatory Authorities
BNM concerned with credit allocation to
private sector.
Securities Commission of Malaysia
concerned with capital market development.
Companies Commission of Malaysia
requires issuers to register prospectuses and
provide information in the prospectus that
complies with BNM & ROC.
 Participants
Financial institutions, Bank Negara Malaysia,
corporations, brokers, rating agency and foreign
fund managers.
They can take the position as a lead or co-
arranger, underwriter, guarantor, principal
dealers, trustee, registrar, authorized depository
institutions or paying agents.
Provident funds invest heavily in bonds, up to
50% of total investment (EPF Act 1991) and
insurance companies can invest 20% of funds in
low risk instrument like MGS.
 Instruments in the Bond Market
Malaysian Government Securities (MGS)
These are interest-bearing long-term securities
issued by the Government of Malaysia with
interest payable semi-annually and having a tenor
of normally more than one year.
Funds raised will be used for the national
development expenditure.
 Instruments in the Bond Market
Malaysian Treasury Bills (MTBs)
Treasury Bills are short-term government securities
(maturities not exceeding one year) issued by BNM on
behalf of the Government to finance national
expenditure.
Bills are sold at discount through competitive auction,
facilitated by Bank Negara Malaysia, with original
maturities of 3-month, 6-month, and 1-year.
MTBs are auctioned weekly through the Principal
Dealers on a discounted basis and redeemable at face
value on maturity.
 Instruments in the Bond Market
Government Investment Issues (GII)
These are long-term and short-term non-interest
bearing Government securities, respectively, issued
based on Islamic principles by the Government of
Malaysia.
Malaysian Islamic Treasury Bills (MITB)
MITB are short-term securities issued by the
Government of Malaysia based on Islamic principles.
These instruments are usually issued on a weekly
basis with original maturities of 1-year.
Both conventional and Islamic institutions can buy and
trade MITB.
 Instruments in the Bond Market
Bank Negara Monetary Notes-I (BNMN-i)
BNMN-I are Islamic securities issued by Bank Negara Malaysia
replacing the existing Bank Negara Negotiable Notes (BNNN) for
purposes of managing liquidity in the Islamic financial market.
The instruments will be issued using Islamic principles deemed
acceptable to Shariah requirement with maturity of three years.
BNB (Bank Negara Bills)
Similar to MTBs, it is a short-term instrument with maturity not
exceeding one year and issued on a discounted basis by auction
through principal dealers.
Since it is categorized as liquid assets, it is often purchased by
financial institutions to meet their liquidity and statutory
reserve requirement.
 Instruments in the Bond Market
Cagamas Instruments
An interest bearing instrument issued by Cagamas
Berhad, a National Mortgage Corporation.
These instruments are related to the housing loans
financed by financial institutions and the government.
Instruments include Floating Rate Bonds, Fixed Rate
Bonds, Cagamas Notes and Mudharabah Bonds.
Commercial Paper (CP)
An instrument similar to MTBs where the tenors are
no less than one month but not more than 12 months.
 Instruments in the Bond Market
MTNs (Medium Term Notes)
Instruments with tenors of no more than one year but
not exceeding 5 years.
The issued can be conventional or Islamic based and
the mode of issuing is either direct placement or by
tender.
Corporate Bonds
Instruments issued by corporations, Islamic or
conventional, fixed or floating or can be issued
without interest (zero coupon).
Interest payment can be quarterly, semi-quarterly,
semi annually or annually.
 Discussion Questions
Differentiate between equity and bond market.
Explain the importance of index. List the main
international indices of the world.
What is Initial Public Offering? Why is it
categorized as a primary market?
Why is stock investment risky?
What are the factors affecting stock prices?
Describe the features of a bond. Why is bond
relatively safer than stock?
DERIVATIVES MARKET
 Introduction
Derivatives are an instrument for risk
reduction.
Price of the securities are volatile, the more
volatile an instruments/securities is the higher
the participants is exposed to risk.
Derivatives financial instruments used to
manage ones exposure to volatile markets.
 Introduction
Value of derivatives product depends on:-
i. Underlying instruments;
ii. Commodity prices;
iii. Exchanges rates;
iv. Interest rates;
v. Indices;
vi. Share prices

Derivative market offers both hedgers, arbitrageurs,

and traders to deal in wide range of over-the-counter
and exchange-traded financial instruments.
 Types of Derivative Markets
Traded options
Available in the financial instruments decided by the
Exchange (specific marketplace where the derivative
originated from).
Terms are standardized in respect of contract size,
exercise prices and expiry dates.
OTC options
Over-the-counter option whereby the investor
entered the option with another counterparty.
The transactions are tailored to investors
requirements.
 Development of Derivatives Market in Malaysia

Year Development
July 1980 Kuala Lumpur Commodity Exchange (KLCE) was established.
Dec1995 Kuala Lumpur Options and Financial Futures Exchange (KLOFFE).
May 1996 Malaysian Monetary Exchange.
Dec 1998 KLCE merged with MME and known as Commodity and Monetary
Exchange of Malaysia (COMMEX).
Jan 1999 KLOFFE become a subsidiary of KLSE Group of Companies.
June 2001 KLOFFE merged with COMMEX and form Malaysia Derivatives
Exchange (MDEX).
2004 Known as Bursa Malaysia Derivatives Berhad.
 Regulatory and Legal Framework
Derivatives industry is governed by the Futures
Industry Act 1998.
The act gives power to the Ministry of Finance
which empowered the Securities Commission
Malaysia (SC) to regulate the derivatives market.
SC is responsible to give license to future brokers,
futures trading advisers, futures fund managers
and their representatives.
KLOFFE and MME come under the jurisdiction
and supervision of SC.
 Derivatives Clearing House
Malaysian Derivatives Clearing House Berhad
(MDCH).
Established in 1995.
Later the name has been changed to Bursa
Malaysia Derivatives Clearing House.
Provides financial stability by guaranteeing the
performance of all contracts as it acts as the
counterparty to all contracts traded.
 Derivatives Clearing House
Contractual obligation between actual buyer
and seller does not exist as the clearing house
assumes the role of buyer to the seller and
seller to the buyer.
Guarantee is supported by the collection of
margin payment from the buyer and seller.
 Uses of Derivatives
The protect from
price uncertainty
Hedging

To make profits by
capitalizing the
differences in
futures prices.
Uses of
derivatives

Risk
Speculation Management
Market participants
Investment
bankers

General Fund
businesses managers

Market
participants

Commodity
MNCs
producers

Financial
institutions
 Uses of Derivatives
Type of Institutions Use of Futures
Commercial Banks To hedge against interest rate risk.
Fund Managers To hedge portfolios against stock market and interest rate
fluctuations.
To speculate on future stock market or interest rate
movements.
Securities Firms To hedge own portfolios against stock market and interest
rate movements.
To execute (hedge) transactions for clients (firms or
individuals).
Pension Funds To hedge portfolios against stock market and interest rate
fluctuations.
Insurance Companies To hedge portfolios against stock market and interest rate
fluctuations.
 Derivatives products and the underlying
instruments in Malaysia
No Derivatives products Underlying instrument/
commodity
1. Crude Palm Oil Futures (FCPO) CPO
2. KLCI Futures KLCI
3. Kuala Lumpur Composite Index Options (OKLI) KLCI
4. 3-month KLIBOR Futures (FKB3) 3 month KLIBOR
5. 3-year MGS Futures (FMG3) 3 year MGS
6. 5-year MGS (FMG5) 5 year MGS
7. 10-year MGS Futures (FMGA) 10 year MGS
8. Crude palm kernel oil Futures (FPKO) Crude palm kernel oil
 Derivative Products
Futures and options are basic derivative instruments
whose values are dependent on the value of an
underlying asset such as stocks, bonds, indices,
currencies or commodities.
Futures
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.
Options
Provides the holder/buyer the right, but not the
obligation, to purchase or sell a certain quantity of the
underlying instruments.
 Types of Derivatives
Futures contracts
Legally binding agreements contract specify
something gold, tin, palm oil, foreign currency,
shares or interest rate quantity.
Quantity and time of delivery - Buyer/ seller agree on
price today for product to be delivered and paid for in
the future.
Options
contract between two parties in which buyer has the
right but not obligation to buy/ sell a specific amount
at a specific price, at or before a specific date for
seller.
 References
Financial Market and Institution, Rohani A.
Ghani and Ibrahim Ab. Rahman, InED, UiTM.
www.bursamalaysia.com
www.sc.com.my
www.ram.com.my
www.marc.com.my
End of Chapter 5

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