Derivative Market

Securities

Aliza Imran 1034

What is derivative?
he term ‘Derivative’ stands for a contract whose price is
derived from or is dependent upon an underlying asset.
The underlying asset could be a financial asset such as
currency, stock and market index, an interest bearing
security or a physical commodity.
As Derivatives are merely contracts between two or more
parties, anything like weather data or amount of rain can be
used as underlying assets.
The need for a derivatives market
The derivatives market performs a number of economic
functions:
1. They help in transferring risks from risk averse people to risk
oriented people
2. They help in the discovery of future as well as current prices
3. They catalyze entrepreneurial activity
4. They increase the volume traded in markets because of
participation of risk averse people in greater numbers
5. They increase savings and investment in the long run
 P a r t i c i p a n t s i n D e r i v at i v e m a r k e t s

Hedgers use futures or options markets to

reduce or eliminate the risk associated with price
of an asset.
Speculators use futures and options contracts
to get extra leverage in betting on future
movements in the price of an asset.
Arbitrageurs are in business to take advantage
of a discrepancy between prices in two different
markets
 What are Derivative Instruments?
A financial instrument is a document that
has monetary value or which establishes
an obligation to pay. Examples of
financial instruments are cash, foreign
currencies, accounts receivable, loans,
bonds, equity securities, and accounts
payable
Examples of Derivative Instruments
Call option. An agreement that gives the holder the
right, but not the obligation, to buy shares, bonds,
commodities, or other assets at a predetermined price
within a predefined time period.
Put option. An agreement that gives the holder the
right, but not the obligation, to sell shares, bonds,
commodities, or other assets at a predetermined price
within a predefined time period.
Forward . An agreement to buy or sell an
asset at a predetermined price as of a future
date. This is a highly customizable derivative,
which is not traded on an exchange.
Futures. An agreement to buy or sell an
asset at a predetermined price as of a future
date. This is a standardized agreement, so
that they can be more easily traded on a
futures exchange.
Swap . An agreement to exchange one
security for another, with the intent of altering
the security terms to which each party
individually is subjected
Futures
Futures are derivative financial
contracts that obligate the parties to
transact an asset at a predetermined
future date and price. The buyer must
purchase or the seller must sell the
underlying asset at the set price,
regardless of the current market price
at the expiration date
 Types of swaps
In interest rate swap financing, two parties,
called counterparties, make a contractual
agreement to exchange cash flows at periodic
intervals.
• There are two types of interest rate swaps
- Single currency interest rate swap (interest rate
swap)
- Cross-currency interest rate swap (currency swap)
 Interest rate swaps (IRS)
Interest rate swaps are forward contracts where
one stream of future interest payments is
exchanged for another based on a specified
principal amount. Interest rate swaps can
exchange fixed or floating rates in order to
reduce or increase exposure to fluctuations in
interest rates.
 Cross-currency swap
In a cross-currency swap, interest payments
and principal in one currency are exchanged
for principal and interest payments in a
different currency. Interest payments are
exchanged at fixed intervals during the life of
the agreement.
N A M E O F C O M A PA N Y: G A D O O N T E X T M I L L S L I M I T E D

• NATURE OF THE OPTION:CROSS CURRENCY SWAPS (CSS)

✓ Particulars: The Company has entered into a Cross Currency

interest rate swap arrangement amounting to PKR 155mn with banks.
Under the arrangement the principal amount is swapped with UD$
component. The Company pay six month US$ LIBOR and receive six
month KIBOR minus spread as per the arrangement. Settlements are
made on semi-annual basis. The Company has terminated the
contracts after the balance sheet date.
Source: Annual report 2008
 Name of Company: Azgard - 9
✓ Nature of Option: Cross Currency Interest rate swap ✓ Particulars: The
Company has entered into a Cross Currency interest rate

swap arrangement amounting to PKR 1,500mn with Citibank to cover various

short term facilities. The Company is liable to pay interest at 6 months LIBOR.

Source: Annual report 2007

✓ Azgard-9 was one of the first ones to undertake Cross Currency Swap in

Pakistan. Azgard-9 benefited to a large extent in the initial years from this
arrangement however now due to significant devaluation of PKR this
arrangement has exposed them to losses.
Thank you