Derivatives Market in Nepal

CONTENTS:

1. INTRODUCTION TO DERVATIVE MARKET IN NEPAL

2. HISTORY OF DERIVATIVE MARKET

3. TYPES OF DERIVATIVE CONTRACTS IN NEPAL

4. BENEFITS OF DERIVATIVE MARKET

5. DRAWBACKS OF DERIVATIVE MARKET

6. THE PRESENT SITUATION OF DERIVATIVE MARKET IN NEPAL

7. CONCLUSION

INTRODUCTION TO DERIVATIVE MARKET:

Derivatives are financial contracts or financial instruments whose prices are derived from the price of something else (known as the underlying). The underlying price on which a derivative is based can be that of an asset (e.g., commodities, equities (stock), residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI) i.e. inflation derivatives), or other items. Credit derivatives are based on loans, bonds or other forms of credit. Derivatives allow risk about the price of the underlying asset to be transferred from one party to another. The main types of derivatives are forward, futures, options and swaps.

The word “Derivative” is a magic word. There can be derivative of everything e.g., commodities, equities (stock), residential mortgages, commercial real estate, loans, bonds), an index (e.g., interest rates, exchange rates, stock market indices, consumer price index (CPI) i.e. inflation derivatives), or other items. So there is scope for every one and every sector like growers, traders, exporters, importers, financial institutions, industrialists, investors and end users.

HISTORY OF DERIVATIVE MARKET (IN NEPAL):

Markets for futures trading were developed initially to help agricultural producers and consumers manage the price risks they faced harvesting, marketing and processing food crops each year. Today, futures exist not only on agricultural products, but also a wide array of financial, stock and forex markets.

The world's oldest established futures exchange, the Chicago Board of Trade, was founded in 1848 by 82 Chicago merchants. The first of what were then called "to arrive" contracts were flour, timothy seed and hay, which came into use in 1849.

Meanwhile, what is now the USA's largest futures exchange, the Chicago Mercantile Exchange, was founded as the Chicago Butter and Egg Board in 1898.
In 2007, CME and CBOT officially merged, and are now collectively known as CME group Inc., the worlds largest and most diverse derivatives exchange.

In the 21st century, online commodity trading has become increasingly popular, and commodity brokers offer front-end interfaces to trade these electronic-based markets. A commodities broker may also continue to offer access to the traditional pit-traded, or open-outcry, markets that established the commodity exchanges.

In Nepal, three commodities exchanges — Commodities & Metal Exchange Nepal Ltd (COMEN), Mercantile Exchange Nepal Ltd (MEX) and NDEX — are working to provide investment opportunities to around 2,000-3,000 people. The majority of transactions of community exchange are in gold and crude oil, products not produced in Nepal.

In Nepal, commodity market is introduced by Commodities Exchange Nepal Ltd (COMEN). COMEN have been providing trade services in agriculture goods. It will build warehouses to improve services. It also applied to Securities Board of Nepal (SEBON) on November 11, 2009 for starting a new stock exchange.

Now with new vision and new technology Mercantile Exchange Nepal Ltd. (MEX) has been established. MEX has also made immense contribution in raising awareness about and catalyzing implementation of policy reforms in the commodity sector. MEX is the first Exchange to take up the issue of differential treatment of speculative loss. It is also the first Exchange to enroll participation of high net-worth corporate securities members in commodity derivatives market.

Nepal Derivative Exchange (NDEX) is an Electronic Commodity and derivative Market which provides online state-of-the-art platform for traders to buy and sell Commodities and derivatives products efficiently and at a justified price. NDEX aims to facilitate trading on commodities, metals, energies, currencies and others.NDEX was developed considering all the sophisticated needs of traders. It contains tools and information that a trader needs to successfully engage in trading and investment. Here one will find the easy-to-use and pioneering trading software that gives fast and accurate prices of various products. At NDEX, people can trade in its products through its software and fulfill their respective needs.NDEX is a professionally managed on-line multi commodities and derivatives exchange. NDEX is a public limited company incorporated on November 20, 2008 under the Companies Act, 2063.

TYPES OF DERIVATIVE CONTRACTS IN NEPAL:

There are two distinct groups of derivative contracts, which are distinguished by the way that they are traded in market:

1. Over-the-counter (OTC) derivatives

These derivative contracts are traded directly between two parties, without going through an intermediary product. For example, forward rate agreements or exotic options.

2. Exchange-traded derivatives

These derivative contracts are traded via derivatives exchanges. Here the exchange acts as an intermediary and takes initial margins from both sides of the trade.

The difference to OTC is that there is no direct link between the parties, but the exchange is playing the counterpart role.

The most used derivatives are:

· Economic derivatives

They pay off according to economic reports as measured and reported by national statistical agencies.

· Energy derivatives

They pay off according to a wide variety of indexed energy prices. They are classified as either physical or financial. Physical derivatives include the obligation to actual delivery of the underlying energy commodity, whatever this may be

· Freight derivatives

They represent trading in future levels of freight rates, primarily for dry bulk carriers and tankers. They include exchange traded futures and options as well as freight forward contracts. They are used by ship owners and operators, oil companies, trading companies and grain houses as tools for managing freight market risks

· Insurance derivatives

· Weather derivatives

They can be used by organizations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions. Here the underlying asset rain/temperature/snow has no direct value. Farmers can use weather derivatives to hedge against poor harvests caused by drought or frost, theme parks may want to insure against rainy weekends during peak summer seasons, and gas and power companies may use heating (HDD) or cooling degree days (CDD) contracts to smooth earnings.

· Credit derivatives

They transfer credit risk from a protection buyer to a credit protection seller. Credit derivative products can take many forms, such as credit default options, credit limited notes and total return swaps.

BENEFITS OF THE DERIVATIVE MARKET (OF NEPAL)

• Growers, traders, exporters, importers can insure their risk from the fluctuating product prices by taking futures position in the derivative market.

• Financial institutions can mitigate or even eliminate 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 so that they can get away from the risk of increase in price.

• Utilizing this market, 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.

DRAWBACKS OF THE DERIVATIVE MARKET(OF NEPAL)

Different kinds of risks are faced by participants in derivatives market:

• 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.

THE PRESENT SITUATION OF THE NEPALESE DERIVATIVE MARKET

The Nepalese Derivative Market is very young. The investors haven’t been able to analyze the situation properly. They are not smart enough to study the situation and take good judgments. There is no regulating body in the Nepalese derivative market. Most of the investors find the derivative market as some sorts of gambling place where people gather together for gambling purpose and try to make out high returns with least investments. But it is very important that one must realize that there is a difference between gambling and speculation and the future markets are not like “Satta” markets.

Participants in physical markets use futures market for price discovery and price risk management. In fact, in the absence of futures market, they would be compelled to speculate on prices. Futures market helps them to avoid speculation by entering into hedge contracts. It is however extremely unlikely for every hedger to find a hedger counterparty with matching requirements. The hedgers intend to shift price risk, which they can only if there are participants willing to accept the risk. Speculators are such participants who are willing to take risk of hedgers in the expectation of making profit. Speculators provide liquidity to the market; therefore, it is difficult to imagine a futures market functioning without speculators.

So there comes a question like what is the difference between a speculator and a gambler. Speculators are not gamblers, since they do not create risk, but merely accept the risk, which already exists in the market. The speculators are the persons who try to assimilate all the possible price-sensitive information, on the basis of which they can expect to make profit. The speculators therefore contribute in improving the efficiency of price discovery function of the futures market.

But it doesn’t mean that the speculation is always good for the economy of a country. Over-speculation needs to be curbed because it can lead to distortion of price signals. For this in case of the Nepalese Derivative Market, the positions held by speculators are subject to certain margins.

In the Nepal’s economy, there are various factors that are having a real negative impact on the overall performance of the Nepalese markets. First comes is the power supply problem. With the increasing temperature and drought in the country, the power supply is getting poor. Till the month of Magh-2066, the country is facing 11 hrs of load shedding. Because of this, the manufacturing and other industries are suffering a heavy loss everyday. Also, the global economic crisis has forced the industries to cut off the number of employees and thus prevent them from the probable future crisis. The continuous political instability has also hit hard to the market.

CONCLUSION:

All in all the derivatives market in Nepal does not have a longer history and thus seems to be still underdeveloped. Government has prepared some concepts on the derivatives market for risk minimizing for farmers but still the investors are motivated towards earning abnormal profits from speculation. Even though the focus is for agricultural risk management the overall utilisation of the market is for speculation. People are utilizing the derivative market for speculating rather than risk hedging. Existing commodities exchanges and the people who take part in the market phenomena should be aware to keep the future of the derivatives market bright. The derivatives market needs to focus on variery of commodities that can manage the risks of that particular commodity. The derivative market on the resources available locally can help develop the derivatives market as well the infrastructrures making people as well as the country resourceful. The people should be aware of these markets and the role it can play in their economic elevation. It can bring the stability in the market condition of derivatives in nepal. It’s solely the effect of role that people can play to balance the derivatives economy. How fast and with what level of ease does the economy overcome the imbalance is what determines the future of the Nepalese Derivative Market

Management Information System

There is no universally accepted definition of MIS and those that exist reflect the emphasis and prejudices of particular writer.

Gordon B. Davis

"MIS is an integrated user machine system, which provides information to support the operations, management analysis and decision making functions. This system utilizes:

- Computer H/W and S/W

- Manual procedures

- Models for analyzing, planning, control and decision making

- A database

Jerome Kanter

"A system that aids management in making, carrying out and controlling the decisions".

James O'Brien

"An information system that can be any organized combination of people, hardware, software, communication networks and a data resource that collects, transforms, and disseminates (distribute) information in an organization."

Some other definition are:

1. The MIS is defined as a system which provided information support for decision making in the organization.
2. The MIS is defined as an integrated system of man and machined for providing the information to support the operation, the management and the decision making function in the organization.
3. The MIS is defined as a system based on the database of the organization evolved for the purpose of providing information to the people in the organization.
4. The MIS is defined as a computer-based information system.

“The MIS is a system to support the decision making function in the organization. In today’s world, the MIS is a computerized business processing system generating information needs for decision making to achieve the corporate objectives of the organization.”

An information system generates information using data. If the information system generates information useful for managers in planning and control, the whole system is called management information system.

The management information system uses computers and communication technology to deal with these points of supreme importance:

- Handling of a voluminous data.

- Confirmation of the validity of data and transaction.

- Complex processing of data and multidimensional analysis.

- Quick search and retrieval.

- Mass storage.

- Communication of the information system to the user on time.

- Fulfilling the changing needs of the information.

The Subject of MIS is broader than the words Management information system imply. This subject includes managers, but it also includes all of the other people in an organization and the structure and design of the organization as well.

MIS is not new; only its computerization is new. Before computers, MIS techniques exited to supply managers with the information that would permit them to plan and control operations. The computer has added one or more dimensions, such as speed, accuracy, and increased volumes of data, that permit the consideration of more alternatives in a decision.

The Scope and Purpose of MIS is better understood if each part of the term is defined. Thus,

Management

Management comprises the processes or activities that describe what managers do in the operation of their organization: Plan, Organize, Initiate and control operations.

Because of decision making is such a fundamental prerequisite to each of the foregoing processes, the job of an MIS becomes that of facilitating decisions necessary for planning, organizing and controlling the work and functions of the business.

Information

Information consists of data that have been retrieved, processed, or otherwise used for informative or inference purpose, argument, or as a basis for forecasting or decision making.

System

A system can be described simply as a set of elements joined together for a common objective. A subsystem is part of a larger system with which we are concerned. For our purpose the organization is the system, and the parts (divisions, department, functions, units etc.) are the subsystems.

The system concept of MIS is optimizing the output of the organization by connecting the operating subsystems through the medium of information exchange. (The concept of synergy applied in the integration of subsystem)

Characteristic of Management Information System:

Jerome Kanter in his work titled "Management Information System" mentioned several characteristics of management information system, which are:

Management information system is management oriented:

The design of management information system takes care of the managers, who need information to make decision. The development of the system starts after deciding the management needs and keeping in view the overall objectives of the management.

Management Directed:

Since management information system requires heavy planning and investment, management is deeply involved in the design, implementation and the maintenance of system.

Integrated system

Five Ms- Men, Machine, Money, Materials and Methods are recognized as an important factor and its effective use contributed to the success of the management. Management information system is the 'catalyst and the never center' of the organization. It has a number of subsystems. In order to make these subsystem effective; It becomes necessary that they have to be viewed as an integrated system, so that the result may be gained. It binds together database of all the subsystem of the business system and through information sharing integrates the organization.

Avoid redundancy in Data Storage:

Since management information system is an integrated system it avoids unnecessary, duplication and redundancy in data gathering and storing.

Common data flow:

To achieve the objectives of integration and to avoid duplication and redundancy in data gathering, storage and retrieval, data capturing is usually confined to original sources and it is done only once. Common data flow tries to utilize minimum data processing efforts and strives (attempt) to minimize the number of output documents and reports.

Heavy planning element:

Design and implementation of management information system requires detailed planning of activities such as acquisition and deployment (use) of hardware, software, data processing operations, information presentation and feedback.

Subsystem Concept:

Management information system gives provision for breaking into various subsystems based on the activity as well as the function of the organization, so that effective implementation of each subsystem is possible in time.

Common database:

It acts as the master that holds the functional subsystem together. It achieves this aim by allowing access to different master files of data to several functional subsystems.

Flexibility and the ease of use:

Management information system has to be designed flexible enough to accommodate new requirements. The system is easy to operate so that not much computer skill is required on the part of the user to access the database for information or for carrying out special analysis of data.

Importance of MIS in Business

Why study information systems and information technology? That's the same as asking why anyone should study accounting, finance, operations management, marketing, human resource management, or any other major business function. Information systems and technologies (including E-business and E-commerce technologies and applications) have become vital component of successful businesses and organizations. They thus constitute an essential field of study in business administration and management. That's why most business majors must take a course in information systems. Since you probably intend to be a manager, entrepreneur, or business professional, it is just as important to have a basic understanding of information systems as it is to understand any other functional area in business.

MIS is viewed and used at many levels by management.

MIS helps business to:

- Enhance communication among employees.

- Deliver complex material throughout the institution.

- Provide an objective system for recording and aggregating information.

- Reduce expenses related to labor-intensive manual activities.

- Support the organization's strategic goals and direction.

- Because MIS supplies decision makers with facts, it supports and enhances the overall decision making process.

- MIS also enhances job performance throughout an institution. At the most senior levels, it provides the data and information to help the board and management make strategic decisions. At other levels, MIS provides the means through which the institution's activities are monitored and information is distributed to management, employees, and customers.

- MIS is a critical component of the institution's overall risk management. MIS is used to recognize, monitor, measure, limit, and manage risks.

- Management can use MIS to measure performance and manage resources.

Importance of MIS can be further summarized in following Points:

1. Meeting global challenges

2. Taking advantages of opportunities in market

3. Linking groups whose functions are different.

4. Enhancing the productivity of worker and quality of goods.

1. Meeting Global Challenges:

From the initial age when person started doing business, the size, complexity and cost of the business has increased many folds (times). Initially the businesses were done in some small geographical area with very less complexity. There was no need of keeping records and be aware of the situations because they were not changing frequently. There were no big challenges but in current scenario when the technology is so advanced and the changes are so frequent it is essential for every business house to be aware of the changes which are taking place globally.

The whole world is now treated as global village. Due to of this every business house which are expanded globally have to tackle some challenges which may arise globally or locally.

MIS works as assistance to finding out the solution of the challenges. MIS have different capabilities of problem recognition, analysis and finding a solution.

2. Taking Advances of opportunities in market:

The current market has become ready for several changes either conventional or unconventional and these changes are so fast that if any business house is dealing in it then the chances of expansion or taking advantages from situation will be abolish. So to take full advantage of opportunities which are available in market two things are very critical (a) identification of opportunity and (b) taking decision very quickly by communicating the information to the right person and these works are perform very effectively by the MIS.

3. Linking groups where the function are different:

Due to the diversity of the current days business every business houses have their different groups which are designed for encountering different types of situation and the demand of the market. The major problem in this situation arises due to the lack of some common point between those groups. To coordinate them, a very quick and effective communication medium is required which is provided by any MIS by analyzing the groups effectively.

4. Enhancing the productivity of worker and quality of goods:

Business can be run very effectively if right person is selected for right job and timely information is supplied to them for doing this. MIS is a tool which can analyze the capabilities of the person, which can also identify the circumstances in which the productivity can be enhanced.

The most important aspect is how to coordinate between the quality, cost and the expectation and demands of the user. An appropriate blend of the production, cost and demand of the users increase the quality of the goods. For doing this the information about the strategies of the competitors is also required and a carefully designed MIS can take care of all these aspects.

q Data: raw facts q Information: collection of facts organized in such a way that they have value beyond the facts themselves Types of Data

Information Concepts

The process of transferring data into information

Information:

• Data that have been shaped into a form that is meaningful and useful to human beings.

– Data are:

» Stored Facts

» Inactive (they exist)

» Technology-based

» Gathered from various sources

– Information is:

» Presented facts

» Active (it enables doing)

» Business-based

» Transformed from data

Data Vs. Information

Attributes/Characteristics of Information

Information and Management:

· Improves presentation of an entity.

· Updates the level of knowledge.

· Has a surprise value.

· Reduce uncertainty.

· Aids in decision making.

Information Classifications:

Information may be classified in many ways including:

By Source	eg. Internal, external, primary, secondary etc.
By Nature	eg. Quantitative, qualitative
By Level	eg. Strategic, Tactical, Operational
By Time	eg. Historical, Present, Future
By Frequency	eg. Continuous, Hourly, Daily etc
By Use	eg. Planning, Control, Decision Making etc
By Form	eg. Written, Visual, Oral
By Occurrence	eg. at planned intervals, occasional etc.
By Type	eg. Detailed, Summarized etc.

Cost of Information Vs. Value of Information

- The cost of information means the expenses on taking information from informants. Example: Telephone calls, meeting expenses, survey expenses etc.

- The value of information means that how much information is useful in its purpose. The example is that the information which is taken from telephone calls or meeting is how much success for achieving the goal.

- Cost of information = mainly valued in monetary term.

- Value of information = not always expressed in monetary term.

- What we have loss for getting the information is cost of information

- What we have gain from the information is value of information.

Redundancy and Inconsistency

- Redundancy: more than the need.

- If anything is over than the need than it is called redundancy.

- Duplication copy is redundancy.

- Inconsistency: no fixed state

- If there is change or if there is no fixed state then it is said to be inconsistence.

Redundancy and Inconsistency both are bad for quality information. A good information must be consistence and must sufficient enough (conciseness).

IS Strategies

IS Strategies

Cost Leadership (low cost producer)

– Reduce inventory (JIT)

– Reduce manpower costs per sale

– Help suppliers or customers reduce costs

– Reduce manufacturing costs (process control)

Differentiation

– Create a positive difference between your products/services & the competition.

– May allow you to reduce a competitor’s differentiation advantage.

– May allow you to serve a niche market.

Innovation

– New ways of doing business

– Unique products or services

– New ways to better serve customers

– Reduce time to market

– New distribution models

Growth

– Expand production capacity

– Expand into global markets

– Diversify

– Integrate into related products and services.

Alliance

– Broaden your base of support

• New linkages

– Mergers, acquisitions, joint ventures, “virtual companies”

– Marketing, manufacturing, or distribution agreements.

Value chain Analysis

ð The term value chain describes a way of looking at a business as a chain of activities that transform inputs into outputs that customer's value.

ð Value chain analysis views the organization as a sequential process of value-creating activities, and attempts to understand how a business creates customer value by examining the contributions of different activities within the business to that value.

System Concepts

- System is defined as a set of elements arranged in an orderly manner to accomplish an objective.

- More simply, it is a group of interrelated or interacting elements forming a unified whole.

Examples:

Systems	Elements	Objective
Computer	Input, process and output devices. OS, packages, DBMS	Process the data and provide information.
Business Organization	People, plant and machinery, product and services, transport	produce goods and services to achieve the business objectives-profits

- It is to be noted that a system is not a randomly arranged set. It is arranged with some logic governed by rules, regulations, principles and policies.

- If a system in any field is analyzed, then you will find three basic parts:

Input:

Input involves capturing and assembling elements that enter the system to be processed. For example, raw materials, energy, data, human effort etc.

Processing:

It involves transformation processes that covert input into output. Examples are manufacturing process, the human breathing process or mathematical calculation.

Output:

Output involves transferring elements that have been produced by a transformation process to their ultimate destination. For example, finished products, human services, management information etc.

The system concept becomes even more useful by including two additional components: Feedback and control. A system with feedback and control component is sometimes called a cybernetic system, that is self monitoring, self-regulating system.

A system may have single input and multiple outputs or may have several inputs and outputs.

- For example, a business organization system has several inputs and multiple objectives such as sales, profit, service and growth.

				Output 1
				Output 2
				Output 3
		System with many inputs and outputs

System Classification

Some system examples:

- Information system

- Computer based information system

- Transaction processing system

- Workflow system

- Management information system

- Artificial intelligence (AI) systems

- Virtual reality systems

- Geographic Information Systems (GIS)

- Decision support system etc

System Performance

q Efficiency: output/input

q Effectiveness: extent to which system attains its goals

General model of System

- The general model of system consist input, process and output.

- All the systems operate in an environment. The environment may influence the system in its design and performance.

- When a system is designed to achieve certain objectives, it automatically sets the boundaries for itself. System works inside the boundary. The environment is outside the boundary.

- In some cases, it is fairly simple to define what is part of the system and what is not. In other, the person studying the system may have to define the boundaries. Some example of boundaries are:

o Human system = Skin, hair, nail etc

o Automobile system = Automobile body, tire

The environment influences the choice of inputs, the method of processing and the nature and contents of the outputs.

- Since the system is designed for specific objectives/outputs, the designer provides a filter around the system to control the influence on the system.

Subsystem concept

System is an arrangement of smaller systems in a logical order. When many smaller systems together make a larger system, the smaller systems are called the subsystems of the larger system.

- A large system can be decomposed into smaller subsystems.

- The decomposition of a system into subsystems can be a serial form of it could be in a matrix form as illustrated in the following figure:

- In any system, the inputs are transformed into the output by a process.

- We say that the process is transparent to us when we are able to understand the system. But, if the process of input transformation is not visible and understandable then we say that the system is a black box.

Open Vs. Closed System

- If a system is functioning in isolation from the environment, then the system does not have any exchange with the environment nor is it influenced by the environmental changes. Such a system is called a closed system.

- If the system has exchange with the environment and is influenced by the environment then it is called an open system.

- All kinds of accounting systems such as cash, stocks, attendance of employees are closed systems. Most of the systems based on rules and principles are closed system. The system of manufacturing are also closed system.

- The system which are required to respond to changes in the environment, such as marketing, communication and forecasting are open systems.

Components of Information System

People Resources:

F Specialist - System Analysts, Software developers, system operators.

F End users - anyone else who uses information systems.

Hardware Resources

F Machines - computers, video monitors, magnetic disk drives, printers, optical scanners.

F Media - floppy disks, magnetic tape, optical disks, plastic cards, paper forms.

Software Resources

F Programs - operating system programs, spreadsheet programs, word processing programs, payroll programs

F Procedures - data entry procedures, error correction procedures, paycheck distribution procedures.

Data Resources

F Databases - that hold processed and organized data

F Knowledge bases - that hold knowledge in variety of forms such as facts, rules and case examples about successful business practices.

Network Resources

F Communication media - Twisted pair wire, coaxial cable and fiber-optic cable; and microwave, cellular and satellite wireless technologies

F Network support - modems, network operating systems and internet browser packages.

Types of Information System

Trends in Information System