It is fashionable to talk about different kinds of bonds, equities and insurance policies available as financial 'products'. The term 'products' is used because some believe that people buy things, they don't buy concepts. Financial products are imaginary.
They are ideas, which may not have some relationship with the natural world, and the products, which we can see, feel and use. We experience the natural world and such products in the here and now, whereas financial products exist only in relation to the future. Yet future has no reality. It is an idea in our heads. We believe that we have a future and we guess at what it might be, but we can only know what the future is when it becomes the present.
Step in to the derivatives market and you enter the world of imaginary, ideas about money and value in the future. Of course the floor of Financial Futures and options Exchange looks real enough with its bank of computers and its pugnacious and noisy young men, but what is going on is a game of ideas. After much of dawdling, hopefully we will see same passion and enthusiasm as soon as the Commodity Exchange of Pakistan starts operating.
Financial products are games. Every so often someone thinks up a new game, called a new product. However, most new products are just reworking or an extension of an old product.
Derivatives are often spoken as being new but in fact they have been around for a long time. Derivative always relate to the future. Its aim is to make something certain in the future for the purchaser of the derivative despite the fact that the future is always uncertain in any market.
The commodities futures markets are now huge and dependent on computers talking to one another to record the sale and arrange for the transaction to be carried out, but the rationale of their basic operation is as straightforward.
There is buying and selling of currencies and bonds the future markets, where there is a promise to sell or buy at a future date. Star-crossed when Pakistan starts its operations which it has been constantly postponing would be limited to yarn, gold and cotton in the primarily while on the other hand there is an extensive scope in this domain.
The National Commodity Exchange Ltd (NCEL) was firmly incorporated on April 20, 2002, it was authorized by the SECP on May 16, 2002. However, it plans to start its operations live on track by the end of June 2004. Its paid-up capital is Rs40 million (post ZBT) and its authorized capital is Rs50 million.
The KSE holds 40 per cent, the LSE 10 per cent and the ISE 10 per cent. Apart from this the Pak Kuwait Investment Co. grasps 10 per cent and the Zarai Taraqiati Bank Ltd holds 10 per cent of the shares (approved by the BOD).
In the future they would be conducting contracts in rice, sugarcane, wheat, financial derivatives, crude oil and oil product imports, palm oil import but initially they would be trading in gold and cotton yarn (their major products).
In the long run there would be immense opportunities with effects, which will be, felt and trigger throughout our economy. The managing director of the NCEL says: "We are talking to the major players in the agri-financial sector to join hands with us.
The market is functioning and at present there is price distortion and wide spreads in rates. There is abstinence of standardization. There is complete counter party risk e.g., the sugarcane farmers sell their crops to mills and they don't get paid for two years.
The small tenent farmers in Pakistan are not organized; in fact the middlemen manipulate them. This bends to complete price manipulation in commodity. In such a situation there will be narrow spread prices to be listed on the exchange quality standardization.
The counter party risk will disappear and there would be easy pricing and financing which the exchange would provide a platform for everyone to see the prices in the market. Ultimately, the aim of the NCEL is to provide an opportunity to the farmers in the market to phase out the middlemen and get them fair market prices.
The derivatives market exists in order to transfer risk. There is no escape from risk. There is only freedom to choose which risk you want to take. One way of dealing with risk where there is a great deal of money at stake is to buy into or hedge your funds.
Hedge funds are not concerned with balancing risk but with making profit. They assume risk by using the money put into them by their investors as well as by using funds which were borrowed to increase the scale and risk of their activities in arbitrage strategies (taking advantage of small price differences in different markets) in derivatives. This is not hedging but speculation.
Why is there indeed a need for a futures market? In other words, might this not merely the invention of a legalized form of gambling, another unnecessary evil? Certainly that has been suggested by many, on more than one occasion. One might even ask why a futures market in anything?
The fact is that, whether we like it or not, we deal in futures all the time. The housewife who buys more than she immediately needs because a given product is on sale; the butcher who contracts for delivery of at an agreed price months in advance of his anticipated sales: the weaver who agrees to deliver his cloth at a future date, long before the product is ready; the wholesaler who builds inventory in advance of anticipated demand.
Isn't the investor in real estate speculating in futures? Isn't the farmer doing the same when he plants his crop? Surely a securities analyst is speculating in futures when he gives a buy recommendation on a particular stock on the basis of his projection of future earnings.
Doesn't the buyer for a department store take into consideration the same elements that go into futures market trade? What is the supply, what is the demand, what is the trend? Indeed, there are thousands of everyday examples in business and social life that inherently include the elements of futures trade and futures speculation. Dealing in futures is an ordinary, daily occurrence.
Not that the financial world is unanimous in regarding speculation as bad. The central banks might fear that operations of the hedge funds are adding to the volatility in the world capital markets and so creating instability in banking which could lead to the collapse of one bank, triggering a domino effect on others and bringing them all down.
Are you looking for an investment with good risk/reward potential? Are you a good decision-maker? Do you like a challenge that is fast-paced and exciting? Are you willing to accept risk? Maybe you are looking for a way to diversify your portfolio of stocks and commodities, or hedge your equity holdings in volatile markets?
If so, the futures and options on futures markets at the National Commodity Exchange Limited (NCEL) provides a number of opportunities for those seeking profit or risk management.
With futures and options on futures, the ability to buy and sell provides ample trading opportunities, while leverage helps to magnify your gains and losses. It emphasizes that it is the first geographically neutral exchange.
The NCEL is indeed the first to introduce the concept of "the central counter party". One of the main key drivers for success of the NCEL would be that it is the first adequately integrated electronic exchange proficient of handling financial futures and the first to provide liquidity by growers, exporters, importers, intermediaries, the FI's and risk takers.
As per exchange priorities risk takers (speculators) come at the end as far as liquidity is concerned, but according to various independent analyses it is the risk taker who will ultimately run and dictate the newly upcoming commodity exchange in Pakistan.
Though it seems that the NCELs vision and mission is "to provide an opportunity to the farmers to farm for the market" but there is a high risk that the exchange would be dominated by the "speculative" forces which are prevalent in Pakistani financial markets and manage dictatorially.
In the most general sense, futures are all about future prices. People who trade futures essentially trade agreements about the price they will buy or sell something for at a specific date in the future - usually the nearby future, within a few months or less. These agreements are contracts that also specify the quantity and other details of the commodity being traded.
Like the hare in the Aesop's fable commodity prices tend to take quick, early lead in inflation cycles, but ultimately loose the race, falling in real terms. Higher demand for final goods increase the demand for commodity inputs and even though the inflation impetus may start in final goods markets the first visible increase in prices may be in the flex-price commodity markets.
As commodities are widely traded internationally this aggregate demand signal would most likely occur when strong domestic demand is not offset by the weak foreign demand. These demand-induced commodity price run-ups presumably will be concentrated in industrial materials. Secondly, commodity prices and broad inflation are directly linked because commodities are an important input to production.
The third linkage between the commodity prices and future inflation stems from the first two because commodity prices respond quickly to general inflation pressures.
Futures contracts are traded through an auction like process, with all bids and offers on each contract made public. Through this, a market price is reached for each contract, based primarily on the laws of supply and demand. This forum is a useful and an essential element in a free market economy.
It is a surprise to know that the futures markets rarely are used to actually buy or sell the physical commodity or financial instrument being traded; they're used for risk management and for some people, investment and profit seeking.
In regard to a question the NCEL, MD explained that we are actually designing our own standards by the variables tick size, the contract size and delivery amount as per any other exchange in the world but ours would be in rupees. The contract is based exactly the way the world functions e.g., the CME and the IMM. We are also signing up with the Bloomberg to show our rates in the world.
Dating back to the 1800s (and in some ways, back to the earliest beginnings of commerce), the futures markets were initially developed to help agricultural producers and consumers manage the price risks they faced with harvesting, marketing, and processing annual crops.
The futures industry still serves those markets, but has expanded with the economy-beyond its agricultural roots. Today, futures are also essential to the financial markets, and provide risk management tools related to foreign exchange, interest rates, and equity and commodity indexes.
The futures markets have succeeded and thrived because they have attracted two kinds of traders - "the hedgers" (those seeking to minimize and manage price risk) and "the speculators" (those willing to take on risk in the hope of making a profit). The success of the industry is also related to the variety of futures contracts that have been developed to meet the needs of today's complex business enterprises.
In injunction for a future market to be prosperous, there ought to be a colossal aggregate of participants in the market. In a 'thin market', which is one where there are relatively inconsiderable participants, the market will not be proficient.
An efficient market, also called a continual market or a liquid market, is one in which there are small variations between bids and offers and small variations between subsequent transactions. If there were large number of buyers or sellers actively competing with one another, the spread between the bid and offer would be small.
Which means that the variations between posterior trades will all be small. However, if there are few participants in the market, the spread between bids and offers will be relatively wide and there will be large fluctuations between consecutive transactions. This is known as a volatile market.
