Exchange traded derivatives( Sept. 2008)

Transcription

1 7. Analysis of Secondary Statistical Data. This chapter deals with the analysis of available local as well as global secondary data regarding trading in various segments of derivatives. The major sources of data were Publications of Bank for International Settlement, ISDA survey of Global fortune 500 companies and National Stock Exchange of India (NSE). The purpose of this analysis was to find out and compare the global pattern of trading in derivatives with trading of derivatives in India. In the following section, analysis of the available database is done. 7.1 Secondary Statistical Data Analysis using graphs: Graph 7.1: Exchange Traded Derivatives for September 2008 Equity index options 9% Exchange traded derivatives( Sept. 2008) Currency options 0% Interest rate options 59% Currency futures 0% Equity index futures 2% Interest rate futures 30% Interest rate futures Equity index futures Currency options Currency futures Interest rate options Equity index options (Exchange traded derivatives: Data source: Bank for International Settlement) The above graph shows the maximum coverage by interest rate options followed by interest rate futures for quarter ended Sept Equity index related derivatives cover about eleven percentages. While currency derivatives are less than one percentage. 177

2 Graph 7.2: Exchange Traded Derivatives from 1993 to 2008 Derivatives (Exchange traded) $ b illion s Dec.1993 Sep.1994 Jun.1995 Mar.1996 Dec.1996 Sep.1997 Jun.1998 Mar.1999 Dec.1999 Sep.2000 Jun.2001 Mar.2002 Dec.2002 Sep.2003 Jun.2004 Mar.2005 Dec.2005 Sep.2006 Jun.2007 Mar.2008 Interest rate futures Equity index futures Currency options Currency futures Interest rate options Equity index options (Exchange traded derivatives: Data source: Bank for International Settlement) The abovementioned graph explains the same thing just explained with total amount in billion dollars. Graph 7.3: OTC Interest Rate Derivatives from 1998 to 2008 OTC interest rate Derivatives in (%) Forward rate agreements Interest rate swaps Options Dec.98 D e c. 9 9 Dec.00 D e c. 0 1 Dec.02 D e c. 0 3 D e c. 0 4 D e c. 0 5 D e c. 0 6 D e c. 0 7 (OTC Derivatives: Data source: Bank for International Settlement) 178

3 The above graph explains the division of interest rate derivatives among FRA, IRS, and interest rate options. Almost seventy five to eighty percentages of total derivatives traded were by way of IRS. FRA and Options share nearly equal of ten percentages each. Graph 7.4: OTC Forex Derivatives Contracts (in %) from 1998 to 2008 OTC Forex Derivatives Contracts in (%) Forwards and forex swaps Currency swaps Currency Options Dec.98 Dec.99 Dec.00 Dec.01 Dec.02 Dec.03 Dec.04 Dec.05 Dec.06 Dec.07 (OTC Derivatives: Data source: Bank for International Settlement) The graph explains division of Forex derivatives among Forward and Forex Swap, Currency swap and currency options. Forwards are the maximum traded derivatives in Forex followed by Currency swaps and currency Options Graph 7.5: OTC Equity Linked Derivatives (in %) from 1998 to 2008 OTC Equity Linked Derivatives in (%) Equity-Forwards and swaps Equity-Options D e c. 9 8 D e c. 9 9 D e c. 0 0 D e c. 0 1 D e c. 0 2 D e c. 0 3 D e c. 0 4 D e c. 0 5 D e c. 0 6 D e c. 0 7 (OTC Derivatives: Data source: Bank for International Settlement) 179

4 In the equity derivatives segment Options dominate the OTC market. But equity options growth is found in a last few quarters. Graph 7.6: Index and Stock Derivatives Turnover (in %) for to at NSE Index v/s Stock Derivatives (Turnover in %) Index deri Stock derivativ (Data source: In India, Equity Index Derivatives are more traded than Stock Derivatives for This is apparent from the above percentages graph. The graph shows the changing trend. Graph 7.7: Futures and Options Turnover (in %) from to at NSE Futures v/s Options(Turnover in %) Futures(General) Options(General) (Data source: In Indian exchange traded equity derivatives market, futures are more popular than options. But from the last two years options are also growing in terms of turnover. The above fish shaped graph explains this. 180

5 Graph 7.8: Index and Stock Derivatives from to at NSE Index v/s Stock Derivatives Number of contracts (in %) Index Deri(Option+ Futures) Stock Deri(Option+ Futures) The similar scenario is found in terms of number of contracts. Graph 7.9: Futures and Options Contracts (in %) from to Futures v/s Options (Number of Contracts in %) Futures (stock+ Index) Options(stock+ Index) In the following pie charts, the comparative analysis is given between year and Year This shows change in preferences to investors for various derivatives. For example index option covers thirty-four percentages of total market, which was just four percentages in

6 Graph 7.10: Turnover of Derivatives (in %) for Turnover of Derivatives for Index options 34% Stock option 2% Index futures 32% Index futures Stock futures Index options Stock futures 32% Stock option (Data source: Graph 7.11: Various Derivatives Contracts for Derivatives contracts for year Index options 4% Stock option 25% Interest Rate option 0% Stock futures 47% Index futures 24% (Data source: 182

7 Graph 7.12: Various Derivatives Contracts for Derivatives Contracts for Index options 32% Stock option 2% Stock futures 34% Index futures 32% Index futures Stock futures Index options Stock option Graph 7.13: Turnover of Derivatives Contracts from to Year-wise Turnover of Derivatives contracts Turnover in (%) Index futures Stock futures Index options Stock option Interest Rate option Year (Data source: The above graph shows the turnover of various derivatives since year It shows many ups and downs of preferences for equity derivatives to investors, from time to time. 183

8 7.2 Other statistical findings: The OTC interest rate Derivatives have been traded in the following order of preferences / average proportion. 1. Interest Rate Swap (77%) 2. IR Options (14%) 3. Forward Rare Agreement (9%) The OTC forex derivatives have been traded in the following average proportions. Table 7.1: Trading of OTC forex Derivatives (in %) Forwards and forex swaps % Currency swaps % Currency Options % The equity-linked derivatives (OTC) have found to be the following order of preferences. Table 7.2: Trading of Equity Linked OTC Derivatives (in %) Equity-Forwards and swaps % Equity-Options % The following table shows the average percentage of various equity derivatives traded between and at National stock Exchange. Table 7.3: Trading of Equity Derivatives (in %) at NSE between and Index Futures Stock Futures Index Options Stock Options No. of Turnover No. of Turnover No. of Turnover No. of Turnover contracts(%) (%) contracts(%) (%) contracts(%) (%) contracts(%) (%) The following table shows the average percentage of various equity derivatives traded between and at National stock Exchange of India. Table 7.4: Trading of Equity Derivatives (in %) at NSE between and Index Futures Stock Futures Index Options Stock Options Turnover No. of Turnover No. of Turnover No. of (%) contracts(%) (%) contracts(%) (%) contracts(%) No. of contracts(%) Turnover (%)

9 1. Stock futures (43.33 %) 2. Index futures (35.48 %) 3. Index options (18.96 %) 4. Stock options (02.23 %) The division of various OTC Derivatives contracts (average between Dec-2004 and June 2008) is shown below. (In %) Table 7.5: Division of OTC Derivatives Traded between Dec and June 2008 (in%) Interest rate contracts Unallocated Foreign exchange contracts 9.89 Credit default swaps 6.94 Equity-linked contracts 1.65 Commodity contracts 1.54 The division of various Exchange traded Derivatives contracts in the world (average between Dec-1993 and September 2008) is shown below. (In %) Table 7.6: Division of Exchange Traded Derivatives between Dec and Sept., 2008 (in %) in World Instrument (%) Average Total Interest rate options Interest rate futures Equity index options 6.99 Equity index futures 1.52 Currency futures 0.22 Currency options Analysis of ISDA survey of Global fortune 500 companies: ISDA has done derivatives survey of global fortune 500 companies for year The customized analysis of database using SPSS software is given below: There are seven Indian companies in the list of fortune 500 companies. They are Indian Oil, Reliance industries, Bharat Petroleum, Hindustan Petroleum, Tata Steel, Oil and Natural Gas Corporation and State Bank of India. All the seven firms have applied derivatives in year Only one firm uses equity derivatives. Four firms use interest rate derivatives. Five firms use commodity derivatives. All the six firms use forex derivatives. None uses credit derivatives. 185

10 There are one hundred seventy two North American companies. Out of which one hundred fifty eight firms i.e. almost 92 percent firms use derivatives. One hundred twenty eight firms (74 percent) use interest rate derivatives. Eighty percent of the firms use forex derivatives. Forty six percent of the firms use commodity derivatives. Only 25.6 % use equity derivatives. Around twenty percent use credit derivatives. There are One hundred ninety firms from Europe in the list of global fortune 500 companies. Ninety seven percent of the firms use interest rate derivatives, ninety eight percent use forex derivatives, fifty seven percent use commodity derivatives, thirty nine percent use equity derivatives, while only twenty four percent use credit derivatives. There are sixty-four Japanese companies. About ninety four percent firms use interest rate derivatives, hundred percent use forex derivatives, thirty nine percent use commodity derivatives, sixteen percent use equity derivatives, while fourteen percent use credit derivatives. There are sixty-one companies representing Asia excluding Japan but including India. Out of which seventy seven percent firms use various derivatives. The break-up of various derivatives usage is as follows: 1. Forex derivatives- 69 % 2. Interest rate derivatives- 54.1% 3. Commodity derivatives- 31 % 4. Equity derivatives % 5. Credit derivatives % Thus forex derivatives are the most important derivatives tools for Asian firms and credit derivatives are the least important derivative tools. 7.4 Comparison of similar primary research done in various countries Comparative analysis of similar primary studies (carried out in different countries) by other researchers is shown below. Lien and Zhang (2008) performed a survey on emerging derivatives markets concluding that both commodity and financial derivatives markets have grown in emerging market economies over the past few years, though the sizes of the markets are relatively small compared to those of matured economies. Lien and Zhang (2008) also stress that the underlying reasons for the negative effects are associated with the leverage nature of derivatives transactions, nontransparent reporting of transaction risks, and unsophisticated or insufficient risk management controls in financial institutions, as well as weak prudential supervision. A study was done to assess the way investors evaluate managers in accordance to their option towards using or not derivatives. Koonce et al (2007) find that investors are more satisfied with firm managers and assign a higher value to firms when managers use derivatives (that address firm risks) than when they do not. Their study also stresses the idea that investors believe that managers who use derivatives in these situations exhibit a higher level of decision-making care, than those who do not use derivatives. Moreover they have documented that these inferences about greater decision-making care do not apply to the speculative use of derivatives. 186

11 Söhnke M. Bartram, Gregory W. Brown, and Frank R. Fehle (2009) conducted a large scale study for derivatives. In this study, they examined the use of derivatives by 7,319 firms in 50 countries that together comprise about 80% of the global market capitalization of nonfinancial companies. The study was the first comprehensive global examination of hedging practices and the use of foreign- exchange, interest-rate, and commodity price derivatives. They utilized a simultaneous equations technique to examine the effect of derivatives use on other firm policies. This analysis shows that derivatives use is significantly related to other important financial characteristics such as leverage, debt maturity, holdings of liquid assets, dividend policy, and operational hedges. Another important conclusion is that firms with less liquid derivatives markets, typically in middle- income countries, are less likely to hedge. This finding is consistent with the assertions of some policy makers that derivatives could be important in limiting the ruthlessness of economic downturns in developing economies. Therefore financial policy makers could facilitate corporations' financial risk-management activities by pursuing strategies that encourage the development of local-currency derivatives markets. Ahmed Hachicha (2008) from Economic and Development Research Department, (Tunisian University of Management and Economics Sciences), brings some theoretical evidence from financial innovation (i.e., credit derivatives) and their impact in the credit market.he concludes that the process of financial innovation poses at least two key challenges for policy-makers. First, the supervisory framework needs to be constantly updated. Second, the legislative process needs to react in an effective and timely manner to the challenges created by market developments. The theoretical key finding in his work is that a financial innovation in the credit derivatives market may increase bank risk. Credit derivatives trading are, therefore, a potential threat to coil stability even if banks use these instruments solely to hedge or securitize their credit exposures. Since the credit risk linked to the elastic segments of the credit markets leads to more aggressive credit derivatives trading, the direction of the financial innovation process is potentially also a threat to bank stability. The innovations that yield the most commercial success are precisely those that yield the minimum impact in terms of welfare. El-Masry (2006) focused on determining the reasons for using or not using derivatives for 401 UK non-financial companies and observed that larger firms are more likely to use derivatives than medium and smaller firms and derivatives usage is greatest among international firms. The results of the study also reveal that half of the firms do not use the derivative instruments because their exposure are not significant and costs of establishing and maintaining derivatives programmes exceed the expected benefits. The most important reason for using derivatives is hedging (managing) the volatility in cash flows. The Turkish Capital Market Board (CMB) conducted a questionnaire survey in March 2005, covering 225 industrial and service sector companies operating in the Istanbul Stock Exchange (ISE). Financial companies (banks, brokerage houses, leasing companies, insurance firms and investment trusts) were excluded from the study. Out of 225 companies, 118 firms participated to the survey, representing a 52.4 % participation ratio. The first result of the study is the risk perception of the non-financial companies. Most of them give priority to currency risk and commodity price risk, which they believe affect their in-out cash flows. They put little attention to the interest rate risk in their management. There is a close relation between the company size 187

12 and the usage of derivatives. While most of the large companies follow a sound risk management policy to manage their risks in the marketplace, some small companies believe that they do not need a separately defined policy to hedge their risks. Although the non-financial companies are subject to currency risk and interest rate risk to a certain extent, the use of derivatives by those companies in organized market is not widespread. Rather, they prefer to manage their risks by balancing their assets and liabilities instead of derivative transactions. Moreover, the companies using derivatives tend to prefer forward agreements or other derivative instruments with banks in the over the counter (OTC) market. There is also roll-over risk for non-financial firms, as their trades are short-term sided either in the OTC market or in TurkDEX (Turkish Derivatives Exchange). Among the reasons for not trading in the TurkDEX, the participating companies in both surveys state the immature nature of the market and the transaction costs, besides the lack of managers knowledge and experience notified by the regulatory authorities.( Engin K., International Research Journal of Finance and Economics, 2007) Karen Benson and Barry Oliver (2004) have surveyed a sample of Australian firms on attitudes to derivative use and financial risk management. The top 500 listed companies in Australia were sampled through a mailed questionnaire. The details of each company were obtained from Huntley s database and the questionnaire was mailed to the CEO or CFO of each company in June About 23 percent of total potential responses i.e., One hundred useable responses were received. The questionnaire was divided into four key areas. The aim in the first section was to determine if management had a risk management plan, if they used derivatives and if the main purpose for derivative use was for: i) hedging; or ii) speculation and/or arbitrage. In the second section 19 theoretical reasons for the use of derivatives for hedging purposes were listed and In the third section of the questionnaire, the financial risks were categorized in terms of foreign exchange risk, interest rate risk, commodity price risk and other financial risks. Lastly, in section four the information on the techniques applied in the risk management of derivatives was requested. From the analysis it is concluded that the main risks which are hedged are foreign currency and interest rate risks and derivatives are the favored way to hedge these risks. Forward, options and swaps are the more common contracts that are used to hedge financial risks. It was also discovered that a large proportion of financial risk exposure is unhedged and a very small number of firms hedge all their financial risk exposure with derivatives. This is a very relevant finding for investors in organizations given that a high proportion of diversifiable risk is uncovered. The issues of taxation and difficulties in pricing derivatives are significantly different in importance, depending upon whether the firm uses derivatives and whether it has a risk management plan. Pei-Gi Shu and Hsuan-Chi Chen (2003) from Taiwan, examined the major determinants of a firm's derivatives use, for companies listed in Taiwan Stock Exchange in the period from 1997 to Data were collected from firms' annual financial reports from year 1997 though After screening out companies with incomplete information, there were 336, 338, and 348 effective samples, and the proportions of firms declaring derivatives use were 31%, 35%, and 37% in 1997, 1998, and 1999, respectively. The statistics show that the proportions of derivatives use range from 31% to 37% in Taiwanese listed non-financial companies. Currency derivatives stand for the majority of product type, and forward derivatives dwarf other instrument types. Firms' use of currency derivatives is mainly due to their international involvement, while the use of forwards is attributed to firms' availability of the instrument. The 188

13 data implied that the involvement of international trade drives a firm's derivatives use, and implicitly focus on currency forwards. However, compared to the sophisticated and liquid financial market of the United States, the derivatives markets in Taiwan were still premature to be widely adopted by ordinary companies. Gordon M. Bodnar and Giinther Gebhardt (1999) did a comparative study of the responses to the 1995 Wharton School survey of derivative usage among US non-financial firms and a 1997 companion survey on German non-financial firms. They find that German firms are more likely to use derivatives than US firms, with 78 percent of German firms using derivatives compare to 57 percent of US firms. Aside from this higher overall usage, the general pattern of usage across industry and size groupings is comparable across the two countries. In both countries, foreign currency derivative usage is most common, followed closely by interest rate derivatives, with commodity derivatives a distant third. In contrast to the similarities, firms in the two countries differ notably on issues such as the primary goal of hedging, their choice of instruments, and the influence of their market view when taking derivative positions. According to them these differences appear to be driven by the greater importance of financial accounting statements in Germany than the US and stricter German corporate policies of control over derivative activities within the firm. German firms are more likely to incorporate their own view on price movements when taking derivative positions than US firms. German firms indicate a significantly lower level of concern about issues related to derivatives than US firms. They infer this could be partially as a result of stricter policies of control over derivatives activities within the firm. Chris Mallin, Kean Ow-Yong and Martin Reynolds (2001) from U.K. presented the results of a 1997 survey of derivative used by some 231 UK non-financial companies. The questionnaire instrument used in this research was based upon the postal survey methodology. The results of this survey indicate that the use of derivatives to hedge financial price risk amongst larger UK companies; over 60% of companies reported using at least one derivative instrument. The primary objective cited in using derivatives was to manage fluctuations in accounting earnings, a focus that was inconsistent with the theoretical view of paying attention to cash flow benefits of hedging. The predominant issues of concern to UK financial directors are the lack of evaluation of risk of proposed derivative transactions and the level of transaction costs incurred. This contrasts with the greater concerns of credit risk and market risk raised by their US counterparts. The survey results shows companies are exposed to low degrees of equity and commodity risks, with derivatives being used predominately to hedge contractual obligations that results in currency and interest rate risk. OTC forwards is the most used instrument to hedge currency risk and swaps is the most popular derivative instrument for hedging interest rate risk. Worth noting is the low use (just over 20% of firms) of derivative instruments to hedge competitive exposure. Despite some of the high profile cases of significant financial loss through use of derivatives, this survey indicates that a few firms attempt to speculate or undertake arbitrage action through use of derivatives. 189