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Chapter-I Introduction

CHAPTER-I

Introduction

1.1 Foreword

The chapter provides an insight into the rationale of this study and Pakistan’s

market potential. Further it looks into the research question and its objectives

and briefly states the methodology, scope and scheme of study.

1.2 Rationale of Study

Global economies have evolved greatly in the present times and in the process

the risks associated with the economic system also evolved. Such risks

instigated the introduction of modern day sophisticated financial instruments for

efficient risk management. These dynamic in economic systems facilitated the

development of derivative securities like swaps, options, forward and future

contracts which are deemed to be the specialized treatment of specialized risks.

(Whatsham, 1992).

This growth in derivative trade started in the western developed economies like

America and Europe and now expanding the outreach to the developing

economies like Asian emerging markets which includes Korea, India, China,

and Malaysia etc. This study initially overviews the impact of derivatives trade

on these Asian economies and its financial markets which started to expand in

the later part of twentieth century (Fratzscher, 2006).

Amongst other factors contributing towards this volatility. one major factor is low availability of efficient risk management instruments. The financial market in Pakistan is deemed highly volatile (World Bank. At present it is a developing country but with its strategic location and population capacity it is an attractive market and grasps the interests of many worldwide (Ahmad. Derivatives trade and its concept are still juvenile in Pakistan where it has been introduced in over the counter markets lately and no such trade takes place in its listed exchanges. 1. 2010 and makes it the 6th largest country in terms of population.Chapter-I Introduction Exploring the positive outcome of derivative trade on these emerging Asian markets the study moves on to establish the need for introduction of these specialized financial instruments in Pakistan listed exchanges. 1969). 2006).48% of the world’s population as per consensus in Sep. It has a population of 170. 904 square kilometres lies at a strategic location which joins South Asia with Central Asia and Middle East and neighbouring economic giants like India and China. Therefore the introduction of formal exchange traded derivatives in Pakistan will help strengthening its financial market and contribute towards its economic growth. They include Punjab with the largest population and agricultural land.430. The country has 4 states which also represents the major cultures in the country. Sindh with the largest financial city also considered as the financial capital of .000 which is 2.3 Pakistan’s Market Potential Geographically Pakistan with an area of about 803.

2% Total Investments 19. According to Economic Survey of Pakistan 2008-2009 published by Ministry of Finance the following statistics shows economic activity: Economic Survey Pakistan 2008-2009 (Growth Rate in Percentage) Overall Growth Rate (GDP) 2% Money Supply (M2) (4. Khyber Pakhtunkhwa in the north attracting tourists due to its immense natural beauty and mountain ranges like Karakoram and world’s 2 nd tallest peak K-2. law and order situation.gov. In addition to that there is Pakistan’s administered part of Kashmir which is still under dispute with the neighbouring country India.9% Services Sector 3.3% population as Muslims (CIA World fact book).e. rising demand .8 %) Public Sector Investment 1.5% Real Private Consumption 5.htm) According to Ministry of Finance Pakistan’s economy has gone through booms and slumps due to political instability.2%) Imports (9.Chapter-I Introduction Pakistan i.3% National Savings 0.7% Sensitive Price Indicator (SPI) 9.pk/survey/index.1% Mining and Quarrying 1. Islam being the principal religion with 96.8% Foreign Direct Investment (13.37%) Manufacturing Sector (7.6% Table-I Economic Survey Pakistan 2008-2009 Source: Ministry of Finance official website (http://finance.7 %) Inflation 12% Agriculture Sector 4.6 % Exports (3%) Finance and Insurance (1. Karachi which also have the Arabian Sea port.8%) SME Sector 7.7% External Debt Liabilities 2. Baluchistan largest state by area and 2nd largest provider of natural gas in Pakistan.

Karachi stock exchange (KSE) with its indices of 100 companies. Manufacturing and Services. . technological advancements. (2006).Chapter-I Introduction with low level of supply causing increased inflation but still is resilient enough to show constant growth which also concurs to the argument of Ex-country Director World Bank Pakistan John Wall.5% to 12360 points in April. the GDP is mainly dependent upon 3 major sectors including Agriculture. Though the evolution process is sluggish and little implementation has been seen till date. 2006). 2007 with Market Capitalization going up from USD 46. Financial Sector in Pakistan is going through an evolution process as State Bank of Pakistan in cooperation with Securities and Exchange Commission of Pakistan (SECP) are introducing measures to restructure the market via improvement of legislative infrastructure. Finance sector in Pakistan constitutes Banks and Non-Banking Finance Corporation (NBFC’s) and banking sector owes 70% to the growth of this sector (Akhtar. Capital markets in Pakistan have shown significant potential in the recent past.3 Billion. 2007). But this growth had very little impact on the overall economy (Ministry of Finance Pakistan. the largest in Pakistan went up to 23. market infrastructure. Though the manufacturing sector suffered seriously due to the current financial crisis throughout the globe. amendments in Prudential Regulations which shall help in the reinforcement of Pakistan’s financial markets (Akhtar. (Ministry of Finance Pakistan) According to Ex-Governor State Bank of Pakistan Shamshad Akhtar.4 Billion to USD 59. 2006).

political turbulence. economic sanctions.Chapter-I Introduction Pakistan is classified as a low-income economy by World Bank regardless of its growth and assigns it factors like macro-economic instability.4 Research Problem The research question is:  To determine whether there is a need for introduction of Listed Exchange Traded Derivatives in Pakistan’s Financial Market? 1. Secondary data is collected through articles/e- . the 9/11 dogma.  To find whether exchange traded derivatives are needed in the current market scenario. 1. military disputes with neighbouring country India.5 Research Objectives Key objectives of this research are given below:  Examining the role of derivatives trade in Pakistan’s financial market from future point of view and to see whether they can effectively perform in this market.6 Research Methodology The research commence with review of the extant literature on the role of derivatives trade in emerging Asian markets and its development in the context of Pakistani market until now. 2005 massive earthquake. investors safety etc (World Bank. exposure to internal and external shocks. 2009). military interventions in the government. 1.

7 Scope of the Research This research explains the major features and applications of derivative securities and is particularly related to future of derivatives in Pakistan’s financial market.Chapter-I Introduction articles. Qualitative research methodology is applied for the purpose of analysis. 1. books. The research investigates various aspects that are deemed to be of much significance for derivatives to perform well in the financial markets. . This research will facilitate individuals with keen interest in derivatives and its applications to financial markets and investors who are considering an investment in Pakistan as the research provides an overview of this market. individual investors and local academe. Primary data via telephonic interviews with 30 respondents from various backgrounds relevant to the field was collected making use of the semi-structured questionnaire. Investment banks. business and finance journals/newspapers. previous researches on subject matter and internet etc in order to formulate a structure and identify the factors to be considered for the semi-structured questionnaire (See Questionnaire) and later the responses of the interviewers were matched with the literature for analysis. regulatory authorities. The respondents belonged to brokerage houses.

Chapter-I Introduction 1.8 Scheme of the Research The research follows the following scheme: Chapters Title of Chapter Chapter-II Literature Review: Efficacy of derivatives in Emerging Asian Economies Chapter-III Research Methodology Chapter-IV Identifying need for Exchange traded derivatives: Analysis of Interviews Chapter-V Conclusions and Recommendations Table-II Scheme of research .