KATHMANDU UNIVERSITY SCHOOL

OF MANAGEMENT

Report on ‘Practices and trends of

derivatives market in Nepal’

Course Instructor – Asst. Prof. Hari Gopal Risal

Submitted on June 27, 2018

Submitted by:

Pranamya Man Dhoubhadel

Priyanka Subedi

Rejika Joshi

Samyak Raj Shakya

Sparsh Jung Rana

Yukta Amatya

6th Semester
ACKNOWLEDGEMENT

We are very grateful to Kathmandu University School of Management and Mr. Hari Gopal
Risal for giving us the opportunity to do this research project.

We would like to thank you for providing us with a platform to improve our practical skills and
broaden our knowledge and understanding about the derivative market of Nepal.

We would also like to thank all the organizations and individuals who cooperated with us with
the interviews. We would also like to thank all those people who have helped us in the
completion of this project.

This proposal is submitted as a part of internal examination included in the curriculum of

Financial Derivatives and Risk Management is one of the credit course in BBA Finance
(Honors) Semester-VI.
Contents
Introduction ................................................................................................................................ 4

Background of the study ........................................................................................................ 4

History of Derivative market in Nepal ................................................................................... 5

Why is this Topic selected? .................................................................................................... 5

Methodology .............................................................................................................................. 6

Overview of the market ............................................................................................................. 7

Benefits of the derivative market ........................................................................................... 7

Drawbacks of the derivative market....................................................................................... 7

Commodities available in the futures market ......................................................................... 8

Operations of brokerage firms ................................................................................................. 10

Scope .................................................................................................................................... 10

Areas to improve .................................................................................................................. 11

Turnover ............................................................................................................................... 11

Views of traders ....................................................................................................................... 12

Risk and Return........................................................................................................................ 14

Scope ........................................................................................................................................ 14

Comparison with stock market ................................................................................................ 14

Recommendations .................................................................................................................... 14

Conclusion ............................................................................................................................... 15

References ................................................................................................................................ 15
Introduction
Background of the study
Derivatives are financial contracts or financial instruments whose prices are derived from the
price of something else. It is an arrangement or product (such as a future, option, or warrant)
whose value derives from and is dependent on the value of an underlying asset, such as a
commodity, equities, residential mortgages, commercial real estate, bonds, currency, interest
rates, stock market indices or security. There can be derivatives everything so, there is scope
for everyone and every sector such as traders, exporters, importers, financial institutions,
industrialists, investors and end users.

The derivative market is the financial market for derivatives, financial instruments like futures
contracts, forwards, options or swaps which are derived from other forms of assets. A
derivative is a financial instrument which derives its value from the value of underlying assets
and has no intrinsic value in itself. Derivatives can be used either for risk management (to
hedge by providing compensation) or speculation. There is a distinction between the two as
risk management is a legitimate and prudent aspect of operations and financial management
whereas speculation offers an opportunity to increase profits.

The main types of derivatives include:

i. Forward: Bilateral contract exposing counter party risk including specified price,
specified time, specified quantity but does not need daily settlement and organized
exchange.
ii. Future: Agreement between two parties with specified time, specified price and
specified quantity including daily settlement and organized exchange.
iii. Option: Instrument which has both obligation and option for the rights of buying and
selling of shares.
iv. Swap: Agreement of exchange in terms of cash flow, interest rates, currency, etc
History of Derivative market in Nepal
In the initial phases, markets for futures trading were developed to help agricultural producers
and consumers manage the price risks they have faced from harvesting, marketing and
processing food crops each year. Today, futures exist not only on agricultural products, but
also on a wide array of financial, stock and forex markets. Only forward and future contracts
are traded in Nepalese derivative market.

In Nepal, three commodities exchange- Commodities and Metal Exchange Nepal Ltd.
(COMEN), Mercantile Exchange Nepal Ltd. (MEX) and Nepal Derivative Exchange (NDEX)
are working to provide investment opportunities to around three thousand people. The majority
of transactions of commodity exchange are in gold and crude oil.

COMEN has been providing trade services in agricultural goods. It builds warehouses to
improve services and has also applied to SEBON on November 11, 2009 for starting a new
stock exchange. MEX has also made immense contribution in raising awareness about
implementation of policy reforms in commodity sector. It is the first exchange to take up the
issue of differential treatment of speculative loss and enroll participation of corporate securities
members in commodities derivative market. NDEX is an electronic commodity and derivative
market which provides an online platform for traders to buy and sell commodities and
derivatives products efficiently and at a justified price. It aims to facilitate trading on
commodities, metals, energies, currencies and others. NDEX was developed considering all
sophisticated needs of the traders. People can trade products through the software and trade as
per their needs. NDEX is a professionally managed online derivative exchange and was
incorporated on November 20, 2008.

Why is this Topic selected?

The major reason why this topic is selected is in order to learn more about the practices of
derivatives in the context of Nepal and the various trends in derivative market. This is also an
opportunity to learn new things and meet new people in the field of derivatives. It is also an
opportunity to build healthy and needed connections in this sector as it will be helpful for our
academic as well as professional growth.
Methodology
We have used both primary as well as secondary data. We have had interviews with exchanges
like NDEX, MEX Nepal, etc. We have randomly selected few traders, active brokerage firm
and clearing house. After the in-depth interviews we have the overview of the current situation
of derivative market. In the interview, have also discussed about capital structure, services
provided by each facilitator, regulation and experience of traders. We have furthermore
discussed with the traders on risk and return from derivative market, strategies used by the
traders and their overall experience.
Overview of the market
Derivative market started operation from 2007 but there was government's involvement only
from 2074 Mangsir 11. The derivative market of Nepal is only used for speculation purpose at
present time. There is no price discovery of commodities in Nepal.

SEBON is the regulatory body and has brought the system of issuing license for traders. There
are currently 70 brokers among which 40 are active in the market. The license system is yet to
be implemented. After the implementation of the system for clearing houses and market
makers, the market will flourish in a systematic and legal way.

The derivative market is currently in a phase of development of regulations and licensing. The
Commodities Act includes contracts trading till November only and the act requires applying
for pre-approval from SEBON. The market was previously self-regulated and institutions such
as NDEX and MEX have been able to create market awareness and trust among the customers.
With the establishment of the Regulations, the markets is expected to increase in volume.

Benefits of the derivative market

 There will be increased tax collection for government.
 It is useful for hedging purpose.
 It will provide employment opportunities for various people. (1500+)
 People will get investment opportunities in products that are not available in Nepal
such as, crude oil.
 The financial market will also grow as derivative market is an emerging market.
 The farmers will come under banking channel and will start paying tax.
 The insurance sector will also improve (warehouse insurance etc.)

Drawbacks of the derivative market

 There is no market awareness program due to which many people do not have idea
about derivative market.
 We can say there is no regulation because practically it has not been implemented till
now.
 There is lack of professional brokers in derivative market.
 There is no security mechanism for investment as many traders do not even know
they are facing loss due to software problem.
  Most traders do not have market knowledge which increases their losses rather than
gain.
 Everyone cannot use this platform due to lack of technological knowledge as it is
available to those who have access to their mobile app and it is tough for people
without education.

Commodities available in the futures market

- Agro Products

 AGRO PRODUCT CORN 50000 KG

 AGRO PRODUCT SOYBEAN 30000 KG
 AGRO PRODUCT SOYBEAN OIL 25000 KG
 AGRO PRODUCT WHEAT 30000 KG

- Energy

 CRUDE OIL MINI 100 BBL

 CRUDE OIL REGULAR 250 BBL
 CRUDE OIL SMALL 50 BBL
 EXPOSURE CRUDE OIL 250 BBL
 ENERGY HEATING 8400 GALLON REGULAR
 ENERGY NATURAL GAS 2500 MMBTU

- Fiber

 FIBRE COTTON 10000 KG

- Industrial Metals

 COPPER 100 KG
 COPPER 500 KG
 COPPER MINI 2500 KG
 COPPER REGULAR 5000 KG
 COPPER SMALL 1000 KG
 EXPOSURE COPPER 5000 KG
  WEEKLY COPPER 5000 KG

- Precious Metals

 EXPOSURE GOLD 1 KG
 EXPOSURE GOLD 10 GRAM
 EXPOSURE GOLD 200 GRAM
 GOLD 10 GRAM
 GOLD MINI 500 GRAM
 GOLD REGULAR 1 KG
 GOLD SMALL 100 GRAM
 WEEKLY GOLD 1 KG
 PALLADIUM 1 KG REGULAR
 PLATINUM 1 KG REGULAR
 EXPOSURE SILVER 10 KG
 EXPOSURE SILVER 30 KG
 SILVER 1 KG
 SILVER MINI 15 KG
 SILVER REGULAR 30 KG
 SILVER Small 5 KG
 WEEKLY SILVER 30 KG

- Soft Agro Products

 COFFEE 5000 KG
 COFFEE SMALL 1000 KG
 COFFEE XMALL 50 KG
Operations of brokerage firms
First of all, a broker needs to register a company as its “brokerage firm” with a paid up capital
of 50 Lakhs. The office size should be at least 700 sq. ft. The brokers earn “brokerage” as
commission through clients. They need to market their firm and bring in more and more clients
as possible. Broker’s major job is to brief their clients about:

- Training the clients

- Suggesting them based on proper analysis
- Marketing on a day to day basis

The more clients they get, the more business they will be able to conduct earning them higher
profits. So in order to expand and flourish their firm they need to get more and more clients
involved with the firm. With the increase in competitions for brokerage firms, the “wrong calls”
by the brokers should able to recover some percentage of the losses in order to retain their
clients.
The brokers need to be ethical in suggesting and guiding their clients. Misguiding or “over
trading” can sometimes lead to huge losses for the clients while the brokers will still be making
sufficient profit through commission. These kinds of unethical practice need to be taken care
of by setting according regulations.

Scope
There is a huge scope for brokers in this market especially as the new regulation is about to set
law and order in the market. The market is expected to grow a lot brining in economic
development with the implementation of the license system for trading. This will increase the
trust of clients in the brokers bringing in more clients. The market is expected to bloom and to
the trade volume is expected to grow as much as NEPSE.

The derivative market of Nepal is only used for speculation purpose at present time. So
“scientific pricing mechanism” should be regulated by SEBON in order to encourage more
hedging rather than speculation as the main objective of derivative market is to minimize risks.
The commodity market should be focused on making farmer’s end user better which will
ultimately make the economy better. The price/order driven market both should be given
importance based on the current circumstances by analyzing which will be more beneficial to
use. In this world of tough competition, the better service firms can provide to their clients the
more profit they will be able to earn.
Areas to improve
 Major priority must be given to excellent service to the clients
 Adding employees to handle the grievances of the clients in a better and efficient way
 Training the clients
o Either by taking fees
o Free training
 Implementing the regulation brought in properly to make the market systematic
 Avoiding unethical practices “over trading”
 Taking as much responsibility of the “wrong calls”
 Paying attention to the fundamental news
o International news
o Signs
o Sites
 The regulators should set appropriate qualification requirements

Turnover
The turnover is a very confidential and fluctuating topic so not much information was gathered
on it.
Views of traders
According to a group of sample, they usually traded in gold. They only traded in EXP due to
limited funds. They traded based on their intuition and international news. But some even do
price analysis and trend movements before investing their money. Here random traders fail as
they have lesser knowledge about the market and it has been proven by some of the investment
made by those kinds of traders.

According to them, this platform is beneficial where money grows itself if placed at right place.
With lesser effort and time people can quickly earn good amount of money. The best part of
this market is people are able to trade in margin which enables smallest investor to enter in the
market. Even students get a chance to earn themselves pocket money as they can trade at a very
low scale.

Here according to the traders surficial knowledge is provided to new entrant by the service
provider. Mental preparation should be given to the investor and at what time and how to
control emotions must be a major highlight while providing sessions.

In the current scenario for the investing and trading purpose stock market is better as they
would be paying at full and would be owning the stocks. The market is small and news provided
by the authorized bodies are easier to interpret in the stock market. But in case of derivative
market it is an international market where international news have significant impact and are
difficult to interpret.

Here the risk and return are higher than stock market. There is price volatility and people who
are only involved in derivative trade for living are exposed to higher risk. This market is not
for all the investors as people who have higher emotional stability must only enter in the market
as it is highly volatile. In case of Nepal as investors are concentrated towards stock market a
proper awareness campaign about derivative market must be provided. There must be courses
in colleges to encourage new investors and concept of trading at margin must be stated clearly
to the investors so that they get optimum benefit.

There is a different perception where other group take this as an alternative platform against
stock market and is a hedging tool. If there is proper system of warehouse then Nepal could
benefit from this market as farmers could use to hedge their product. In the context of Nepal
currently it is only a speculative market and people are conducting educated guess. This system
is not being productive as no new money is being created or any value have been added. Money
from pockets are changing. Here we also found that people who take this market seriously trade
on the basis of price analysis. They even conduct trend analysis for better decision making.

Here we also found that investors had a different perception about stock market of Nepal. Here
the investors believed that there is no market efficiency and due to niche stock market handful
of people can manipulate the entire market and drive according to their need. As derivative
market is an international market and is driven by more than one country there is more
efficiency and price is solely driven by the demand and supply. According to the investor this
is a risky market and there is a wide scope for development of derivative market in Nepal.
Nepal is an agricultural country farmers can benefit from hedging price and crop. According
to the investors they also believe that regulations must be improved to develop overall market.
Hence brokerage commission must be decreased to motivate the investors.
Risk and Return
In this market, higher the risk we take, higher the return we will get. We must follow
global news in order to perform well and the most important thing is we must not have
greed.
There can be personal risks is you enter in the market without any knowledge or without
any analysis capabilities. There are low risks in the market as the regulation is certain
to come and all transactions are handled by the bank. Market risk is low.

Scope
There is a very high scope for this market. This market will develop along with
agricultural sector. If the focus is given to agricultural products then this market will
have no end and will run for a long term because no matter what people will have to eat
so agriculture will always be there. Along with this many people will get employment
opportunities and their earning can be high. Similarly, marketing of products will also
happen such as tea, cardamom and other agricultural product and we can export these
products if produced in large quantities. Various other sectors will flourish such as
financial institutions and there will also be warehouse creation.

Comparison with stock market

Derivative market is far ahead of stock market as there are better facilities and services
in comparison to stock market. Services such as margin trading, trading platform,
transparency, 24hrs trading, which is not provided in the stock market make it much
more versatile. In addition to this, short selling provides a wider scope making it
accessible to capture many markets (importers, exporters, farmers and traders) whereas
stock market can only target the traders.

Recommendations
SEBON has mentioned that if the Commodity act 2074 is not met then derivative
market will close after December as contracts till December have already been made.
According to the act, derivative exchange must have a capital of 50 crore, BOD must
consist of 5 people who are above 35 years old and must have a 2000 sq. ft. office.
 The regulation that would be favorable is as follows:
 As it is an emerging market, there is no need 50 crore currently.
 It is a new market and many people do not have idea, so BOD above 35 years
old is not practical.
 Government should initiate awareness about this market.
 Commission rate should be fixed throughout the market.
 Price and all mechanism should be same throughout the market.

Conclusion
The derivatives market is very versatile in terms of all characteristics but it has not been
able to get approval of concerned authorities which has led to the slow growth and lack
of awareness about the market. There are certain improvements required in this field
which will help the market truly flourish. Development of proper acts, supportive
brokers, exploration of markets, endorsement in curriculums and involvement of youths
is necessary to improve the conditions of the derivative market in Nepal.

References
- https://www.slideshare.net/pawankawan/derivative-market-in-nepal
- http://ndex.com.np/
- http://www.mexnepal.com/