Financial Derivative Instruments in Bangladesh

Definition:
A derivative is a contract between two or more parties whose value is based on an agreed-upon
underlying financial asset (like a security) or set of assets (like an index).
Example: when you purchase currency futures based on a specific exchange rate the value of
the futures will will change as their currencies exchange rate changes.
The concept of Financial derivatives is not commonly used by the general public and they are
typically used by large Industries to manage risks there are two concepts about financial
derivatives:

 They help to create leverage so that an object can be related in terms of other valued
and you can minimize risk.
 They are used to either take on more risks or reduced risk depending on what kind of
contractual agreement is made.
Examples of Financial Derivatives:
The contractual set up between an investment asset and share of stock or currency is
characteristic of the concept of Financial derivatives. The price of both should move in tandem
directly related to the increase or decrease in value of the financial derivatives
Derivatives are things that cannot stand alone in terms of value the value is directly related to
something else in the economy.
These investment assets are commonly used as financial derivatives:

 Futures contracts
 Forward contracts
 Options
 Options on futures contracts
 SWAP
 Currency rates
 Interest rates
 Market indexes
 Stocks and bonds
with the underlying value of asset is established. It is almost impossible to conceive of
how much that asset is worth without an underlying of the value of the asset to which it
is dependent as a derivative.
Futures Contract:
A future contract is a legal agreement to buy or sell a particular commodity assets or security at
a predetermined price at a specified time in the future. Future contract are standardized for
quickly and quantity facilities trading on a futures exchange
Example:
An oil producer needs to sell their oil. They may use futures contract to do it. This way they can
lock in a price they will sell at, and then deliver the oil to the buyer when the futures contract
expires.
A future market is a central financial exchange where people can trade standardized futures
contracts defined by the exchange.
Forward Contract:
A forward contract is a customized contract between two parties to buy or sell an asset at a
specific price on a future date. A forward contract can be used for hedging or speculation
Example: Large food manufacturers may purchase a farmer’s wheat forward contract to lock in
the price and control their manufacturing cost. The farmers hope to benefit from the forward
contract by ensuring that he has a buyers for the commodity. He will also have an agreed upon
price if he can meet the forward's contract qualification like producing and delivering bushels of
wheat, corn and Oats. The buyers assumes a longer position and the seller assumes a short
position when the forward contract is executed. The agreed upon price is called the Delivery
price. It is equal to the forward price at the time that two parties enter into a contract.
Option: An option is a financial contract that gives an investors the right but not the obligations,
to either buy or sell an asset at a predetermined price (knows as a the strike price by a
specified date) (known as the expiration date).
There are two types of options.
1. Put option
2. Call option

Call option
Call give the buyer right not the obligations, to buy the underlying asset at strike price specified
in the option contract. Investors buy calls when they believe the price of underlying asset will
Increase and sell calls if they believe in decrease.
Put Option:
Puts give the buyer the right but not the obligations to sell the underlying asset at the strike
price specified it the contract. The seller of the put options is obliged to buy the asset if the put
buyers exercise their options. Inventors buy puts when they believe the price of the underlying
asset will decrease and sells puts if they believe it will increase.
Examples: Company ABC shares traded $60 and a call writer is looking to sell call Sector 65 with
their one month expiration. if the share price stays below $65 and the options Expires the call
writer keeps the shares and can collect and premium by writing call again. if the share price
appraisal to a price above $65, referred to as buying in the money, the buyers call the shares
from the seller, purchasing them at $65. The call buyers can also see the option if purchasing
the shares is not the designed outcome.
Swaps:
A Financial SWAP id a derivative contract where one party exchanges or swaps the cash flows or
value of one asset for another.
Example:
A mortgage holder is paying a floating interest rate on their mortgage but expects this rate to
go up in the future. Another mortgage holder is paying a fixed rate but expects rates to fall in
the future. They enter a fixed-for-floating swap agreement. Both mortgage holders agree on
a notional principal amount and maturity date and agree to take on each other's payment
obligations. The first mortgage holder from now on is paying a fixed rate to the second
mortgage holder while receiving a floating rate. By using a swap both parties effectively
changed their mortgage terms to their preferred interest mode while neither party had to
renegotiate terms with their mortgage lenders.

 Financial derivatives Instruments in perspective of Bangladesh :

In recent years, derivatives market have grown by leaps and bounds in emerging economics
.Given the level of economic and financial risks fraud by market participants and investors in
emerging countries, derivatives contribute to a country’s economy development by making the
risk manageable. For the deepening reform of market economy, monetizing it and making it
compatible. Bangladesh should embrace the instrumental normal practice and develop
derivatives mechanism to promote healthy growth of commercial banks. Some market analyst
estimate that the derivative markets at more than 10 times the size of the total world gross
domestic product (GDP)
The Potential of Derivatives Markets in Bangladesh
The derivatives market has attained the highest growth of all financial market segments in
recent years and has become the central contribution to the stability of the financial world.
Due to the recent catastrophe falls capital market, rapidly declining FDI and seen city of
investment opportunities is an centric economy , investors of Bangladesh is engaging out for an
innovative and versatile financial product such as derivatives securities for hedging and market
expansion.
Derivatives can be traded over the counter (OTC) on an exchange. OTC derivatives are created
(and privately negotiated) by an agreement between two individual counter prices of recent,
the derivative market has attached more attention against the financial crisis.