Chapter 1 Financial Markets

Learning Objectives:

After studying this chapter, you should be able to:

• Learning objectives:
• Write the definition and types of financial markets.
• Understand various financial markets.
• Understand foreign exchange and exchange rates.
• Distinguish between preferred stock and ordinary stock.
• Analyze the basic factors that affect the company’s stock
price.
• Understand the advantages and disadvantages of investing
in stocks.
• Distinguish between stocks, corporate bonds and warrants.
• Understand the role of the stock market, stock exchanges
and stockbroking company.
• Understand the definition and function of stock market
indexes.
• Distinguish between bull market and bear market.
• Explain futures.
• Understand futures trading and spot trading.

Stock market index and futures

Please find the answers to the following items:

1. The company names of the three constituents stocks of the FBM
KLCI in Malaysia.
2. Singapore, China, Japan and the United States major stock market
index name.
3. Two types of futures in Malaysia’s futures trading.
 The way to find information is: Nanyang Commercial Daily Economic
Edition, log in to www.bursamalaysia.com.

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Conceptual diagram of this chapter:

1.1 Concept of financial markets

Financial markets refer to places where financial products (such as stocks,
bonds, foreign exchange and futures) are traded. This place can be an
actual trading location, or it can be an electronic trading platform through
telephone or the internet in accordance with certain rules where buyers and
sellers do not need to meet. For example: Investors ask stock brokers to
buy and sell stocks over the phone.

A sound financial market has the ability to gather funds from the general
public, allow funds to be effectively circulated to those who need funds, and
promote the smooth progress of investment and production activities.

Participants in the financial market include financial institutions (banks),

non-bank financial institutions (such as insurance companies, development
financial institutions, employees provident fund board, unit trust
management companies), stockbroking companies, listed companies, etc.

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The relationship between financial institutions and financial markets is
inseparable. For example, banks and insurance companies invests
customer deposits and premium received in the financial market. These
funds will eventually become sources of funds for industrial and commercial
enterprises and the government.

Malaysia’s financial market is mainly divided into: currency market, foreign

exchange market, capital market and financial derivatives market. The
descriptions are as follows:

1. Money market
The money market is a market for raising short-term funds (a year or within
a year). For example: the government issues treasury bonds with a
repayment period of 3 and 6 months to raise funds; large enterprises with
good reputation and business performance issue commercial paper to raise
short-term funds.

2. Foreign exchange market / forex market

For trade, investment, tourism and other exchanges between countries,
currency payments are required. Because the currencies of different
countries are not the same, the exchange of domestic currency and foreign
currency occurs.

Exchange rate refers to the exchange rate of the two currencies. For
example: Assuming that 1 Singapore dollar cab be exchanged for RM3 and
the exchange rate of the Singapore dollar is RM3 (representing the price of
foreign exchange), then RM90 can be exchanges for SGD30.

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Foreign exchange includes foreign currency (such as Singapore dollar, US
dollar) and payment instruments in foreign currency (such as money order).
For example: if a Malaysian merchants exports goods to Singapore, if the
Singapore importer uses a Singapore dollar bill of exchange to pay, the bill
of exchange is regarded as foreign exchange.

The foreign exchange market is a financial market for buying and selling
foreign exchange. Enterprises exchange or buy and sell currencies through
the foreign exchange market for international trade and investment.

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  A Malaysian merchant sells goods to a Chinese merchant,
and the other party pays by a US dollar draft. How should the
merchant handle this draft?
 Assume that the exchange rate of US dollar to Malaysian
ringgit is USD1 equal to RM4.00. Wan Jun is going to study in
the United States and plans to carry $500 with her as pocket
money. How much ringgit does she need to exchange for
USD?
 Assuming that Mr. Lim uses RM800 to exchange 8000 Thai
Baht, what is the exchange rate of Ringgit to Thai currency?

3. Capital market
It is a market for raising long-term funds (more than one year), including the
stock market and bond market. For example: the government raises long-
term funds by issuing government bonds with a ten-year repayment period
of principal and interest; companies issue stocks and corporate bonds to
raise long-term working capital.
The return on investment in the capital market is usually higher than that in
the money market. For example, when investors purchase government
bonds with a 10-year repayment period, they will face more uncertainties
than buying a six-month treasury bond. Therefore, the interest rate will be
higher than that of the Treasury bond.
4. Financial derivatives market
It is market for buying and selling derivatives contracts. It allows companies
to avoid price risks, but also provides arbitrage opportunities.

Derivatives traded in Malaysia include crude palm oil futures, stock market
index futures, etc. Since 1980, Malaysia has been the world’s largest crude
palm oil futures market.

Information centre: Commercial bill

Generally, it is issued by a company with higher credit, and is a
negotiable, short-term debt certificate.

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1.2 Shares

Stock refers to the negotiable security issued by the company to

shareholders to certify the amount of shares invested by shareholders and
the right to receive dividends.
The company can raise the funds needed to operate the business by
issuing stocks, and the person who subscribes to the company’s stock is
called the company’s shareholder and is also the company’s owner. For
example: Ms Cheng subscribed for the stocks of listed company A,
indicating that she invested the funds in company A, was a shareholder of
company A, and assumed limited debt liability. She can transfer stocks
freely. If the stock price rises, selling the
stocks will make price differential gain.

The stock has only an issue date and no

expiry date, so the company has no
pressure to repay the share capital within a
specified period. Generally, the company
only distributes dividends or bonus shares
when it is profitable. Figure 3 Shareholders share the company’s profits

Dividend refers to the income that the company distributes to shareholders

in proportion to the shares held by shareholders.

Bonus shares refers to company that distributes shares to existing

shareholders free of charge based on the proportion of shares held by
shareholders. For example: if the company announces that 1 share is
distributed with 1 bonus share, then shareholders who own 1000 shares will
receive 1000 bonus shares for free. For the company, issuing bonus shares
is to convert the company’s profit into the company’s equity, and increase
the company’s total equity, while the company’s cash does not increase.

Right issue is when the company expands its business and needs to
increase capital, the company sells new shares at a price lower than the
market price, giving priority to existing shareholders to subscribe, and any
remaining part then only is publicly sold.

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The company’s offering of right shares will increase the company’s total
cash and equity. In addition, it can ensure that major shareholders maintain
control power.

Information centre: Negotiable security

A certificate indicating property ownership or debt, such as stocks,
bonds, etc.

1.2.1 Types of shares

1. Preference shares
Preference shares refer to stocks in which shareholders can obtain
priority or some rights are restricted. The characteristics of preferred
shares are as follows:
 Preference shareholders can receive dividends first, and the
dividends are fixed, independent of the amount of company profits.
 If the company is wound up, with priority over common shareholders
to get back share capital.
 Preference shareholders do not have the right to vote and speak, and
they are not allows to run for directors. But in certain cases, they can
enjoy the right to vote. For example: when a company’s general
meeting of shareholders needs to discuss rights related to preference
shares, preference shareholders have the right to participate in the
general meeting.

2. Ordinary shares
Common stock is the most common type of stock and constitutes the
main part of the company’s capital. The characteristics of ordinary
shares are as follows:
 Ordinary shareholders do not enjoy fixed dividends, which depend on
the company’s profitability and are enjoyed after preference shares. If
the performance is poor, dividends may not be paid.
 If the company is wound up, after the preference shareholders get
back their share capital, then it is the turn of ordinary shareholders to

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 get back the share capital; if the company has no remaining assets,
the shareholders will not be able to get back their share capital.
 Ordinary shareholders have voting rights and the right to speak, and
can attend general meetings and participate in elections for directors.

Large companies with stable finances and

high profits have steadily increasing
dividends on their common stocks. Such
common stocks are called blue chips. For
example, common stocks of Maybank
Berhad, Tenaga National Berhad and
Nestle Berhad listed on Bursa Malaysia are
all blue chip stocks. Figure 4 The more stocks shareholders
subscribe for, the higher the equity.
1.2.2 Share price
Generally speaking, a company’s stock price is affected by the following
basic factors:

1. The company’s financial status

With the company’s strong assets, financial stability and profitability; the
distribution of dividends to shareholders will attract investors to buy the
company’s stock and make the company’s stock price rise; otherwise,
the stock price will fall.
2. Supply and demand of stocks
The stock price fluctuates with fluctuations in the supply and demand of
stocks. If many investors are optimistic about the prospects of a
company’s stock, the company’s stock demand is high and the stock
price rises; otherwise, it falls.
3. The country’s economic conditions
Changes in a country’s money supply, price levels, bank interest rates
and other economic factors play a certain role in the rise or fall of stock
prices.
Generally, if inflation is caused by a large amount of money supply, the
central bank will increase the bank interest rate to attract people to
deposit money in the bank to reduce the circulation of money in the
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 market to stabilize prices. However, this will also make people buy
fewer stocks, and the stock price will fall; on the contrary, the stock price
will rise.

4. Political situation, government policies and laws

Political situation or leadership changes will affect investors’ forecasts of
the stock market. In addition, major government activities and
development plans, new laws and regulations, etc. will all affect stock
price changes.

1.2.3 Shares investment

Generally, investors buy stocks as medium and long-term investments.

Speculators are keen to buy stocks in the short-term, taking advantage of
skyrocketing and falling stocks to seek huge profits through speculation. A
few people get rich overnight, but more people go bankrupt due to
speculation.

Advantages of investing in stocks:

1. Obtain dividends
When the company is profitable, the company generally distributes
dividends to shareholders. The higher the company’s profit, the higher
the dividend. Income from dividends is subject to income tax. (Note:
Under the single-tier system introduced in Tax Budget 2008, where
dividends paid by a resident company would be tax exempt in the hands
of its shareholders.)

2. Earn capital gains

The value of company stocks will increase as the company grows, so if
you sell stocks, you will get capital gains. For example: Mr. Chen used
RM10,000 to buy stocks of ABC listed companies on Bursa Malaysia.
When the ABC stock price rose, he sold the stock and netted RM13,000
after deducting the handling fee. The RM3,000 earned is capital gain.

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3. Exemption from tax on capital gains
The Malaysia government grants exemption from income tax on capital
gains earned on stocks. For example: The RM3,000 earned by Mr.
Chen mentioned above is not subject to income tax.
4. Stocks are easily converted into cash
The stocks of listed companies are marketable securities. Stockholders
can sell their stocks on the stock exchange to get cash back.

Disadvantages of investing in stocks:

1. Difficult to grasp detailed company information

For most listed companies, the information published in the financial
statements is only a rough overview. Investors simply look at the
company’s income statement or financial statement, it will be difficult to
accurately judge the value of the company’s stock, and make
preparations to reduce losses or contingency.

2. No right to inquire about the company’s business at any time

In the case where the company’s ownership and management rights are
separated, shareholders generally can only inquire about the company’s
business at the annual general meeting or the special general meeting.
Therefore, it is too late to know the actual operation and financial
situation of the company.
3. The risk of not being able to protect the principal (principal protected)
The company is losing money and shareholders will not be able to enjoy
dividends. If the stock price falls below the original purchase price, the
stock sold at this time will lose money. If the company goes bankrupt,
the order of claims by common shareholders will be after creditors and
preference shareholders, and they will often face the risk of not being
able to get back their principal.

4. The risk of stock price manipulation

Some investors use abundant funds to push up or suppress the price of
stocks, which will cause stocks to become high-risk investments.
Especially stocks with little liquidity on the market are more susceptible
to manipulation.

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1.3 Corporate bond / loan stock / loan note

In addition to issuing stocks to raise funds, companies can also issue

corporate bonds to raise funds. Corporate bonds are an IOU issued by the
company to investors. When investors buy corporate bonds, they become
the company’s creditors. The creditors of the company have no right to
participate in the management of the company and enjoy fixed interest
regardless of the company’s profit or loss.

Corporate bonds have a specified period and the company must repay the
loan (or principal) to the creditor on the maturity date. If the company is
liquidated, the creditors will be allocated the remaining assets before
preference shareholders.

There are two types of corporate bonds issued by companies on Bursa

Malaysia: convertible corporate bonds and non-convertible corporate bonds.

1. Convertible loan stock

It means that the holders of corporate bonds enjoy fixed interest and
can convert convertible corporate bonds into ordinary shares of the
company at a price set by the company within a certain period of time,
but the principal cannot be withdrawn. Then, its identity has also
changed from a creditor to a shareholder, enjoying shareholder rights
such as: bonus shares, dividends, etc.; for the company, it increases the
company’s equity.

2. Unconvertible loan stock

It means that the holders of corporate bonds enjoy fixed interest and
can withdraw the principal on the expiry date of the corporate bonds, but
they cannot convert the corporate bonds into ordinary shares.

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The difference between corporate bonds and ordinary shares:
Corporate bond / loan stock
/ loan note
The holders of corporate
Holder
bonds are the creditors of
the company.
No right to participate in the
Participation company’s management.
rights
Return The creditor gets a fixed
amount of interest.
Convertible corporate
bonds can be converted
into common stock of the
company at a price set by
the company within a
Maturity date
certain period of time; non-
convertible corporate bonds
have a repayment period,
and the company must
repay the loan when it
expires.
When the company is
wound up, creditors have
priority over ordinary
Dissolution
shareholders to get
repayment.
Ordinary shares
The holders of stocks are
the owners and
shareholders of the
company.
Have the right to
participate in the
company’s operation and
management.
Shareholders receive
variable dividends.
The stock has only an
issue date and no
maturity date, and there
will never be a repayment
problem.
When a company wound
up, it must first repay the
share capital of creditors
and preferred
shareholders, and finally
repay ordinary
shareholders.
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1.4 Warrant

A warrant is a certificate issued by the company to guarantee the exchange of

shares. Warrant holders cannot enjoy dividends or interest, nor do they have
the right to vote.
Within the validity period of the warrant (usually five to ten years), holder can
subscribe for the company’s shares at a predetermined exchange price and
become a shareholder of the company. Once the time limit expires, the
warrant loses its value and is like waste paper. If it is a warrant issued by a
listed company, it can be sold for cash on Bursa Malaysia within the validity
period.

If the company raises long-term funds by issuing rights shares or corporate

bonds. If the issue of rights shares by the company is accompanied by
warrants, for the company, the right shares can be sold at a higher
subscription price; for shareholders, there is a buy and a gift. If a company
sells corporate bonds with a warrant, and reduces the interest rate of the
corporate bonds, it will not make the corporate bonds unattractive, which in
turn can reduce the burden on the company to pay interest.

Information centre: Warrant

There are two types of warrants: one is a warrant issued by a company,
and the other is a structured warrant issued by an investment bank.
Structured warrants include call warrants and put warrants. The
following is a case of warrant issued by the company:

YTL Power issued a 10-year warrant on June 12, 2008, and the
expiration date is June 11, 2018. Based on Bursa Malaysia’s
information on July 30, 2014 : “YTL Power’s share price is RM1.48 per
share. The warrant is converted into ordinary shares at RM1.14 per
unit, and the warrant is realized at RM0.51.”

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 Warrant holders can choose to:

(1) Sell the warrants on Bursa Malaysia and get RM0.51 per unit;

(2) Pay RM1.14 per unit in exchange for ordinary shares with a stock
price of RM1.48.

The warrant price (RM0.51) fluctuates simultaneously with the stock

price (RM1.48), that is, if the stock price rises, the warrant price also
rises, and vice versa.

Generally, the conversion price of the warrant (RM1.14) is

predetermined and unchanged (unless the company specifically
declares before issuing the warrant, then it is another matter).

1.5 Stock market

Private or public limited companies can raise funds by issuing shares. Only
public limited companies that comply with the listing regulations can sell
shares to public investors on the stock market.
The basic structure of the stock market can be divided into two parts: then
primary market and the secondary market.

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1.5.1 Primary market

Public limited companies comply with the listing regulations, and after
obtaining approval from Bursa Malaysia, they can issue new shares
through the primary market. If the company is issuing ordinary shares for
the first time, it is called an initial public offering.

Generally, companies issue and underwrite new stocks through investment

banks (such as Maybank Investment Bank, Public Investment Bank Bhd). If
the public does not subscribe for all shares, the investment bank will be
responsible for purchasing the remaining shares.

1.5.2 Secondary market

The secondary market refers to the market where investors buy and sell
issued securities (such as stocks and warrants). The two major institutions
involved in the secondary market in Malaysia are: Bursa Malaysia and
Stockbroking company.

(I) Bursa Malaysia

Formerly known as the Kuala Lumpur Stock Exchange (KLSE), it is a place

where buyers and sellers can trade issued securities through a centralized
public auction.
In order to ensure fair trading, Bursa Malaysia has formulated trading rules
and does not participate in stock trading and affect the trading price of
stocks.

Bursa Malaysia has two types of trading boards: Main market and ACE
market. For listed companies on the Main Board, their minimum paid up
capital and profit records are higher than those on the ACE market.

Figure 6 Bursa Malaysia logo and building

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Generally, the functions of stock exchanges are as follows:

1. Provide a centralized trading market to promote stock circulation

Stock exchanges provide a centralized trading venue for open bidding,
allowing stock prices to be determined entirely by market supply and
demand, and promoting stock circulation. This is conducive to industrial
and commercial enterprises to raise funds through the sale of stocks
and to increase investors’ confidence in the realization of stocks, so that
the public’s funds flow to enterprises with good operations and high
returns.

2. Regulate the stock market

The stock exchange details the listing regulations and the rules that the
listed company should abide by. It is also responsible for monitoring the
behaviour of stockbroking company and preventing large groups from
using means to manipulate stock prices to ensure the sound
development of the stock market.

3. Protect the rights and interests of investors

The stock exchange is responsible for reviewing the business and

financial information of listed companies, penalizing companies that
produce false information and misleading investors, in order to protect
the rights and interests of investors.

4. Provide stock market quotations

The stock exchange provides investors with the latest stock market
quotations every day, so that investors can understand the stock market
trends and make wise investment decisions. The information provided
by the stock exchange includes stock prices, trading volume, opening
prices, closing prices, highest and lowest prices, the top volume stocks,
the stock exchange total closed trading volume and total closed trading
value, etc.

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 Figure 7 Bursa Malaysia provides stock market information

For more information about Bursa Malaysia listing regulations, please

visit: www.bursamalaysia.com

(II) Stockbroking company

It is a member company of a stock exchange. Malaysia’s stockbroking
company, as example includes: TA Securities Holding Bhd, Inter-Pacific
Securities Sdn Bhd, CIMB Investment Bank Bhd.

The broker of a stockbroking company acts as an intermediary, buying and

selling stocks on behalf of customers (the public and institutions).
There are two types of stock brokers: salaried brokers and commission
brokers.

Salaried brokers (dealers) are salaried employees of stockbroking company

and cannot get commissions for buying and selling stocks on behalf of
customers. Remisier is not a salaried employee of stockbroking company
and can get commissions for buying and selling stocks on behalf of
customers.
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Figure 8 Stockbroking company (left figure), stock broker buying and selling shares on
behalf of investors (right figure)

Information centre: How to buy and sell stocks in Malaysia

Investors (over 18 years old) must open a trading account and a

central depository account in a stockbroking company or investment
bank recognized by Bursa Malaysia.

By entrusting a stock broker to buy and sell stocks, or log in to the

stockbroking company or investment bank’s website by yourself,
enter the stock code, the price and quantity of buying and selling,
and the validity period of the transaction as according to the
procedure. If the buying price, selling price and quantity match
those of other investors, the transaction will be matched on the
stock electronic trading system of Bursa Malaysia.

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Securities Commission (证券监督委员会）

Established in 1993, it is responsible for overseeing the

operation of Malaysia’s securities and futures markets, including
formulating regulations to maintain fair transactions in the
market, protecting the rights and interests of investors, ensuring
that listed companies conduct mergers and acquisitions in
accordance with regulations, and investigating insider trading
and penalizing those involved.

The Securities Commission promotes investor education in order

to assist investors in effective investment activities. For example:
provide investment information through the website, print
investment manuals, and strengthen investors’ understanding of
securities and futures. www.sc.com.my

Minority Shareholder Watchdog Group (MSWG)

Established in August 2000, it is a non-profit organization and

acts as a guide for minority shareholders to make correct voting
decisions at the general meeting of shareholders to protect their
rights.

Encourage listed companies to implement good corporate fad

governance (such as: social responsibility of the whole industry,
the rate of return of the company), the ultimate goal is to protect
the rights and interests of minority shareholders, and increase
the return on investment of minority shareholders.
www.mswg.org.my

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1.6 Stock index

The stock market index/stock price index is compiled by a group of selected

representative stocks as an indicator of the stock market trend.
The main stock market index in Malaysia is the FTSE Bursa Malaysia Kuala
Lumpur Composite Index /FBM KLCI).

The FBM KLCI consists of 30 component stocks. These 30 companies

have the largest market capitalization on the main board and are also
representative and well-capitalized companies in major economic sectors.
Therefore, constituent stocks are generally regarded as blue chip stocks.

Figure 9 Malaysia’s FBM KLCI on a particular year

In the stock market, where the stock index continues to rise is commonly
called the bull market, and the stock market that continues to fall is
commonly called the bear market.
When the stock market is in a bull market, it means that the stock market is
optimistic and the company’s stock price has a continuous upward trend.
As a result, a bull market has appeared, with
more people buying stocks than selling stocks,
and trading volume has increased. During this
period, most stock prices have continued to
rise. Conversely, when a bear market occurs,
investors are pessimistic about the stock
market, with more stocks being sold than
buying, and stock prices tend to continue to fall.
Figure 10 Bull market and bear market

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The functions of the stock market index are as follows:

1. Reflect the trend of the stock market

The stock market index rises, which means that the stock price of the
day generally rises; the index drop means that the stock price of the day
generally falls. Therefore, stock market indexes can reflect stock market
trends.
2. As a reference for buying and selling stocks
The stock market index helps investors predict market conditions and
economic prospects to make decisions about buying and selling stocks.
The stock market index continues to rise, which shows that investors
predict that the market is optimistic and the economic outlook is good;
the stock market index continues to fall, which shows that investors
predict that the market is not optimistic and the economic outlook is dim.

3. As a reference for merchants to make production decisions

The stock market index helps merchants predict national economic
development and market price trends to make appropriate production
decisions.
4. Reflect the country’s economic conditions
Changes in stock market indexes often reflect the country’s economic
conditions, and therefore help the government implement appropriate
economic policies.

Check it out; is Malaysia’s stock market a bull market or bear market

recently?

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Information centre: Stock market index

The company’s weight in the stock market index is determined by

the company’s market value (stock price x paid-up capital). The
reasons for fluctuation of the stock market index are as follows:

1. Gross domestic product (GDP) growth.

High economic growth drives company performance, which in
turn drives stock prices.
2. Inflation
Generally, inflation will reduce people’s willingness to
consume, make the company’s profit decline, and then pull
down the company’s stock price and affect the stock market
index.
3. The performance of index constituent stocks
Generally, the performance trend of constituent stocks is
directly proportional to the stock market index.
4. The level of bank interest rates
High bank interest rates will reduce the willingness of
companies to invest in loans, and will also attract people to
deposit money in banks, both of which are detrimental to the
rise of the stock market index.
5. The performance of overseas stock markets
The United States is the world’s largest economy, and its
stock market performance is usually proportional to Malaysia’s
FBM KLCI.

Bull market and bear market

The legend is that because the bull is attacking upwards (the
horns go up), it represents bullishness and the stock price rises;
the bear attacks downwards (bear paw swings downwards) which
represents bearishness and stock price falls.

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1.7 Futures
Futures contract is not a physical commodity, but a paper contract. The
contract stipulates that the buyer and the seller can buy and sell a specific
product at an agreed price on a specific date in the future.
Futures are regarded as a kind of derivatives (derivative products), its
categories includes:
(1) Commodity futures
Refers to the futures contracts of physical commodities. It includes
agricultural product futures (such as: crude palm oil, rubber, sugar),
energy futures (such as: crude oil, fuel oil) and so on.

(2) Financial futures

Refers to futures contracts for financial products. For example: foreign
exchange futures, bond futures, interest rate futures, stock market index
futures.
The Bursa Malaysia Derivative (BMD), a subsidiary of Bursa Malaysia,
provides derivatives trading. For example: crude palm oil futures (crude
palm oil futures / FCPO), FTSE Bursa Malaysia KLCI Futures / FKLI (3
Month Kuala Lumpur Interbank Offered Rate Futures / FKB3).
The difference between futures transaction and spot trading is
summarized as follows:
Futures trading Spot Trading
期货交易 现货交易
1. Time and The prescribed time and Any time and place.
place to trade exchange.
2. Products to Futures contract. Physical goods.
trade
3. Obligations Before the expiration of the Buyer pays and
of buyer and futures contract, use hedging seller delivers.
seller to fulfil the contract. On the
expiry date, commodity futures
must actually deliver the
commodities, while financial
futures are settled in cash.
4. Purpose of To avoid the price risk of spot Transfer ownership
the transaction transactions, or speculative of goods.
arbitrage. (投机套利)

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The price trend of futures trading and spot trading is basically the same,
that is, both of them will raise when they rise, and both fall when they fall.
Futures trading are conducted through open bidding. In other words, the
futures price reflects the merchant’s prediction of the future price of the
commodity. Therefore, it can also be used as a reference for the
merchant’s budget of production cost or output.
Hedging transaction refers to a futures contract with the same delivery
month and quantity but the opposite direction is made by the merchant.
This type of trader is called a hedger.
The purpose of hedging transactions is to avoid or reduce the loss caused
by the price risk of spot transactions by profiting from the price difference
between buying and selling futures. For hedging examples, see Appendix 1.
Some people buy and sell futures purely for arbitrage (套利). This type of
trader is called a speculator. Speculators adopt the strategy of “buy at low
prices and sell at high prices” to reap the benefits of the price difference. If
the price of the futures is contrary to the speculator’s prediction, it will suffer
losses.
The purpose of hedgers is to avoid risks, while speculators are willing to
take risks for profit. The goals of the two are different.

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Appendix 1: Buying hedge and selling hedge

(I) Buying hedge

Example (1): Fuel futures

Assumptions: Fuel futures prices and fuel spot prices are rising
simultaneously.

Z Airline based on the trading situation in the spot market, predict future
fuel price increases, so they first buy
short (buy) in the futures market. When
the fuel futures expire, if the fuel price
really rises, Z Airline will use this to sell
the originally purchased fuel futures to
close the position. Airline Z’s profit from
the price difference earned from selling
fuel futures avoids the increase in fuel
costs caused by rising fuel prices in the
spot market.

Example (2): Crude palm oil futures

Assumptions:

(a) The price of crude palm oil futures and the spot price of crude palm oil
increase simultaneously;
(b) 1 metric ton of crude palm oil can
be used to extract refined palm
oil of the same weight.
(c) In the crude palm oil futures
markets, each crude palm oil
futures contract (per transaction)
is 25 metric tons, and the price is
calculated per metric ton.

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The transaction is as follows:
Date Spot trading
February Assume that the spot price
of crude palm oil is
RM1080.
A Malaysia palm oil refining
company sold 1000 metric
tons of refined palm oil to
Indian edible oil importers at
this price. The delivery date
was May.
May Assume that crude palm oil
prices rise to RM1180.
Palm oil refining companies
bought 1000 metric tons of
crude palm oil from the oil
palm mill company to
manufacture refined palm
oil.
Results In spot trading, palm oil
refining companies lost
money in RM100,000.
[(1000 metric tons x RM1080) – [(40 x 25 metric tons x RM1150) – (40
(1000 metric tons x RM1180)
= - RM100,000]
Future trading
Assume that the crude palm oil
futures price is RM1050 per
metric ton. In order to avoid
losses due to the increase in the
spot price of crude palm oil, the
palm oil refining company
bought (shorted) 40 futures
contracts with a delivery date of
May at this price as a hedge.
(1000 metric tons ÷ 25 metric ton = 40
futures contracts)
Assume that the crude palm oil
futures price also rises to
RM1150 per metric ton. The
palm oil refining company sold
the 40 crude palm oil futures
contracts with a delivery date of
May for liquidation/offset.
In future trading, palm oil
refining companies earned
RM100,000.
x 25 metric tons x RM1050) =
RM100,000]

The above transaction shows that the spot price of crude palm oil has
increased, causing palm oil refining companies to suffer a loss of RM100
per metric ton in spot transactions. However, due to timely buying and
hedging, RM100 per metric ton was earned in futures trading. Therefore,
the profits of futures trading make up for the losses of spot trading and
achieve the purpose of hedging.

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(II) Selling hedge
Assumptions:
(a) The crude palm oil futures price and the crude palm oil spot price fell
simultaneously.
(b) In the crude palm oil futures market, each crude palm oil futures
contract (per transaction) is 25 metric tons, and the price is calculated
per metric ton.
Mr Wong owns a large oil palm plantation, and the average oil palm fruit
produced every month is enough to
yield 1000 metric tons of crude
palm oil. Based on spot
transactions in April, he predicted
that crude palm oil prices would fall
in June.
Mr Wong’s transactions are as follows:
Date Spot trading Future trading
April Assume that the spot price Assume that the crude palm oil
of crude palm oil is futures price is RM1050 per
RM1050. metric ton. In order to avoid a
Mr. Wong hopes to sign a loss in the spot price of crude
contract for the delivery of palm oil, Mr. Wong sold
oil palm fruit in June with (shorted) 40 crude palm oil
the oil palm mill company at futures contracts with a delivery
this price. Oil palm mill date of June at this price as a
companies are reluctant to hedge.
buy oil palm fruit in June at (1000 metric tons ÷ 25 metric ton = 40
this time. futures contracts)
June Assume that the spot price Assume that the crude palm oil
of crude palm oil falls to futures price also fall to RM950
RM950 per metric ton. Mr. per metric ton. Mr. Wong bought
Wong sold the oil palm fruit 40 crude palm oil futures
that could yield 1000 metric contracts with a delivery date of
tons of crude palm oil to the June for liquidation/offset.
oil palm mill company.
Results In spot trading, Mr. Wong In futures trading, Mr. Wong
lost RM100,000. earned RM100,000.
[(1000 metric tons x RM950) – [(40 x 25 metric tons x RM1050) – (40
(1000 metric tons x RM1050) = - x 25 metric tons x RM950) =
RM100,000] RM100,000]
27
In the above transaction, Mr. Wong could make a profit of RM100 per
metric ton in futures trading, which just made up for the loss of RM100 per
metric ton in spot trading, achieving the purpose of hedging.
Note: Close out a futures position refers to the sale or purchase of futures to offset the
original long sale or short sale. If the trade does not close the position before the
expiration of the futures, it is responsible for the delivery of the commodity to fulfil the
contract.

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(A) Objectives questions:
1. Which of the following statements about financial markets is correct?
I The place where financial products are traded
II Commodity futures are traded in the money market
III Banking institutions are participants in the financial market
IV The supply and demand sides determine the price of financial products
A I, II, III B II, III, IV
C I, II, IV D I, III, IV

2. Which of the following is not Malaysia’s foreign exchange?

A Singapore dollar B Foreign currency
C Money order paid in U.S. dollars D Cheque paid in ringgits

3. Which of the following has nothing to do with how listed companies raise
funds?
A Issuing corporate bonds B Issuing right shares
C Issuing stocks D Selling futures

4. What are the benefits of investing in blue chip stocks?

I Get back the share capital first
II Have the opportunity to enjoy dividends
III Easy to convert into cash
IV Enjoy long-term fixed income
A I, IV B I, II
C I, III D II, III

5. What rights do the holders of listed company warrants enjoy during the
specified period?
I Sell the warrant on the stock exchange
II Convert the warrant into ordinary shares
III Obtain the interest paid by the company
IV Participate in the general meeting of shareholders
A I, II B I, IV
C II, III D II, IV

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6. Which method can the company use to convert the profit to be distributed
to shareholders into the company’s capital?
A Issuance of corporate bonds B Issuance of rights shares
C Distribution of dividends D Distribution of bonus shares

7. Mr. Xing purchases issued consumer product shares on the main board
in the stock market. Which of the following stock markets belong to the
above-mentioned stock market?
A Currency market B Secondary market
C Primary market D Issuance market

8. Which of the following is not a function of the stock exchange?

A to promote stock circulation
B to provide stock market information
C to protect the rights and interest of investors
D to issue company stocks

9. Which statement about the commission broker is correct?

A underwrites stocks
B does not enjoy trading commissions
C Staff of stock brokers
D Buys and sells stocks on behalf of the public

10. If there is a bull market phenomenon in the stock market, it means:

I There are more sellers than buyers
II There are more buyers than sellers
III The stock market is rising
IV The stock market is falling
A I, III B I, IV
C II, III D II, IV
11. Which of the following is a characteristic of futures trading?
A Can trade anytime and anywhere
B Cannot use hedging to perform the contract
C Cash on delivery
D Buy and sell futures contracts

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12. In what way does the merchant hedge the large volume of rubber
transactions to avoid risk?
A Futures trading
B Spot trading
C Stock trading
D Foreign exchange trading

(B) Subjective questions:

1. Try to write the functions of the stock exchange.

2. Explain the difference between the rights enjoyed by preference stocks

and ordinary stock shareholders.

3. How does the following situation affect the company’s stock price? Try to
explain it.
(a) The company announced the distribution of bonus shares.

(b) Investors are on the sidelines (wait and see attitude) of the company’s
development prospects.

4. Try to explain the impact of the following conditions on the stock market
index:
(a) The central bank announced:” The economic growth rate of Malaysia in
the next quarter will reach 8%, and it is in a period of prosperity.
(b) Stock market rumors: “There are currently eight large groups snapping
up the stocks of many listed companies.

5. Try to judge whether the following statements are correct and explain the
reasons:
(a) Commodity futures are physical commodities;

(b) The domestic political situation is unstable, which has caused stock
prices in many industries to fluctuate.

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(C) Case Study Question
After Oriental Berhad met the listing requirements set by Bursa Malaysia, it
successfully applied for listing as a public limited company.

Oriental Berhad planned to write a prospectus to sell shares to the public,

which attracted investors to subscribe, and thus successfully raised the
long-term development funds needed by the company. According to
newspaper reports, the profit of Oriental Berhad has risen sharply this year,
and the company has decided to distribute dividends to shareholders. In
addition, the company’s chief executive officer also stated in a special
interview in the economics section of the newspaper that the company
intends to expand its business overseas in the next year, while opening
multiple subsidiaries in the local market.

Try to answer based on the above cases:

(a) In addition to distributing dividends, what other methods can Oriental

Berhad use to reward shareholders?

(b) Try to analyze the impact of the company’s current situation on its
ordinary shareholders.

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