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Karachi
Thursday, September 9, 2004
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ï  established on April 20, 2002
ï ermission granted by S on May 16,
2002
ï resent Shareholders:
± KS40%
± S10%
± IS10%
± ak Kuwait Investment o. ± 10%
± Zarai Taraqiati Bank td. ± 10%
ï Another FI has an approval for a 10%
equity stake
ß
ï  demutualized exchange in akistan
ï  fully integrated electronic exchange
capable of also handling financial futures
ï  to employ modern risk management
techniques ± Valueatisk
ï  to introduce the concept of ³The entral
ounterparty´
ï  to introduce Vault eceipts and Warehouse
eceipts
ï  to become a    
 in akistan ± secure network access
ï  to deploy       
þ 
FM T
ï imited access ï qual access to all
ï rice distortions ï bservable future prices
ï Wide spreads or one way ï arrow spreads and two way
quotes quotes
ï Absence of ï uality certification &
standardization standardization
ï ounterparty risk ï entral ounterparty
ï Impediments in financing ï ase in financing
ï ack of long term funding ï Vibrant long term market
or there is a mismatch

         


     
=     ! 
ï ß  in price discovery of both cash and futures
ï ß  in transferring risk ± averse to risk to someone
with an appetite
ï ß  in transforming cash markets into vibrant
markets
ï ß  in transitioning investors into a more controlled
environment
ï ß  in entrepreneurial activity in an economy
ï ß  in creating savings and investments in the long
run
ï ß  in developing intellectual capital and awareness
 enhances markets image and standing, and leads to
an increase in FDI
ý    "  
ï ardware and software fully installed
ï Members and their clients ± Mock Trading
ï
old will be the first contract to be listed
ï egulations are ready and are to be
approved by the Board and then S
ï learing Bank has been appointed for online
bank transfers (MB)
ï otton Yarn, ice and Wheat contracts are
being developed for 4
ý    "    #$%

ï 181 Members have been trained so far


ï Staff is highly educated and experienced
in trading futures, risk management, IT,
investment banking, agriculture, textiles,
financial mathematics, operations,
corporate & securities law, stockbroking,
accounting, tax, process improvement,
etc««
ï ³
o ive´ ?
2   
ï rovide a transparent platform for   and
&   to all participants
ï egulations will provide  
   and  to investors
and users
ï isk Management, and Surveillance &
Monitoring will be based on the
    = ' 
ï Developing   
contract specifications
  
ï onflict of interest clearly defined
ï nbusinesslike conduct, misconduct and
unprofessional conduct have been
introduced
ï Board does not have the right to waive
compliance
ï Incorporated orporate ode of

overnance and ³Best Business
ractices´
ï ommittees only have recommendatory
powers
 þ  
ï retrade risk checks
ï learing Deposits & learing imits
ï osition imits ± Members & lients
ï Variation margin ± T+0 settlement in cash
ï Valueatisk methodology using xtreme Value
Theory
ï rovision for intraday margin calls
ï xchange reserves the right to enforce special
margins
ï  &       (  
     
ï It captures an important aspect of risk
in a single number
ï It is easy to understand
ï It asks the simple question: ³ ow bad can
things get?´
ï Va models will be continuously back
tested and stresstested
þ    ) !  
ï xample ±
old
ï Va for learing imit = 2 * Sigma = 3%
± learing Deposit: s1.0 million = x 33.33
ï Va for Initial Margin = 4 * Sigma = 5%
± Initial Margin: s0.5 million = x 20.00
ï Initial Margin: 99% Va over 1 day
ï Spot/Delivery Month Margin: 99% Va over
3 days
')   þ  
ï Against an initial margin
ï an also set:
± Maximum click trading limit
± Maximum order size
± Maximum sum of contract size limits
± Maximum long positions
± Maximum short positions
± Maximum intraday loss
¢  

þ  
 
    


 


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  2
---...-..2
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ï pon matching of a trade,  becomes a
buyer to every seller and a seller to every
buyer and guarantees settlement
ï The risk of each counterparty is transferred
to a entral ounterparty ()
ï  is fundamental to the existence of a
derivatives market
ï
        + 
,      -  
 
=    ' .þ  /

=  



=  
     
ï Benefits of :
± Acts as a entral Bank to learing Members
± Simplifies isk Management
± reates rocess fficiency
± Increases iquidity
± Anonymity
± Standardization of rocessing
ï    þ+  0  
   +       
  -1      0 
(   þ   
ï learing imits
ï osition imits
ï     .þ+  / 2 3
        
ï Wash Trading
ï Front unning
ï Trading pposites ± prearranged trading
   4

ï Single lectronic front end trading platform
accessible up to the client level
ï sing a single front end for trading on
Multiple Markets
ï entralized learing & Settlement
Infrastructure
ï Multilateral etting
ï ross Margining if we run multiple markets
   4
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ï       '  should provide:


± an be used for accessing multiple markets (J
Trader being used by over 6,000 traders for
accessing 13 lectronic xchanges with 500,000
futures contracts being traded every single day)
± Trader (hand held device such as a alm ilot)
± fficient screen based trading
± omplete anonymity
± rder driven with price/time priority
    þ  þ 
 
ï Features & Functionalities:
± reTrade heck based on an initial margin for
all
± Setting trading limits based on an initial margin
± Monitoring of learing imits in real time
± Monitoring of osition imits (Members and
lients) in real time
± Bank transfers
± apability of handling shares as collateral
± Back ffice ledgers  accounting
± Share release and bank transfer instructions
 
ï latform for price discovery and hedging of
price risk for farmers
ï rovide a mechanism to lenders for
moving into collateralized commodity
financing
ï Introduce quality standardization
ï Impetus for investment in infrastructure
ï ß*1  )& * +
   *     
*    
  '   +* þ 0 5
þ  þ   ' 
.  6 /
888

<88

;88
Sowing
 88 ?

Sowing arvesting
arvesting Sowing
:88
arvesting
>

988
ed = Average of Three Major Markets
Yellow = Average of 9 minor Markets

88

200001 200102 200203


788
+

+


















=

Source: Federal Bureau of Statistics


 =    
ï Structured form of financing with an
objective of transferring risk from an entity
to a commodity
ï In discussion with an
 to undertake
financing as a pilot project on the following
basis :
1. resowing for inputs against 
contract (short) and social collateral
2. ostharvest and upon storage against a
warehouse receipt
(
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  4

ï isk Management
± Should not be viewed as static
± Time value of money
± Being a  would require huge amount of risk
absorption
± sing Va to quantify and manage this risk
± Initial Margin and learing Deposits to be determined
using Va
ï ew roduct Development
± Benchmark Yield urve
± Interest ate isk
± Interest ate Futures
± Stock Index Futures
   *  * 6þ
ï A bond¶s computed YTM will only actually
be earned if cash flows are immediately
reinvested
ï ne cannot use YTMs of existing bonds to
price a new issue
ï YTM is not a pricing kernel
ï YTM believes the yield curve is flat; it is not
a path to thinking and understanding a
nonflat yield curve
ï It plays no role in the economics of fixed
income markets
   6 
ï rovides a benchmark for valuing

securities across all maturities irrespective
of liquidity
ï To study impact of monetary policy
ï Will help in asset and liability management
of institutions with substantial investment
in
 securities
ï as multiple uses including deriving
forward currency rates
ï Will take akistan a step closer to
international markets
   6
Three main issues:
1.
iven a series of
 securities, how do you
construct the yield curve?
a. inear xtrapolation
b. =  
c. ubic Splines
2. What
 securities data should be used to
construct it?
a. '     2    
b. Secondary market data ± individual instruments
3. What technique?
a.
 
b. xtended elson Siegel
 6  ' 

 |  þ 

@A ß2 =    Bý

bservations:
1. All markets, other than akistan, have efficient
screen based exchange traded interest rate
hedging products
2. All markets, other than akistan, have
benchmark yield curves

 |  þ 

A þ   |       '+ 


'  þ  þ 
ï Market trades on the YTM curve
ï T ± impedes price discovery
ï Fragmented information  an impediment to
liquidity
ï redit risk
ï xtreme concentration
ï ack of edging pportunities
   |    
      
ï A 8.0% 2014 IB new issue (example) will
be quite liquid
ï ould it be used as underlying for a interest
rate futures contract?
ï roblems:
± Short squeeze
± It would no longer be ¶quite liquid¶ in the future
± It does not directly link up to hedging needs
(   
ï ash settlement to notional zero coupon
bond
ï Interest rate futures based on the notional
TBills & IBs
ï Trading such a contract will not require
spot market infrastructure  billions being
transferred on a daily basis
ï liminates ³heapest to Deliver´ games
|       
ï otional 90 day & I Year TBills, otional 5 Year
IB with oupon, otional 10 Year Zero oupon
Bond, etc.
ï Duration of ontracts ± varied
ï isting Frequency  initially, one every month
ï ash settlement
ï ot size, tick size, price steps, order size, etc. to
be determined together with market participants
ï Base price to be determined using theoretical
futures price  ZY
Thank You