Chapter Ten

Derivative
Securities
Markets

Copyright © 2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill.
Derivative Securities: Overview

A

Aderivative
derivative security
security isis an
an agreement
agreement between
between two
two
parties
parties to
to exchange
exchange aa standard
standard quantity
quantity of
of anan asset
asset atat
aa predetermined
predetermined price
price at
at aa specified
specified date
date inin the
the future
future

 Payoff
Payoffisislinked
linkedtotoanother,
another,previously
previouslyissued
issuedsecurity
security

 As
Asthe
thevalue
valueof ofthe
theunderlying
underlyingsecurity
securityto
tobe
beexchanged
exchanged
changes,
changes,the thevalue
valueofofthe
thederivative
derivativesecurity
securitychanges
changes

 Involves
Involvesthethetransference
transferenceof ofrisk
risk
 Traders

Traders can
can experience
experience large
large losses
losses ifif the
the price
price of
of the
the
underlying
underlying asset
asset moves
moves against
against them
them significantly
significantly

 At
Atthe
theheart
heartof
ofthe
therecent
recentfinancial
financialcrisis
crisiswere
werelosses
losses
associated
associatedwith
withoff-balance-sheet
off-balance-sheetderivative
derivativesecurities
securities
created
createdand
andheld
heldbybyFIs
FIs

© 2022 McGraw-Hill Education. 10-2

Derivative Securities: Overview
(Continued)
 Derivative

Derivative securities
securities markets
markets are
are those
those in
in which
which
derivative
derivative securities
securities trade
trade
 Growth

Growth inin derivative
derivative securities
securities markets
markets has
has occurred
occurred
mainly
mainly since
since the
the 1970s
1970s

 First
Firstof
ofthe
themodern
modernwavewaveofofderivatives
derivativestototrade
tradewere
wereforeign
foreign
currency
currencyfutures
futurescontracts
contracts

 Second
Secondwavewaveof ofderivative
derivativesecurity
securitygrowth
growthwas
waswith
withinterest
interest
rate
ratederivative
derivativesecurities
securities

 Third
Thirdwave
waveof ofinnovations
innovationsoccurred
occurredininthe
the1990s
1990sand
and2000s
2000s
with
withcredit
creditderivatives
derivatives(e.g.,
(e.g.,credit
creditforwards,
forwards,credit
creditrisk
risk
options,
options,and
andcredit
creditswaps)
swaps)
 Rapid

Rapid growth
growth of
of derivatives
derivatives has
has been
been controversial
controversial
© 2022 McGraw-Hill Education. 10-3
Spot Markets

A

Aspot
spot contract
contract isis an
an agreement
agreement to
to transact
transact involving
involving
the
the immediate
immediate exchange
exchange of
of assets
assets and
and funds
funds

 Unique
Uniquefeature
featureof
ofaaspot
spotmarket
marketisisthe
theimmediate
immediateandand
simultaneous
simultaneousexchange
exchangeof ofcash
cashfor
forsecurities,
securities,or
orwhat
whatisis
often
oftencalled
calleddelivery
deliveryversus
versuspayment
payment

 Spot

Spot transactions
transactions occur
occur because
because the
the buyer
buyer of
of the
the
assets
assets believes
believes its
its value
value will
will increase
increase in
in the
the
immediate
immediate future
future (over
(over the
the investor’s
investor’s holding
holding period)
period)

 IfIfthe
thevalue
valueof
ofthe
theasset
assetincreases
increasesasasexpected,
expected,the
theinvestor
investor
can
cansell
sellthe
theasset
assetat
atits
itshigher
higherprice
pricefor
foraaprofit
profit

© 2022 McGraw-Hill Education. 10-4

Forward Markets:
Forward Contracts
A

Aforward
forward contract
contract isis an
an agreement
agreement to
to transact
transact
involving
involving the
the future
future exchange
exchange of
of aa set
set amount
amount of
of
assets
assets at
at aa set
set price
price

 Market
Marketparticipants
participantstake
takeaaposition
positionininforward
forwardcontracts
contracts
because
becausethethefuture
future(spot)
(spot)price
priceororinterest
interestrate
rateononananasset
assetisis
uncertain
uncertain

 Can
Canbebebased
basedononaaspecified
specifiedinterest
interestrate
rate(e.g.,
(e.g.,LIBOR)
LIBOR)
rather
ratherthan
thanaaspecified
specifiedasset
asset(called
(calledforward
forwardrate
rate
agreements)
agreements)

 Often
Ofteninvolve
involveunderlying
underlyingassets
assetsthat
thatare
arenonstandardized,
nonstandardized,
because
becausethetheterms
termsofofthe
thecontract
contractare arenegotiated
negotiatedindividually
individually
between
betweenthethebuyer
buyerand
andseller
seller

© 2022 McGraw-Hill Education. 10-5

Forward Markets

 Commercial

Commercial banks,
banks, investment
investment banks,
banks, and
and broker-
broker-
dealers
dealers are
are the
the major
major forward
forward market
market participants,
participants,
acting
acting as
as both
both principals
principals and
and agents
agents

 In
InSeptember
September2019,
2019,U.S.
U.S.commercial
commercialbanks
banksheld
heldover
over$43.1
$43.1
trillion
trillionof
offorward
forwardcontracts
contractsthat
thatwere
werelisted
listedininOTC
OTCmarkets
markets
 Each

Each forward
forward contract
contract isis originally
originally negotiated
negotiated between
between
the
the FI
FI and
and the
the customer
customer

 AArisk
riskof
ofdefault
default(by
(byeither
eitherparty)
party)exists
exists

 Recently,
Recently,credit
creditderivative
derivativeinstruments
instrumentshave
havebeen
beendeveloped
developed
to
tobetter
betterallow
allowFIs
FIsto
tohedge
hedgecredit
creditrisk
risk
 Advent

Advent of
of secondary
secondary market
market trading
trading has
has resulted
resulted in
in an
an
increase
increase in
in the
the standardization
standardization of
of forward
forward contracts
contracts
© 2022 McGraw-Hill Education. 10-6
 Futures Markets:
Futures Contracts
A

Afutures
futures contract
contract isis an
an agreement
agreement to
to transact
transact involving
involving
the
the future
future exchange
exchange of
of aa set
set amount
amount of
of assets
assets for
for aa price
price
that
that isis settled
settled daily
daily

 Traded
Tradedon
onan
anorganized
organizedexchange
exchange
 Very

Very similar
similar to
to aa forward
forward contract
contract

 One
Onedifference
differenceisisthat
thatthe
thedefault
defaultrisk
riskon
onfutures
futuresisissignificantly
significantly
reduce
reduceby bythe
thefutures
futuresexchange
exchangeguaranteeing
guaranteeingto toindemnity
indemnity
counterparties
counterpartiesagainst
againstcredit
creditor
ordefault
defaultrisk
risk

 Another
Anotherdifference
differencerelates
relatesto
tothe
thecontract’s
contract’sprice,
price,which
whichininaa
future
futureisismarked
markedto tomarket
marketdaily
daily
 Unless

Unless aa systematic
systematic financial
financial market
market collapse
collapse threatens
threatens
an
an exchange
exchange itself,
itself, futures
futures are
are essentially
essentially risk-free
risk-free
© 2022 McGraw-Hill Education. 10-7
Contract Terms for 10-Year
Treasury Note Futures

© 2022 McGraw-Hill Education. 10-8

 Futures Markets

 Futures

Futures trading
trading occurs
occurs on
on organized
organized exchanges
exchanges

 Chicago
ChicagoBoard
BoardofofTrade
Trade(CBOT)
(CBOT)and
andthe
theNew
NewYork
YorkMercantile
Mercantile
Exchange
Exchange(NYMEX),
(NYMEX),both
bothof
ofwhich
whichare
arepart
partof
ofthe
theCME
CMEGroup
Group

 Financial
Financialfutures
futuresmarket
markettrading
tradingwas
wasintroduced
introducedinin1972
1972
 Most

Most trading
trading takes
takes place
place in
in trading
trading “pits”
“pits” using
using an
an open-
open-
outcry
outcry auction
auction method
method among
among exchange
exchange members
members

 Floor
Floorbrokers
brokersplace
placetrades
tradesfrom
fromthe
thepublic,
public,while
whileprofessional
professional
traders
traderstrade
tradeforfortheir
theirown
ownaccount
account

 Position
Positiontraders
traderstaketakeaaposition
positionbased
basedon ontheir
theirexpectations
expectations
about
aboutthethefuture
futuredirection
directionofofthe
theprices
pricesof
ofthe
theunderlying
underlyingassets
assets

 Day
Daytraders
tradersgenerally
generallytake
takeaaposition
positionwithin
withinaaday
dayand
andliquidate
liquidate
ititbefore
beforeday’s
day’send,
end,while
whilescalpers
scalperstake
takepositions
positionsfor
forvery
veryshort
short
periods
periodsof oftime
time(e.g.,
(e.g.,minutes)
minutes)
© 2022 McGraw-Hill Education. 10-9
 Futures Markets (Continued)

 Futures

Futures trades
trades may
may be
be placed
placed as
as market
market or
or limit
limit orders
orders

 Order
Ordermay
maybe befor
forlong
longposition
position(the
(thepurchase
purchaseof ofaafutures
futures
contract)
contract)or
orshort
shortposition
position(the
(thesale
saleof
ofaafutures
futurescontract)
contract)
 Clearinghouse

Clearinghouse isis the
the unit
unit that
that oversees
oversees trading
trading on
on the
the
exchange
exchange and and guarantees
guarantees all
all trades
trades made
made by
by the
the
exchange
exchange traders
traders
 Holder

Holder of
of aa futures
futures contract
contract has
has twotwo choices
choices for
for
liquidating
liquidating his
his or
or her
her position:
position:
1.1. Liquidate
Liquidateposition
positionbefore
beforethe
thefutures
futurescontract
contractexpires
expires
2.2. Hold
Holdthe
thefutures
futurescontract
contractto
toexpiration
expiration
 Traders

Traders in
in futures
futures (as
(as well
well as
as option)
option) markets
markets can
can be
be
either
either speculators,
speculators, hedgers,
hedgers, or
or arbitrageurs
arbitrageurs
© 2022 McGraw-Hill Education. 10-10
Clearinghouse Function in Futures
Markets

© 2022 McGraw-Hill Education. 10-11

 Profit and Loss on a Futures
Transaction: Example

 Table
Table10-4
10-4(below)
(below)shows
showsaaJune
June2020
2020T-bond
T-bondfutures
futurescontract
contract
could
couldbe
bebought
bought(long)
(long)or
orsold
sold(short)
(short)on
onMarch
March13,
13,2020,
2020,for
for
176’15
176’15(or
(or176.469%
176.469%of ofthe
theface
facevalue
valueof
ofthe
theT-bond)
T-bond)


 Minimum
Minimumcontract
contractsize
sizeisis$100,000,
$100,000,so soaaposition
positionininone
onecontract
contract
can
canbe betaken
takenat
ataaprice
priceof of$176,469
$176,469
 IfIfthe

theT-bond
T-bondfutures
futuresprice
pricefalls
fallsto
to175.87%
175.87%of ofthe
theface
facevalue
value
between
betweenMarch
March13,
13,2020
2020andandthetheJune
Juneexpiration,
expiration,the
thelong
long
position
positionincurs
incursaaloss
lossofof$599
$599[(176.469%
[(176.469%--175.870%)
175.870%)xx
100,000],
100,000],while
whilethe
theshort
shortposition
positionincurs
incursaagain
gainofof$599
$599
© 2022 McGraw-Hill Education. 10-12
 Margin Requirements on Futures
Contracts
 Brokerage

Brokerage firms
firms require
require customers
customers to
to post
post only
only aa portion
portion
of
of the
the value
value of
of the
the futures
futures (and
(and options)
options) contracts,
contracts, called
called
an
an initial
initial margin,
margin, anyany time
time they
they request
request aa trade
trade

 Amount
Amountof ofthe
themargin
marginvaries
variesaccording
accordingtototype
typeof
ofcontract
contracttraded
traded
and
andquantity
quantityofoffutures
futurescontracts
contractstraded
traded

 IfIflosses
lossesononthe
thecustomer’s
customer’sfutures
futuresposition
positionoccur
occurand
andthe
thelevel
level
ofofthe
thefunds
fundsininthe
themargin
marginaccount
accountdrops
dropsbelow
belowaastated
statedlevel
level
(i.e.,
(i.e.,maintenance
maintenancemargin),
margin),the
thecustomer
customerreceives
receivesaamargin
margincall
call

 Futures

Futures are
are leveraged
leveraged instruments,
instruments, meaning
meaning traders
traders
post
post and
and maintain
maintain only
only aa small
small portion
portion of
of the
the value
value of
of
their
their futures
futures position
position in
in their
their accounts
accounts
© 2022 McGraw-Hill Education. 10-13
Impact of Marking to Market and Margin
Requirements on Futures Investments

© 2022 McGraw-Hill Education. 10-14

 Options

 An

An option
option isis aa contract
contract that
that gives
gives the
the holder
holder the
the right,
right,
but
but not
not the
the obligation,
obligation, to
to buy
buy or
or sell
sell the
the underlying
underlying asset
asset
at
at aa specified
specified price
price within
within aa specified
specified period
period of
of time
time

 Call
Calloption
optiongives
givesthe
thepurchaser
purchaser(or(orbuyer)
buyer)the
theright
rightto
tobuy
buyan
an
underlying
underlyingsecurity
security(e.g.,
(e.g.,aastock)
stock)at
ataaprespecified
prespecifiedprice
price
called
calledthe
theexercise
exerciseororstrike
strikeprice
price(X)
(X)
 In

Inreturn,
return,buyer
buyerof
ofcall
calloption
optionmust
mustpay
paythe
thewriter
writer(or
(orseller)
seller)an
an
up-front
up-frontfee
feeknown
knownas
asaacall
callpremium
premium(C)
(C)

 Put
Putoption
optiongives
givesthe
theoption
optionbuyer
buyerthe
theright
rightto
tosell
sellan
an
underlying
underlyingsecurity
security(e.g.,
(e.g.,aastock)
stock)at
ataaprespecified
prespecifiedprice
priceto
to
the
thewriter
writerof
ofthe
theput
putoption
option
 In

Inreturn,
return,the
thebuyer
buyerof
ofthe
theput
putoption
optionmust
mustpay
paythe
thewriter
writer(or
(or
seller)
seller)the
theput
putpremium
premium(P)
(P)
© 2022 McGraw-Hill Education. 10-15
 Option Values

 Model

Model most
most commonly
commonly used
used to
to price
price and
and value
value options
options isis
the
the Black-Scholes
Black-Scholes pricing
pricing model
model
 Black-Scholes

Black-Scholes model
model examines
examines five
five factors
factors that
that affect
affect
the
the price
price of
of an
an option:
option:
1.1. The
Thespot
spotprice
priceof ofthe
theunderlying
underlyingasset
asset
2.2. The
Theexercise
exerciseprice
priceononthe
theoption
option
3.3. The
Theoption’s
option’sexercise
exercisedatedate
4.4. Price
Pricevolatility
volatilityof
ofthe
theunderlying
underlyingasset
asset
5.5. The
Therisk-free
risk-freerate
rateofofinterest
interest

 Time
Time value
value of
of an
an option
option isis the
the difference
difference between
between an
an
option’s
option’s price
price (or
(or premium)
premium) andand its
its intrinsic
intrinsic value
value
© 2022 McGraw-Hill Education. 10-20
Option Markets

 The

The Chicago
Chicago Board
Board of
of Options
Options Exchange
Exchange (CBOE)
(CBOE)
opened
opened in
in 1973
1973

 First
Firstexchange
exchangedevoted
devotedsolely
solelyto
tothe
thetrading
tradingof
ofstock
stock
options
options
 In

In1982,
1982,financial
financialfutures
futuresoptions
optionscontracts
contractsstarted
startedtrading
trading
 An

An American
American option
option can
can be
be exercised
exercised at
at any
any time
time
before
before (and
(and on)
on) the
the expiration
expiration date
date
A

AEuropean
European option
option can
can be
be exercised
exercised only
only on
on the
the
expiration
expiration date
date
 The

The trading
trading process
process forfor options
options isis similar
similar to
to that
that for
for
futures
futures contracts
contracts
© 2022 McGraw-Hill Education. 10-21
Characteristics of Actively Traded Options

© 2022 McGraw-Hill Education. 10-22

 Options Concluded

 The

Theunderlying
underlyingasset
asset on
onaastock
stockoption
optionisisthe
thestock
stockof
of aa
publicly
publiclytraded
tradedcompany
company
 The

Theunderlying
underlyingasset
asset ononaastock
stockindex
indexoption
optionisisthe
thevalue
valueof
of
aamajor
major stock
stockmarket
market index
index(e.g.,
(e.g., DJIA
DJIAoror S&P
S&P500)
500)
 The

Theunderlying
underlyingasset
asset ononaafutures
futuresoption
optionisisaafutures
futurescontract
contract
 Two

Twoalternative
alternativecredit
credit option
optionderivatives
derivativesexist
exist totohedge
hedgecredit
credit
risk
riskon
onaabalance
balancesheet:
sheet:
1.1. AAcredit
creditspread
spreadcall
calloption’s
option’spayoff
payoffincreases
increasesas
asthe
the(default)
(default)
risk
riskpremium
premiumor oryield
yieldspread
spreadon
onaaspecified
specifiedbenchmark
benchmarkbondbond
of
ofthe
theborrower
borrowerincreases
increasesabove
abovesome
someexercise
exercisespread
spread
2.2. AAdigital
digitaldefault
defaultoption
optionpays
paysaastated
statedamount
amountininthe
theevent
eventof
ofaa
loan
loandefault
default
© 2022 McGraw-Hill Education. 10-23
 Regulation of Futures and Options
Markets
 Derivative

Derivative securities
securities are
are subject
subject to
to thee
thee levels
levels of
of
institutional
institutional regulation
regulation
1.1. Regulators
Regulatorsof ofderivatives
derivativesspecify
specify“permissible
“permissibleactivities”
activities”that
that
institutions
institutionsmay
mayengage
engagein in
2.2. Once
Oncepermissible
permissibleactivities
activitieshave
havebeen
beenspecified,
specified,institutions
institutions
engaging
engagingin inthose
thoseactivities
activitiesare
aresubjected
subjectedto tosupervisory
supervisory
oversight
oversight
3.3. Regulators
Regulatorsattempt
attempttotojudge
judgethetheoverall
overallintegrity
integrityof
ofeach
each
institution
institutionengaging
engagingin inderivative
derivativeactivities
activitiesby
byassessing
assessingthe the
capital
capitaladequacy
adequacyof ofthe
theinstitutions
institutionsand
andby byenforcing
enforcingregulations
regulations
to
toensure
ensurecompliance
compliancewithwiththose
thosecapital
capitalrequirements
requirements

© 2022 McGraw-Hill Education. 10-24

 Swaps

A

Aswap
swap isisan
anagreement
agreement between
betweentwo
twoparties
partiesto
toexchange
exchangeaa
series
seriesofof cash
cashflows
flowsfor
for aaspecific
specificperiod
periodof
of time
timeat
at aa
specified
specifiedinterval
interval

 First
Firstdeveloped
developedinin1981
1981when
whenIBM
IBMand
andthe
theWorld
WorldBank
Bankentered
entered
into
intoaacurrency
currencyswap
swapagreement
agreement
 An

Aninterest
interest rate
rateswap
swap isisan
anexchange
exchangeof
of fixed-interest
fixed-interest
payments
paymentsfor
for floating-interest
floating-interest payments
paymentsby
bytwo
two
counterparties
counterparties

 Allows
Allowsthe
theswap
swapparties
partiesto toput
putininplace
placelong-term
long-termprotection
protection
against
againstinterest
interestrate
raterisk
risk
 The

Theswap
swapbuyer
buyermakes
makesthe thefixed-rate
fixed-ratepayments
paymentsininan
aninterest
interest
rate
rateswap
swaptransaction
transaction
 The

Theswap
swapseller
sellermakes
makesthe thefloating-rate
floating-ratepayments
paymentsininan
an
interest
interestrate
rateswap
swaptransaction
transaction
© 2022 McGraw-Hill Education. 10-25
Swaps (Continued)

A

Acurrency
currency swap
swap isis aa swap
swap used
used to
to hedge
hedge against
against
exchange
exchange rate
rate risk
risk from
from mismatched
mismatched currencies
currencies onon
assets
assets and
and liabilities
liabilities
 Credit

Credit swaps
swaps (i.e.,
(i.e., credit
credit default
default swaps)
swaps) were
were
developed
developed toto better
better allow
allow FIs
FIs to
to hedge
hedge their
their credit
credit risk
risk

 Total
Totalreturn
returnswap
swapinvolves
involvesswapping
swappingan anobligation
obligationto
topay
pay
interest
interestat
ataaspecified
specifiedfixed
fixedor
orfloating
floatingrate
ratefor
forpayments
payments
representing
representingthe thetotal
totalreturn
returnon
onaaloan
loanof
ofaaspecified
specified
amount
amount
 Pure

Purecredit
creditswaps
swapsremove
removethethe“interest
“interestrate”-sensitive
rate”-sensitive
element
elementof oftotal
totalreturn
returnswaps,
swaps,and
andare aresimilar
similarto
tobuying
buying
credit
creditinsurance
insuranceand/or
and/oraamulti-period
multi-periodcredit
creditoption
option

© 2022 McGraw-Hill Education. 10-26

Swap Markets

 Swaps

Swaps are
are not
not standardized
standardized contracts
contracts

 Generally
Generallyheterogeneous
heterogeneousin
interms
termsofofmaturities,
maturities,indexes
indexes
used
usedto
todetermine
determinepayments,
payments,and
andtiming
timingof
ofpayments
payments
 Swap

Swap dealers
dealers (usually
(usually FIs)
FIs) keep
keep markets
markets liquid
liquid by
by
matching
matching counterparties
counterparties or
or by
by taking
taking positions
positions
themselves
themselves
 Unlike

Unlike futures
futures and
and options
options markets,
markets, swapswap markets
markets
were
were historically
historically governed
governed byby very
very little
little regulation
regulation

 Because
Becauseof ofthe
therole
rolecredit
creditswaps
swapsplayed
playedin
inthe
thefinancial
financial
crisis,
crisis,the
thecall
callfor
forstricter
stricterregulation
regulationover
overthese
thesesecurities
securities
was
wasstrong
strongin
inlate
late2008
2008andandearly
early2009
2009

© 2022 McGraw-Hill Education. 10-27

Caps, Floors, and Collars

 Caps,

Caps, floors,
floors, and
and collars
collars are
are derivative
derivative securities
securities that
that
have
have many
many uses,uses, especially
especially in
in helping
helping an
an FIFI to
to hedge
hedge
interest
interest rate
rate risk
risk
A

Acap
cap isis aa call
call option
option on
on interest
interest rates,
rates, often
often with
with
multiple
multiple exercise
exercise dates
dates

 Equivalent
Equivalentto
tobuying
buyingaacall
calloption
optionon
oninterest
interestrates
rates
A

Afloor
floor isis aa put
put option
option on
on interest
interest rates,
rates, often
often with
with
multiple
multiple exercise
exercise dates
dates

 Similar
Similarto
tobuying
buyingaaput
putoption
optionon
oninterest
interestrates
rates
A

Acollar
collar isis aa position
position taken
taken simultaneously
simultaneously in
in aa cap
cap
and
and aa floor
floor (e.g.,
(e.g., buying
buying aa cap
cap and
and selling
selling aa floor)
floor)
© 2022 McGraw-Hill Education. 10-28
 Hypothetical Path of Interest Rates

Cap Agreement

Floor Agreement

© 2022 McGraw-Hill Education. 10-29

International Aspects of Derivative
Securities Markets

 Between

Between 1999
1999 –– 2018,
2018, global
global OTC
OTC trading
trading far
far
outweighed
outweighed exchange
exchange trading
trading

 In
Inboth
bothmarkets,
markets,interest
interestrate
ratecontracts
contractsdominated
dominated
 Markets

Markets were
were heavily
heavily impacted
impacted as
as aa result
result of
of the
the
financial
financial crisis
crisis of
of 2008
2008
 U.S.

U.S. markets
markets and and currencies
currencies dominate
dominate global
global
derivative
derivative securities
securities markets
markets

 The
Theeuro
euroand
andEuropean
Europeanderivative
derivativesecurities
securitiesmarkets
marketsare
are
aastrong
strongsecond
second(and,
(and,in
insome
someareas,
areas,exceed
exceedthat
thatof
ofthe
the
U.S.)
U.S.)

© 2022 McGraw-Hill Education. 10-30

Derivative Market in the
Philippines

10-31
Derivative Market in the
Philippines
The derivatives market in the Philippines is still
developing but has been gradually growing in terms of
infrastructure, regulatory support, and participation.

Derivatives are financial contracts whose value is derived

from an underlying asset, such as stocks, interest rates,
currencies, or commodities. Common types include:
• Futures
• Options
• Swaps
• Forwards

10-32
Derivative Market in the
Philippines
📈 Current State of the Derivatives Market in the
Philippines

1. Regulatory Environment
• Bangko Sentral ng Pilipinas (BSP): Regulates derivatives
used by banks and other financial institutions.
• Securities and Exchange Commission (SEC): Oversees
securities-related derivatives.
• Philippine Dealing & Exchange Corp. (PDEx): Facilitates
trading in fixed-income and derivatives products.
Regulations have become more robust over the past decade to
align with global standards, especially after the 2008 financial
crisis.
10-33
Derivative Market in the
Philippines
📈 Current State of the Derivatives Market in the
Philippines

2. Philippine Dealing & Exchange Corp. (PDEx)

• Offers interest rate swap (IRS) trading and some basic

structured derivative products.

• Main platform for over-the-counter (OTC) trading of

government securities and related derivatives.

10-34
Derivative Market in the
Philippines
📈 Current State of the Derivatives Market in the
Philippines

3. Philippine Stock Exchange (PSE) Derivatives Market

• The PSE launched its own derivatives exchange — the

PSE New Product Launch included index futures (initially
based on the PSEi or the Philippine Stock Exchange index).

• PSEi Futures Contract:

• Introduced to allow investors to hedge or speculate on
the performance of the PSEi.
• Traded via the PSE's derivatives trading platform.
10-35
Derivative Market in the
Philippines
📈 Current State of the Derivatives Market in the
Philippines

4. Market Participants

• Mostly institutional investors (banks, insurance firms, asset

managers).

• Retail participation remains low due to:

• Lack of awareness
• Complexity of products
• Regulatory and capital requirements

10-36
Derivative Market in the
Philippines
📈 Current State of the Derivatives Market in the
Philippines

5. Challenges

• Low liquidity and limited product variety

• Limited awareness and education
• High costs and margin requirements
• Need for infrastructure and technology upgrades

10-37
Derivative Market in the
Philippines
📈 Current State of the Derivatives Market in the
Philippines

6. Opportunities

• Rising interest from foreign investors and local institutions.

• Increased focus on financial literacy and product
innovation.
• Potential development of derivatives for:
• Agricultural commodities
• Energy products
• Climate risk (e.g., weather derivatives)

10-38
Derivative Market in the
Philippines
📊 PSEi Futures: The Philippine Index Futures Contract

The PSEi Futures is a financial derivative that allows

investors to speculate on or hedge against future movements of
the PSE Composite Index (PSEi), which tracks the
performance of the top 30 listed companies in the Philippines.

10-39
Derivative Market in the
Philippines
📊 PSEi Futures: The Philippine Index Futures Contract

Key Features:
• Underlying Asset: PSE Composite Index (PSEi)
• Contract Size: Typically represents a specific monetary
value per index point (e.g., ₱50 per point)
• Tick Size: The minimum price movement allowed (e.g., 1
index point)
• Settlement: Cash-settled based on the final settlement
price of the PSEi on the expiry date
• Trading Hours: Align with the Philippine Stock
Exchange's regular trading hours

10-40
Derivative Market in the
Philippines
📊 PSEi Futures: The Philippine Index Futures Contract

Example:

If the PSEi Futures contract is priced at 6,000 points, and each

point is worth ₱50, the total contract value would be ₱300,000.
A movement of 10 points would equate to a profit or loss of
₱5,000.

10-41
Derivative Market in the
Philippines
📊 PSEi Futures: The Philippine Index Futures Contract

Timeline for Launch

• Target Launch Date: The Philippine Stock Exchange (PSE)

aims to introduce derivatives trading, including index futures,
by early 2026.
• Collaborations: The PSE has entered into a memorandum of
understanding with the Taiwan Stock Exchange (TWSE) to
develop the necessary infrastructure and share best practices
in areas such as operations, governance, and product
development .

10-42
Derivative Market in the
Philippines
📊 PSEi Futures: The Philippine Index Futures Contract

Regulatory and Market Developments

• Regulatory Framework: The Securities and Exchange

Commission (SEC) is in the process of finalizing the
regulatory framework for futures markets in the Philippines .
• Market Education: The PSE is actively engaging in market
education initiatives to prepare investors and market
participants for the upcoming derivatives products .

10-43
Derivative Market in the
Philippines
📊 PSEi Futures: The Philippine Index Futures Contract

Getting Started with PSEi Futures

For those interested in learning more about PSEi Futures and
derivatives trading:

• PSE Market Education: The PSE offers resources and e-

learning modules to educate investors about derivatives and
other financial instruments.
• Brokerage Firms: Leading brokerage firms in the
Philippines are expected to offer access to PSEi Futures once
they are launched. It's advisable to stay updated with
announcements from these firms regarding product offerings.
10-44