F&D_FINAL.docx - Task 1 KLCI Futures(FKLI Kuala Lumpur Composite Index(KLCI future contracts also known as FKLI is future contracts traded on Bursa

F&D_FINAL.docx - Task 1 KLCI Futures(FKLI Kuala Lumpur...

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Task 1: KLCI Futures (FKLI) Kuala Lumpur Composite Index (KLCI) future contracts, also known as FKLI, is future contracts traded on Bursa Malaysia Derivatives providing market participants exposure to the underlying FBM KLCI constituents such as interest rate stock, commodity, currency and more. It is actively being used by both the institutional and retail investors in their respective trading portfolios as an efficient way to reduce risk related to changes in the value of the underlying variables. To make it simple, future contract is an agreement between two parties in which one party agrees to buy or sell an asset at a fixed time in the future for a price that they agree upon today. Assuming I will be holding the FKLI for 3 months, where the FKLI is traded at 1,707. If the market is on bull run, I would be able to make profit from the following scenario; buy (long) one contract FKLI at 1,707, after 3 months the FKLI surged to 1,757, I sell the contract at 1,757, thus gaining a profit of RM2,500 (contract size of FBM KLCI multiplied by RM50 x 50 points difference). Inversely, during bear market, the FKLI declined to 1,657, I would loss RM2,500. Or, in a bear market scenario; sell (short) one contract FKLI at 1,707, after 3 months FKLI declined to 1,657, selling it would allow me to gain a profit of RM2,500. It depends on whether I’m entering a contract to buy or sell, during bull or bear market situation. So, how should one determine the fair price of the derivatives? A fair price would mean the value of the contract entered by both parties must not gain any advantage of price differences in two markets. Assume the FBM FKLI is now at 1679.68, contract size is FBM KLCI multiplied by RM 50, the 3-month SIF is 1,693, the market risk-free rate is 4.08% and the dividend yield is 2.96%. Time to maturity of SIF are 90 days. To see if arbitrage is possible we need to check for the mispricing. Based on the calculation the correct value of 3- month FKLI will be: F 3 = S 0 o (1 + rƒ – d) ¿ 0.25 = 1679.68 (1 + 0.0408 – 0.0296 ¿ 0.25 = 1,051.51 points Since 3-month SIF price quoted as 1693, the future is clearly overpriced. 1
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To trade future contract, it is also important to know that there are several factors that might affect the futures market movement. One of the most crucial factor would be the movement of FBM KLCI as it is the underlying asset of FKLI. FKLI reflects the future expectation for FMB KLCI, and the movement of KLCI is affected by both local and global economic conditions. Local economic conditions can be the political stability or uncertainty and the potential growth of an industry will deliver a major impact on the future prices as these would affect the economy of a country. For example, due to the trade war between US and China, Malaysia benefitted from it as the sales of semiconductor sector surged, thus the technology sector would bring up the index. Next, the movement of US and China markets will affect the index as well. US two main stock market indices, S&P 500 and Dow Jones Industrial Average (DJIA) will influence the movement of FKLI. Any policies changes made
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  • Summer '18
  • kelly

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