1. Derivatives Markets In Developing Countries Chapter 14 Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 20081

2. Background China: Population = 1.3 billion India: Population = 1.1 billion China and India between them currently account for about 36% of the world’s population By 2030 India’s population is expected to overtake that of China Both China and India are actively developing their derivatives markets Other developing countries such as Brazil have already been very successful in developing their derivatives markets Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008 2

3. Key Issues in Developing Countries Regulatory environment: governs what can be traded; who can trade; what are the risk controls; approval process for exchange- traded contracts, etc How well developed are equity and interest rate markets Convertibility of currency Legal framework Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008 3

4. China: regulation Prior to 2004 there were many restrictions on the trading of derivatives. In particular they could be used by financial institutions only for hedging purposes. The restrictions were eased by the China Bank Regulatory Authority in 2004 The new rules allowed forward, futures, options, and swaps to be traded for hedging or profit-making purposes Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008 4

5. China: currency China’s currency (known as the yuan, renminbi, RMB, or CNY) is not yet freely convertible Exchange rate movements are restricted by the government Most economists think that free convertibility would lead to its value against the U.S. dollar increasing This in turn would lead to China’s trade surplus with the U.S. increasing Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008 5

6. China: commodity futures exchanges Futures contracts trade on a number of exchanges Shanghai Futures Exchange (SFE) trades futures on copper aluminum, natural rubber, fuel oil, gold and zinc Dalian Commodity Exchange (DCE) trades futures on soybean, soybean meal, soybean oil, corn, low-density polyethylene, and palm olein Zengzhou Commodity Exchange (ZCE) trades futures on wheat, copper, and pure terephthalic acid Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008 6

7. China: Financial Futures The China Financial Futures Exchange (CFFEX) will launch a CSI 300 index futures once regulatory approval is obtained The CSI index tracks the daily performance of 300 stocks listed on the Shanghai Stock Exchange and the Shenzen Stock Exchange Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008 7

8. China: OTC Markets Contracts traded include forward and swap contracts on foreign exchange, interest rate swaps and bond forwards Convertible bonds and warrants are popular Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008 8

9. India Teji (call options), mandi (put options) and fatak (staddles) have traded in Mumbai since 1900 The Securities Control and Regulation Acts of 1956 and 1969 severely restricted the types of products that could be traded and the development of derivatives markets suffered a set back In 1995 the prohibition on the trading of options was lifted Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008 9

10. India continued In 1999 a legal framework for the trading of derivatives was developed Derivatives trading has developed fast since 2000 The National Stock Exchange (NSE) and the Stock Exchange, Mumbai (BSE) traded index futures, stock futures, index options, and stock options The over-the-counter market is also active Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008 10

11. A Future Development? Derivatives trades between national governments to hedge their economic risks If country X exports commodity A to country Y and country Y exports commodity B to country X it might make sense for them to enter into a swap that fixes prices for several years into the future. Options, Futures, and Other Derivatives, 7th International Edition, Copyright © John C. Hull 2008 11