The financial crisis in 2008 has caused the derivatives instruments to be blamed for increasing systemic risk. Although derivatives were not a central cause of the crisis, the market’s complexity and limited transparency reinforced the potential for excessive risk-taking, as regulators did not have a clear view of how derivatives were being used.

1. a) Future Contract/Agreement

A futures contract that has been used during the financial crisis in 2008 has caused the derivatives instruments to be blamed for increasing systematic risk. Derivatives additionally alluded to as “futures contracts,” have worked for over 100 years to go about as a hedge against changes in costs of products, for example, commodities, metals, energy items, and financial instruments. Control of derivatives was safeguarded under the Commodity Exchange Act of 1936, which called for guidelines and oversight of derivatives (Stunda, 2014). A critical development in the utilization of derivatives happened at about a similar time. The Federal government chose to deregulate them in 2000 through the passage of the Commodity Futures Modernization Act. Accordingly, derivative development alongside the concurrent expulsion of all controls related to them, help lead to the awful financial crisis in the U.S. economy in over 75 years. A conventional futures contract is a legal agreement between a merchant and a purchaser that the dealer will convey to the purchaser, at a value consented to when the deal is first entered. The purchaser will acknowledge and pay for, a predefined amount and grade of an identified item later on (Chen, 2020).

Futures contracts are standardized for quality and amount to encourage exchanging on a futures trade. While the future agreement’s role was first created for the agriculture area, it expanded into metals and caffeinated drinks. There has been a nonstop extension of the futures and derivatives market to financial futures on government securities; private obligation issues foreign currency and stock indexes an inexorably significant part of the product’s world. Standardized product is a crucial component of traded on an open market futures contract. Under these, most clients do not hope to take delivery. There is a chance to balance, and the client has a privilege to exchange as opposed to take or make delivery (Greenberger, 2010). Just using profoundly standardized items can the fundamental liquidity be built up that permits a dealer the genuinely necessary capacity to counterbalance rapidly delivery obligation to prevent the undesirable delivery commitment. The market for futures contracts is profoundly liquid, enabling speculators to enter and exit at whatever point they decide to do so. These agreements are most of the time utilized by speculators, who bet on the direction in which an assets price will move, they are typically finished off before development and delivery as a rule never occurs. For this situation, a cash settlement typically happens.

1. b) Forward Contract/Agreement

A forward agreement is a customized contract between two parties to purchase or sell an asset at a predefined price on a future date. It can be utilized for hedging or speculation and fundamentally speaks to a financial item, regardless of whether it depends on products, interest costs, and the foreign currency or stock market indices (Dhir, 2020). Firstly, currency forward. Transactions carried out currency forward agreements represent an impression of the future currency value. Secondly, commodities forward the same as money forwards, whereby the main distinction lies in the way that the previous depends on merchandise, and the latter depends on money exchange. Exchanging product forwards are done on a stock trade. Thirdly, weather derivatives represent the most recent kind of forwards, made with the end goal of protections against terrible climate conditions, and this has become the quickest developing business sector. Since the development of the derivatives market, hedging activities are progressively acted in the forward business sectors. Investors use forwards to ensure a specific yield level through the transfer of risk to other exchange members. This risk is attempted by theorists who take inverse situations from the hedgers and thus make the market fluid. Hedgers secure themselves by the transfer of risk to different members against losses, yet diminish the chance of profit increment (Barjaktarovic, 2012).

Hedger usually plays in this contract and would typically endeavor at decreasing the introduction of their situation to value unpredictability and, in a derivative market, would go into a position, which is inverse to the hazard he takes. The requirement for risk management that futures can meet remains constant for all business sectors, including financial markets and organizations hedge their foreign exchange and interest rate exposure (TrustPilot, 2020). Correspondingly, portfolio supervisors hedge stock fund risk as well. Using derivatives, risk-averse banks and other investors may extensively moderate risk exposures by moving risks to different investors who are eager to expect them. Financial markets are also better equipped for alleviating stuns acquired by an adjustment in interest costs, inflation, currencies, securities price, or different variables. During the crisis, investors in the market may take one or both first places that exist in the stock exchange. The long position incorporates procurement and holding of the obtained resources, and this is frequently the only position of which numerous market players are aware. The short position is more complicated and regularly unfathomable to customary investors. Hedging might be characterized as the demonstration of taking two opposite positions with the goal that the expected losses from one position is neutralized by benefit from the other position. In a perfectly established hedging, no loss can be accomplished. Profits and losses from the contrary views give a zero-sum in achieving any price in the market.

1. c) Options Contract

Options illustrate an arrangement between two parties to perform a potential transaction in the future at a predetermined price, known as the strike price, before maturity (Hargrave, 2019). Generally, there are two types of options, which are call options and put options. By buying a call option, a person has the right to purchase the underlying assets at the strike price. On the other hand, a put option gives the buyer the right to sell the underlying assets at the strike price.

There are two classifications of options, which are U.S. options and European options that each incorporates a unique mechanism. For instance, U.S. options can be exercised at any time before maturity, while European options can only be exercised on the exact maturity date (Douthit, n.d.). Generally, hedgers and speculators are the main market players in options trading. For instance, hedgers may buy put options on the assets they are holding, especially when they have no intention in closing the long position in the future. For instance, when the price of the underlying asset decline, they can partially offset the losses on the actual asset with the gains upon the exercising of the options (Corporate FInance Institute, n.d.).

On the other hand, investors may buy calls options or sell puts options for speculative purpose. For instance, if the future stock price is expected to increase, by buying call options, the investor can purchase the underlying asset at the strike price while selling it at the higher market price, earning a profit. Therefore, theoretically, there is unlimited potential profit. Consequently, the seller of the put is only subject to limited profit, which is the premium paid upon purchase of options. The possible outcome will be reversed when a person sells puts instead of buying calls to speculate.

The two main types of options contract in Malaysia are OKLI (Options on KLCI Futures) and OCPO (Options on Crude Palm Oil) (Bursa Malaysia). Their underlying instruments are FBM KLCI Futures (FKLI) and FCPO, respectively. Subsequently, these two are European options contracts. On 13^th January 2020, Bursa Malaysia has launched options contract on palm olein futures (POL) and refined, bleached and deodorized (RPD) that are both U.S. dollar-denominated (NST Business, 2020). Concurrently, there is a total of 17 brokerage firms and investment banks that act as market makers in derivatives trading in Malaysia, which is further illustrated in the figure below.

1. d) Swaps

Swaps define an agreement between two parties to exchange a series of cash flow for a stipulated period in the future (Mccaffrey, 2019). The three basic types are interest rate swap, currency swap and commodity swap (Corporate Finance Institute, n.d.). For instance, interest rate swaps typically involve the exchange of one cash flow of fixed-interest rate with another of variable interest rate, vice versa. For instance, a firm may be earning revenues on variable rates while incurring in business costs that have a fixed rate, and another firm is earning revenues on fixed rates while incurring variable rates on costs. Both firms may agree to swap their future cash flows, which results in the first firm getting fixed rates on revenue and the other firm getting variable rates on their revenue. Hence, both firms can achieve cash inflows that are more coherent with their cash outflows, effectively minimizing their interest rate risks.

Currency swaps allow for the exchange of cash flows of different currencies and are majorly utilized by multinational corporations and financial institutions to hedge against currency risk (Segal, 2019). For example, a multinational firm based in the U.S. has business operations in Canada. They earn revenue in Canadian dollar but are obliged to pay off their debts in U.S. dollars. Therefore, they are exposed to substantial foreign exchange rate risk. To hedge the risk, the firm can enter into a USD/GBP swap, which fixes the exchange rate between USD and GBP in the future. However, it requires the buyer and swap seller to have opposed opinions on the future movement of the foreign exchange rate for the swap to happen (Corporate Finance Institute, n.d.)

Commodity swaps allow for the exchange of commodity price between two parties, where one takes the fixed price and pays the market price of the commodity, vice versa (Seth, 2019). The mechanism behind commodity swaps are somewhat similar to interest rate and currency swaps and is used primarily to hedge against fluctuations in commodity prices. Therefore, commodity swaps are common among raw material suppliers that are motivated in hedging any uncertainties in future commodity prices.

KLIBOR (Kuala Lumpur Interbank Offered Rate) is the key rate involved in the Malaysian interest rate swaps market and is the rate on term deposits offered by major banking institutions in the Malaysian interbank market or wholesale market (br, n.d.). Major banks in Malaysia references the KLIBOR to price their loans. For instance, Standard Chartered and Hong Leong Banks Berhad use KLIBOR to structure their housing loans prices. Back in 2019, the Malaysian central bank has signed a three-year currency swap agreement with the Indonesian central bank that allows currency exchanges of up to USD 2 billion (China.org.cn, 2019). On 3^rd February 2020, Bank Negara Malaysia has also renewed their bilateral currency swap arrangement with Bank of Korea that costs around 15 trillion won or RM5 billion, where the initial arrangements date back to 2017 (Xinhua, 2020).

References

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