Introduction to Financial Futures

Financial futures are futures contracts base on short term interest rate (STIR). Contracts vary, but are often defined on an interest rate index. Futures contracts are standardized legal agreements to buy sell a commodity or financial instrument at some time in the future. The quantity and quality of the good are specified in the contract, and the price and delivery period are set at the time the contract is opened.

Malaysia also has futures market – Bursa Malaysia Derivatives Berhad (BMDB). All the futures contracts are mainly transacted here. There are a few types of futures contracts traded in the markets. Namely:

1.) Agricultural futures:

These are humanity’s oldest and most basic commodities. The forces of nature as well as people’s habits affect the supply and demand of food products. Contracts include wheat, oats, corn, barley, sugar and etc. Example: Crude palm oil futures contracts (FCPO)

2.) Metal:

Since early human existence, metals have been a prized possession. Precious metals include gold. Silver, palladium, and platinum. Industrial metals include copper, zinc, lead, aluminum and tin.

3.) Foreign currency futures:

As exchanges rate fluctuate in the world economy, international and local investors, companies and institutions, use these futures for protection and profits.

4.) Energy:

Futures contracts include crude oil, gasoline, unleaded gasoline, heating oil and bunker fuel.

5.) Stock index futures:

Introduced in the early 1980s, these contracts have grown in popularity. Each futures contract represents the equivalent of stock portfolio in a major world stock market. Example: KLSE Composite index futures contract (FLKI)

6.) Interest rate futures:

These are one of the most successful contracts introduced worldwide. A change in interest rate can affect the economy. These contracts can limit the risk from such changes and be the means to profits from it. Examples: 3 month KLIBOR Futures Contracts.

In Malaysia, stock index futures were introduced in December 1995 with the launch of KLSE composite index futures contracts on MDEX (known as KLOFFE at the time of the launch). The MDEX stock index futures contract is based on the Kuala Lumpur Stock Exchange (KLSE) Composite Index (CI), a widely-used representation of the Malaysian share market as a whole. A stock index seeks to serve as a measure of share market performance. Hence, the KLSE Composite Index measures the performance of the Malaysian share market.

Kuala Lumpur Stock Exchange Composite Index (KLSE CI) is calculated by using the market prices of companies listed on the KLSE. The KLSE CI is a capitalization-weighted index, which means that the index is weighted according to the market capitalization of the constituents stocks. Thus, companies with a higher market capitalization have a larger weightage in the index.

A futures contract that is based on the KLSE CI is simply an agreement between seller and buyer to respectively deliver and take delivery of the basket of shares that make up the index, at an agreed price, at a specified future date. However, like almost all stock index futures, the KLSE CI futures contract is cash settled.