The Hurdle Zeeshan.docx

Size of the Firms:

“Yes definitely it affects [size of the firm], look, firm’s size is dependent on their financial resources basically, if financial resources will be enough it will be a big company, they can hire more resources, more staffs and other things, so if it is a big company, it will have more space to operate in derivative market and to operate in it and also to sustain it. Meanwhile the smaller company will have less financial resources hence less liquidity so it might cause them to not have enough liquid resources to operate their own operations” ( Financial Advisor- Focus Consulting Group) Size of the firm in terms of capitalization has some significant impact on the usage of derivatives. Larger firms will have redundant financial resources to fulfill their operational needs while smaller firms didn’t have already enough liquid capital to meet their operational needs thus signifies the limited liquid capacity to invest in derivatives because investing in derivatives will reduces the immediate liquidity. Hence this will contributes towards to limited use of derivatives for smaller firms; consequently in Pakistan there are very fewer larger firms while most of the firms didn’t have that much market capitalization that is one of the main hurdles in the development of derivative markets. “Because Pakistan’s derivative market is not that much organized.. as well as high supervision and regulatory requirements by management authorities.. so it will have increased transaction costs means if you have done an investment in derivative market, it will have a transaction cost for disinvestment; so in that case if you have less savings and you need funds more frequently so you cannot disinvest it easily because it have cost and time. Thus large firms have resources and

they can use derivatives but smaller firms usually cannot afford to do that” (Financial AdvisorFocus Consulting Group) Additionally, in Pakistan due to increased regulatory requirement and supervision there is significant transaction costs for disinvesting from derivatives and smaller firm which normally already have very fewer savings and limited liquid resources will might end up avoiding the usage of derivative instruments. As its usage have high transaction costs for disinvestment as well as time consuming processes which will tie-up their resources due which smaller firms cannot afford that. “The hurdle is...now this is seen obviously that larger firms more better can cover the risk, they have more assets, they have more exposure, more financial expertise, for that reasons larger firms generally .. they engage themselves into more in usage of it [derivatives] than the smaller firms” (Ex-Trading Officer- Pakistan Stock Market) In the view of above discussions and as well discussed earlier in literature review, generally smaller firms avoids the usage of derivatives while larger firms have the enough capacity and assets to cover the losses, so they don’t hesitate to invest in financial derivatives. Meanwhile in the current scenario of Pakistan, due to the reason that larger firms are very few in numbers prospects a significant hurdle in the development of derivative’s market.

Awareness: “Companies in Pakistan around registered with SECP, these are more than 65000 and the companies which are listed with PSX or KSE these are only 650 which are market’s base of companies that is less than 1% precisely around 0.1% which is very less, very few companies have exposure and they…come to the stock market where they issue share, its one of the main reason is that weaken and less institutional development in Pakistan, which result is less informative markets” (Ex-Trading Officer- Pakistan

Stock Market) It is evident that in Pakistan, due to non-existence of formal derivative markets as well as debt markets proposes a significant challenge in developing of forward contracts and derivatives. Moreover regulatory Institutions are not that strong as we have seen recently reported the case of JS Group’s scandal as well as 700 billion PKR Modarbah scandal of Meezban stocks while SECP still didn’t take some solid action against; that is eventually making our markets less informative and more synchronous movement creating mistrust among foreign as well as local investors. Thus due to lack of institutional development that fails to develop trust and awareness among market participants, derivative market in Pakistan facing a substantial challenge. “Financial literacy in Pakistan is very less, even the managers here [Pakistan] don’t have that much exposure of the market.. Although SECP is running a program on awareness named as “Jama Pumji” and many more investors awareness programs but still in Pakistan its very weak [less awareness]. (Ex-

Trading Officer- Pakistan Stock Market). The financial literacy also plays an important role in the process of adopting and developing a the derivatives market, especially when the government and institutions are trying to create awareness in the public and investors; but still in the Pakistan’s scenario even after the efforts of

SECP by initiating a program of “Jama-Punji” overall awareness is very less and mistrust among general investors. Volatility: “ Ok, increasing Volatility is not usually an adverse thing, means volatility you have to see that why it is increasing [ stock prices volatility], if that is more informative volatility where inform trading is been done and people taking decision related to fundamentals and due to that if volatility if increasing so it will be a positive thing.. which we can also called it systematic volatility.. indicating a better market response so we cannot say it is wrong but in our [Pakistan] markets there is noice [noise] trading.. so as we know if volatility is high then usage of derivatives will be increased but when there is noise volatility or unsystematic it will further reduces and obstacle the usage [of derivatives]” (Ex-Trading Officer-

Pakistan Stock Market) In the light of above quoted discussion it is presumed that although volatility increases the usage of forwards and derivatives but where there is systematic trading or informative trading but in case of Pakistan, unfortunately the trading is been done on speculative basis and stock market prices varies in a noisy fashion. Noise trading is usually a term used to refer investor’s behavior where decisions are made about buy and sell trades without any provision of professional knowledge or some fundamental analysis; thus further proposing challenges and limits the development of derivatives markets. “If we talk about the current situation of Pakistan’s political stability, economic stability [due to which]; so the stock prices are very much volatile, we hear on daily basis that how much point got down next day we see it goes up because it is running on speculations.. so if the stock market is very much unstable and volatility is much higher than +/- 5%.. so it will create problem for

derivative market as people will not trust on it, basically because derivative market it a long term investment so it will makes it more riskier” ( Financial Advisor- Focus Consulting Group). As the prevalent condition of Pakistan’s political instability and economic crisis, the stock market prices are witnessing huge fluctuations on daily basis. Although the volatility of prices enhance the usage of derivatives but if the volatility exceeds to the maximum accepted criteria that is maximum around +/-5%, than it will inversely affects the growth of derivatives. Thus in Pakistan’s scenario the volatility is creating problems for the development in derivatives market.