The Financial Derivatives

>Chapter 1
Introduction

Financial derivatives are often an efficient policy of the risk management as they are been used in modern economy worldwide. Financial derivatives grow on huge scale and very significant into well accepted definitions, measurement and the revelation of the conventional financial accounting essentials. Financial derivatives have many advantages and they have been used worldwide.

Though, some risks occur in the use of financial derivatives, the management of the financial derivatives become more essential in the modern economy. With the rapid growth of the modern economy, more financial risks exists during the development process which involves the frequent use of financial derivatives, the use of the derivatives assist against potential risks and use of financial derivatives also reveals to the user a huge risk. Financial derivatives are also important through the progress of financial derivatives. 

Globally, the world economy is fast growing which is leading to so many difficulties in the financial derivatives worldwide which are creating more problems for financial derivatives. However this problem requires the introduction of regulatory body such as government to take over in order to supervise the financial derivatives. The supervision of financial derivatives plays a vital role in modern economy while lack of regulation in financial derivation will lead the financial market into disorder, chaos and confusion.

This might destroy the entire nation’s economy. Financial derivatives without regulation will attract a big potential economic risk. For the financial market globally, such economic crisis affects the economy worldwide.

Objectives Of The Study

The People’s Republic of China has a huge economy which is growing rapidly. There are various types of financial derivatives in china, which are widely used in the financial market. This research will analyze the financial derivative in China’s financial market and also discuss the classic supervision (regulations) and the analysis of the performance of the supervision procedure.

China financial market, its advantage and the risks that exist in the classic financial derivative in China will also be reviewed. This research will reveal major classic in the various types of financial derivatives in china and verify the uses of all the financial derivatives in order to demonstrate its performance of those financial derivatives. The supervision of financial derivatives will also lead to reviewing the China’s financial environs. The major purpose of this research is to establish the usage of financial derivatives against the financial derivatives. The findings of the research from both the financial derivatives and role of supervision in China will provide an overall insight in the China financial market and also conclude by making some recommendation on the usage of financial derivation and the status of the supervision of financial derivatives in China.

Structure Of The Research

This research reviews the overall literature on financial derivative in the past with a focus on the impact of the financial derivative, the benefits of the practise of financial derivative and the potential risk of the use of financial derivative. The supervision of the financial derivative analysis will be reviewed with the use of Journals and report. Subsequently, this research work will focus on the case study for the research methodology; the case study is China’s financial market.

This research model information is gathered from both China’s financial market and the supervision of the financial derivatives in China. Information is however collated in china using the position of a standard financial derivative in China. Using the position of a standard financial derivative in China, the analysis of financial market in China is reviewed with some journals and reports which were used as the data in support of the research and the most vital data is collected by the Chinese national statistics. 

The research will use both the qualitative and quantitative analysis method, this used to analyse the research data. From the research of classic financial derivative that is practised in China and the supervision of its financial derivatives. This research will adopt the SLEPT method (Social factor, Legal factor, Economic factor, Political factor and Technological factor) to review the country’s financial markets while the SWOT (Strengthen, Weakness, Opportunities and Threats) method will be used in reviewing the financial derivative in the direction of the China’s financial market, the functions of the supervision of the financial derivatives in China will also be reviewed.

Finally, there will be brief conclusions and provide some recommendations on both China financial for market and supervision of the financial derivatives. The limitations of the study will be highlighted and references for further reading will also be listed at the end of this research.

Chapter 2
Literature Review
The Impact Of Financial Derivative

Financial derivatives have direct influence on the organization as it is a good policy of risk management. Froot et al (1993) observed that the peak level of investment and capital spending are selected at the same time. They recommend that financial cost risk management should have a particular dominant goal; this enables the company to have access to cash to make price improving investments.

The risk management model rely on the fundamental premises that the essentials of establishing corporate value is creating good investment and the essentials to creating good investment is generating adequate cash within, in order to use it to find those investments. Nance et al (1993) and Mian (1994) discover statistically important clear relationship between the tax credits and the practise of risk management instruments. Dolde (1995) reported a clear and an important relation between tax loss carry forwards and the practise of risk management instrument which include hedging. Bhandari (1997) found that calls for supervision through a rise in legislation are not generally accepted. Although the main focus of the supervisory body is that the stability of inter market could be strictly undermined without greater supervision.

Guay (1999) studies financial derivatives responsibilities in organizations by initiating derivatives practises. 

The outcomes were consistent with organization practising derivatives to hedge and not to expand, entity risk. Organization risk is measured in different ways which reduces following the use of derivatives. The study observes a decrease in risks and decisions to introduce derivatives programs vary from hedging.

The outcome highlights the significance of hedge accounting laws that incorporate the influence of derivatives and hedged items at the same time. Fender (2000) discovered some basics of corporate finance of monetary economics examine the influence of corporate risk management policies on the monetary transmission system. They employed an easy model of a financial speed up to sort the information asymmetries, they are the core of the entire models of the transmission system, it establish motivation for corporate hedging activities, that is cash flow administration, they realise that these principles, in turn, reduce the influence of monetary policy degree which is lower to the clear cost of capital effect. Billing (2002) described the reasons behind the protection and enlightened on how auditors should review the different problems raised from the utilisation of financial instrument. 

Heilliar et al (2004) accessed the influence of financial reporting standard 13: Derivatives and different financial instruments, implementations and disclosures which focus is on the treasury department responsibilities. The researchers deliberately conduct interviews with the workers of the UK treasury department in order to review their behaviours towards and observed the impact of FRS 13. At large, the treasurer reply at an advantage to the standard and carefully reviewed the narrative disclosure to be specifically useful.

The numerical disclosures were comprehensive and focused. The rapid growth in the financial derivatives also has an influence on China’s financial market. Ba Shusong (2004) believes that financial derivatives have played a vital role in the growth of China’s market. Subsequently, El-Masry (2006) stated that big firms often used derivatives than average or smaller firms, public companies often use derivatives than the private companies. The use of derivatives is ultimate in the midst of international firms.

The findings reveals that most firms that do not use derivative instrument is attributed to the fact their experiences are not important and the major reasons they avoid derivatives are, they focus on the experiences required by FASB rules under derivatives activity, fees of creating and sustaining derivatives activities go beyond the expected profit, foreign exchange risk is often managed with derivatives and interest rate risk is often managed with derivatives and interest rate risk is risk that is subsequently managed risk and the study reveals that the main reason for the use of hedging with derivatives is supervising the volatility in liquidity. Bartram (2006) explores the incentive and use of non financial firms with respect to using options in managing risk activities. 

The study realized that an important number of 15 – 55% of the companies not within the financial sector practise the options which shows the fact that options are very flexible risk management instrument which can be useful to hedge different types of exposures both linear and non-linear, it also discovered that it rely on the correlation between price and quantity risk, the optimal hedge portfolio involve different combination of both linear and non linear risk management instruments. The accounting ways and the effects of liquidity can influence the selection of derivatives. Eckstein et al (2008) studied the impact of organization using derivatives which applies Statement of Financial Account Standards (SFAS) no 133; it shows the degree of cumulative effects of differences in accounting formulas from the annual income statement adopted, market response to earnings pronounced and the major effect of financial ratio.

The outcome reveals that the important negative unpredicted returns were noticed around earnings pronouncement dates. Abnormal earnings correlate with the cumulative effect instead of the differences in earnings per share from operations which reveals that surprises connected to changes in accounting, it is also established that companies with resources unrealized profit and losses are connected to hedging with derivative instrument.

The Merits Of Financial Derivatives

There are several advantages of financial derivatives from 1990’s McAllister and Mansfield (1998) studies the responsibilities and ability of financial derivatives investment property portfolio management and also focus on the difficulties of direct investment in commercial property. They also analyse and the major principles and all different types of derivatives, they rounded it up that the possibilities of financial derivatives to mitigate most of these difficulties which are connected to direct property investment that are studied. They also decided on Property Index Certificates (PIC) have been narrowed by down with shareholders and ought to produce rise in interest rate and the use of derivatives product within the assets both in the UK and global institutional shareholders.

Tyler and Stanley (2002), Counter Sheedy’s call for further readings through the practical examination of the equity derivatives market in US and UK, quarrelling that while link in this market do, to a certain degree, showing features a typical of broader and indeed inherent, to over-the-counter derivative exchange. 

After that, Zivney et al (2006) discovers the possibilities of using dividend plans by individual shareholders. This plan was raised from the 2003 tax law changes which reduce tax rates on dividends received while abandoning the short term tax rate on capital losses unaffected. Freeman et al 2006, realize that the credit derivatives market is control by high ranking banks and insurance firms that engage in business among themselves.

The growth of credit derivatives market develops into more liquid and transparent. Freeman emphasized that there are various easy and practical ways in which organisation can use credit derivatives to manage risk to show the empirical strengths and weakness of a particular approach. Klimczak (2008) produced a detailed assessment of the main contemporary firms hedging theories. The study focused on a sample of 150 companies listed on the Warsaw stock exchange which shows features shared by companies using hedge.

Risks Attached To Financial Derivatives

From the above literature review it is no gain saying that financial derivatives are advantageous on risk manages of finance. However, some risk occurs in the operation of financial derivatives. Financial derivatives have been faced with so many criticisms this mostly is due to large loose because of leverage and borrowing.

Laker (2008) examined that as the derivatives permit shareholders to earn huge returns from small movement in the basic assets price. Though shareholder might lose more money if the basic asset price moves against them drastically and the financial derivatives might expose shareholders to counter party risk and all types of financial derivatives have different risks at different level to this effect. Also financial derivatives will stand as an unsuitable large amount of risk for little and mostly for shareholders who lack experience as financial derivatives offers chances of huge rewards and so many attractions even to individual shareholders. 

However, speculation under derivatives most presumes a great deal of risk consisting commensurate experience and good market idea which favours a small shareholders, this is the purpose why some financial advisers are opposing the use of these instruments. Derivatives are complicated instrument as forms of insurance in transferring risk among all parties involve which presume an additional risk. Laker further identified that financial derivatives often have a huge estimated value, as a result of that there is a high level of risk and shareholders might lose much without been compensated.

As stated by Berhire Hathaway inc. (2002) on the annual report, that there is a possibility that this could result in a chain reaction and subsequently in an economic crisis. Also Rawles (2006), financial derivatives enormously leverage within the economy, which makes it more complex for the basic real economy to facilitate its debt requirement and restricting the real economic functions which often lead to economic recession.

The Supervision Of Financial Derivatives Analysis

The supervision of the financial derivatives should be acknowledged as both the advantage and risk that are present in financial derivatives. Though, there are few journals which analyse the supervision of financial derivatives, in the late 1990s, Shah (1996), identified that in the rise of huge losses from derivatives dealers and end users in modern years, many issues are being highlighted as regards the regulatory structure that is necessary to supervise and control the use of derivatives, it disagree that the principle in which the issue can be resolved by strict internal policies whereas regulators assume it is necessary for more precise oversight is misplaced though it still can be use for hedging, Derivatives involves high risk technology which often pose problems for regulations and its functions. Recently, Kern (2001) identified that the global regulation of financial markets became obvious in the 1970’s with regards to post Bretton Woods liberalisation of financial markets.

The removal of the fixed exchange rate equal the outcome of gold in the privatisation of finance risk, which established tension to eliminate the functions of cross border capital movements and more deregulation of the financial market. 

However, there is need for general regulatory body to build safe and reliable financial institutions such as bank through an efficient management as systemic risk in general market. Also it is necessary for international standards of supervision to also be acknowledged to avoid solvent in the financial institutions in one jurisdiction from the business to collapse to a less reputable institutions functioning in other jurisdictions whose rules only allowed cut rate financial services and more risky financial functions. The privatization of financial risk leads to establishment of financial institutions to blow out their risks over to many resources and functions which lead to an important rise in short term cross border portfolio asset which could reveal capital importing nation to increase system risk which was cause by volatility of such investments.

Gilnen & Tabak (2007) established a new substitute for gathering information on risks that exists in financial institutions which assist in analysing the risk tools which are found in risk management. This method assists risk managers, supervisors in analysing the potential risk in financial institutions because of derivatives position. The main idea is the linear financial instrument which is also referred to the traditional method often used by management risk system it assist in decreasing roles in risk factors and defend the responsibilities of financial derivatives while the non-linear instrument have roles with different options which are represented as clear as European options. The study shows the proposed method captured the risk occurrence in policies that consists of options with an accepted error margin.

Chapter 3
Data Analysis And Methodology
Case Study

The case study of this research will be the the Republic of China’s financial market; this research analysis will focus on the China’s financial market, together with the growth of the socialist market of the real economic structure. China’s financial market is growing with the ongoing exploration. Currently, China’s financial Market is essentially established as a pure division of the financial system.

China’s financial Market has started forming and many financial commercial have been developed, this includes Bonds, Stock and commercial bills. The capital loan and a bargain securities markets were established steadily after 1985. During the 1988, treasury bonds were established in the transfer market in major and average cities in china. In 1990 shanghai stock exchange was created and 1991 Shenzhen stock exchange was also created. Both stock exchange in 1999, release 98 “A” shares and 117 subsidiary shares, increasing 87.7 billion Yuan, which increase the total number of companies listed to 976; the aggregate increase in foreign capital is about US$610Million with the use of issuing “B” and “H” shares.

China releases 1.5Billion Yuan of “A” shares which can be transferred into bonds. In 1994, 94.1 billion Yuan was realised from issuing and selling stocks.

The level of the transaction in the stock exchange by 1999 surpass 5,000 billion Yuan and it was summed up to about 401.5billion Yuan which was the value of government bonds issued and 191.1 billion Yuan was government bonds value in cash. This fund has successfully improved the financial status of the listed companies and a rise in the sources of money for technological transformation of the public banks and financial markets. In recent years, the financial market in China has been undergoing a rapid growth, Neftci and Yuan, Michelle (2006), stated that China financial markets shows about $2 trillion and are anticipating the market to grow to about $10trillion by 2008, the china financial market continues to expand its investment with a view to ensure that their operations are successful.

Research And Data Collection

There are different types of financial derivatives found in China’s financial market which are vital for the growth of China’s financial market. The use of the financial derivatives has led to many financial difficulties in the rapid growth of the financial system, there is need for regulators to be more effective and implement more laws on the supervision of the financial derivatives. This will help to determine and regulate the stability of both the China financial market and the supervision of financial derivatives in china.

Classic materials similar to the financial market and financial derivatives in China will be used as a guide. Other source of materials will be from the internet, textbooks and journals. This research work is structured to determine the supervision of the financial derivatives in China. The China financial market is chosen as a case for the analysis. 

The source of the main data is from China, National Statistics of China; and few of the firm’s annual report will be used for the data analysis. This research work will further focus on the nature of the China’s financial market and the outcome of the financial derivatives in China and the supervision structure of the financial derivatives in China. The SLEPT (refer to Social factor, Legal factor, Economic factor, Political factor, Technological factor) method will be used to examine the general system of the China financial market, it will also focus on the classic findings of financial derivatives and also on China financial system in order to examine the nature of the financial market in China.

From the results, the research will be based on the nature of the financial derivatives in China to examine the impact, introduction, growth, transactions and practise of the financial derivatives on the China’s financial market. This research will also examine the supervision of financial derivatives in China’s financial market in agreement with related articles and also to make some recommendation on the supervision of the financial derivatives in China.

Data Analysis

The qualitative and quantitative methods are both used to analyze the data. Under the qualitative analysis method, the materials such as journals and all information gathered from the internet are related to China’s financial market and the supervision of financial derivatives, the report of the classic financial organisation will all be gathered as part of the qualitative assistance to the analysis. Some major dialogue by the classic economist in China will also be the main issues for the qualitative analysis; this is due to lack of interviews by government officials and financial managers of most firms.

Generally, the secondary materials used will be part of the quantitative analysis, which will certainly show the problem of this research. As far as the quantitative analysis method is concerned, data and information will be gathered from different firms. The most significant data is gathered from the China National Statistics. Other information and data are gathered from various reports from different firms. It is difficult to make a questionnaire with this research because the research problem is comprehensive.

The major source of information and data are gathered from the internet and few reports from the government are the main structure for the quantitative analysis. The major limitations are the quantitative method in this research is the lack of an individual’s observations and analysis on financial markets and the supervision of the financial derivatives.

Chapter 4
Summary Of Findings
Classical Financial Derivatives Used In China

China commissioned a model in financial future exchange in 1990’s. Ba Shusong (2006) stated that the core financial derivatives are the foreign exchange futures, stock index futures, warrants, convertible bonds and national debt future. Few of them do not function any more, although model is not so successful, it was importance for a lot of valuable experiences.

However, with the growth in China financial market, the financial derivatives perform well and will return to China financial market and a fresh product which correspond to the requirements of the growth of economy; this will be additional expansion and will certainly play a vital role in the China’s financial market. Foreign Exchange futures; Gregory (1995) stated that inside the foreign exchange market, each price in a market is a relative price, which shows an equal rate. In the late 1980’s and from the beginning of 1990’s, China was completely accommodating for financial derivatives and control method of suitable opened. From 1984, the local enterprises and companies can trade the offshore foreign exchange futures via the stock broking company. This will assist in requirement for hedging of local banks & corporations and swap the foreign exchange role.

The first ever foreign exchange swap of China exchange market was commissioned June 1992 in shanghai. 

The transaction in the foreign exchange futures in local have been displayed and developed from time to time. Later on, the Shenzhen foreign exchange centre was due for approval of foreign exchange futures transactions. (Ma Qingquan 2003).

Ma Qingquan (2003) later on accessed the inner and external foreign exchange future and realized that they all have some difficulties which enabled the government of Chinese to take a bold step to resolve and restructure the foreign exchange market. From 1993 to 1995, during this era, the Chinese government has continuously ordered the closure of unlawful foreign exchange futures brokerage firms. All the local foreign exchange in China did not operate extensively due to absence of regulators which lead to failure of the implementation. National debt futures; the national debt future is another method of interest rate futures; it is after the most growth of financial futures in China. The national debt future was originally found December 1992 in china.

The shanghai stock exchange commission was the first contact of national debt future. In the year 1993, the transaction scope of the general debt futures had been worn out mainly, the individuals and brokers was given access to the market.

The Beijing commodity exchange also welcomes the transaction of national debt futures. 

However, the national debt future was unripe for development; this followed the 314 contract irregularities storm in Shanghai stock exchange in Sept 1994 and 327 contract irregularities storm in February 1995 also emerge. May 1995, concluded the transaction of national debt future which finally collapse. Convertible Bonds; Convertible bonds are part of growing process of the growth of China’s Stock market.

Basically convertible bonds have a slight resemblance with stock options. (A stock option is also known as executive stock options). Little (2008) refer to a convertible bond is a kind of bond that can be switch into shares, bonds in an issuing firm. Mostly a few pre-announced proportion which is hybrid safety with same debt and equity characteristics. Ba Shusong (2006), the convertible bonds have experienced and discovered in over a decade since its first implementation in China, they have been known with many groups and they continue to progress and grow since the growth of the recent social economy of China. 

The convertible bonds are financial derivatives which agree with state of the growth of China economy. It will grow more and further along with the growth of the China’s financial market. Warrant, this is a type of derivative protection that gives the owner the ability to buy security direct from the issuer at a given price within a specific period.

Warrant are mostly part in a fresh issue which is refer to sweetener this is just to attract the shareholder. Between 1992 to 1996, China has commissioned a lot of warrants, which include sock warrant La Dai Fei, others are Ba oan 93 and Fuzhou East in Shanghai stock market while others warrant was also commissioned in Shenzhen stock market. This include Gui Liugong, Xia Haifa, Min minding, Xiang Zhongyi. However, because of the uncontrolled speculation of warrants, there are important speculations in the drop prices of warrants. The operations of the warrants were dismissed by the national regulatory body in June 1996.

The reason for the dismissal is due to the absence of regulators of the financial derivative. Hence, it is observed that the supervision and regulation on all types of Financial derivative is very important than the operation of the financial derivative.

As soon as financial derivatives is in operation there is need for government to present a supervision in order to regulate the operations and function of financial derivatives therefore the financial derivatives will grow with health except if it will be dismissed at the closing stages due to the disorder of the financial market. 

In conjunction with the reform of the part construct of warrants, the issue of the warrants were present in the outline again. This is due to bearish and bullish choices with the features of the warrants. It has been an efficient way in the movement for safety of the interests of investors and simultaneously, it leads to a rise in flexible payment of the price of the movement of non-investors.

According to Xu & Peng (2007) since 2007, 27 warrants have been registered in shanghai and Shenzhen stock market. Stock Index Futures; In March 1993, stock index futures surfaced in China’s Hainan securities and exchange center, which showed as Shenzhen composite index and Shenzhen A share index. This is in line with the global practise, such as creation of deposit system. Unfortunately, stock market was not huge enough; the trading activities stopped functioning in the same 1993 due to speculation inside the market. Ba shusong (2006) further stated that 14years after, (April 2007), After the official commissioning of the Future Exchange Management Regulations, the stock index futures has reverted given that it has been compelled to shut down 14years earlier.

This revert will certainly become an important discussion for everyone and local institutions.

Standard Supervision Of Financial Derivatives Used In China

The standard supervision of financial derivatives in China can be categorise into 3, namely, the Risk management, this is the major body of the supervision of financial derivatives, the core regulator of the financial market which is a vital way to regulate the financial derivatives and the creation of rules for financial derivatives which is protection for the supervision of the financial derivatives.

Risk Management

This involves the risk management of the market, the risk management of credit, risk management of liquidity, risk management of operation and legal risk management. Risk management of market; this is referred to as the loss in the rise and fall of interest rates, exchange rate and stock prices. Market risk management shows the status of a bank in a market in order to increase the number of frequency and duration of the market estimation.

Lu wendao (2007), refer this technique of market risk appraisal used in China financial market is to compute the potential of changes in the market price, the exposure of risk and to grow contingency policies in order to enable the right of assessment and to accept the changes in the market. Risk management of credit; The risk management of credit failure is to implement derivatives agreements or breach of contract of financial derivatives credit risk which means when the financial institutions such as banks decide to emulate a transaction which is in agreement with certain regulations. It is recommended that bank should focus more on risk diversification rather than avoiding more concentration of transactions. 

The risk management of liquidity; Xu and Peng (2007), management of liquidity risk is the non existence of depth of market or changes in difficulties which might lead to risk of exposing positions. It is also the absence of liquidity party which led to the termination of contract which cannot be paid or the risk of more deposit cannot be made due to the consistent fall in market. Bank in liquidity risk management should stay away from all sorts of business within a period of time to reduce the attention of more concentration of transaction which often leads the risk of the gap risk of capital flow.

The risk management of operation; Zhou Yunbo (2003), operation risk is the risk of inner control and absence of information system. Operation risk management is precise partition of the trading apartment, balance apartment and risk management apartment. This involve the firm to focus more on welfare of their staff, improving the standard of working and when there is a default in the related information system, there should be an instant measure to ensure the normal free flow of information to make sure there is a proper supervision on the risk factors. The legal risk management; this risk is that risk that unable to execute contract or risk that occur due to absence of legal factors in contract. Most financial institutions such as banks need to consult legal advisers for a certain legal document, this is to make sure the transaction of contract is legal.

Lu Veandao 2007.

The Center Control Of Financial Market;

The principle of center control; the function of senior management; brokers and clients in the use of derivatives ought to be in line with complex approval through the risk and capital management procedure. Those procedure should be functional with different in market situations. Advanced managers ought to study and accept policies for the execution of these policies management at different stage should do the same too.

The allocation of responsibility; this is the allocating responsibilities to personnel at different stages in order to avoid errors at the place of work. Risk Management; there is a huge risk in financial derivatives business, it is necessary to ascertain the exact risk management system. It is also necessary to investigate and measure the best alternative to manage the risk. Emergency response; Due to possibilities of market volatility and unpredictable human factors, it is necessary to arrange method to reduce the risk.

Operation Of Internal Control

Accounting Supervision; the supervision of financial derivatives involves an accurate and effective accounting requirement. Background Control; this involves with creating monitor procedure in background, which deals with control, daily supervision, estimation of market value, forecasting and assessing the risk associated to the study of the counterparty. Internal Audit; financial derivatives businesses are vital to allocate base over a period to supervise the audit and report at the right time.

Stop loss control; every business assume by great loss and there is need to discontinue the loss supervision of huge amount of transaction providing extreme daily loss restrictions in surplus of the ceiling. Front control; there is a trading limit control within the bank, financial derivatives businesses restrict the overall amount of self control which involves open positions and the quantity authorised.

The Formation Of Regulations For Financial Derivatives

It is proposed to create the certain regulation organisation in order to develop the supervision of financial derivatives and to ensure that financial derivatives businesses are legal. To also initiate laws on the transaction of financial derivatives, only the creation of legal procedure and a few related laws will make financial derivatives grow. This is necessary to sustain the supervision of the financial derivatives that will prevent the financial market from being disorganised or chaotic.

Chapter 5
Discussions
The Analysis Of China Financial Institutions Using The Slept Method

This research examines the SLEPT analysis method to examine the impact and effect of macroeconomic environment of China’s financial market. The research will analyse the China financial system in the following order; the Social factor, Legal factor, Economic factor, Political factor, Technological factors.

Social Factors

Proportion of the population structure; China as a nation has a huge population, the National Bureau of Statistics of China (2008) stated that the population of China is about 13.15billion in 2007. This is 0.606% increase rate than the previous year (2006) (Fig I) and 9.20% of the population falls within the age range of 65years and above. Fundamentally, the population of China is in a tendency of maturing.

The educated Chinese up to the tertiary level and above is about 6.22% with about 8.79% of the population are uneducated. The Chinese citizen’s standard of living; As stated in the Chinese statistical annual book 2007, asserted that the per capita disposable income of the metropolitan residents was 11759 RMB in 2006 and about 12.07% extra in the previous year (2005), the per capital yearly expenditure on the metropolitan residents consumption was 8697 RMB in 2006, about 9.49% extra than the previous year (2005), in the year 2006, the per capita savings deposit became 12293 RMB and additional of 13.96% from the previous year (2005), the region of house construction per citizen was 26.1 Sq meter in 2006 and became 28.62 higher than the previous year (2005), in 2006, the regular consumption expenditure per citizens of metropolitan residents in housing increase to 904.19RMB. 

Investment Enlightenment; Along with the growth of the China economy (fig.1), the Chinese citizens will probably invest more in securities, the financial derivatives are familiar with the Chinese investment citizens, the citizens focus more on the financial derivatives because of its gain. Most of the firms and organization have also selected the financial derivatives as part of their financial risk management. The stocks in the financial market turn out to be very common in recent Chinese citizens and organizations.

Legal Issues

The Chinese has well disciplined laws for the supervision of financial market. These laws include rules governing the citizens of china, securities rules and provisional measures of settling securities risk. There are numerous laws governing the financial market but there is no exact amount on the China financial derivatives market.

Economic Issues

National economic condition; as stated by the World Bank group (2007), it states that the GDP of China in 2006 was 210871.0 billion RMB (2657.881 US$). This shows an increase of 14.69% greater than the previous year (2005). In 2006, the occupant’s consuming expenditure was 80120.5 billion RMB (2235.914 US$) showing about 12.5% rise from the previous year (2005) (Fig.II), the occupants expenditure was 15.79% in the overall spending, about 0.16% more than the previous year.

Annually, the occupant’s consumption rate often increases; there was 9.3% more than the previous year (2005). Price Index; as stated in the data of the National Bureau of Statistics of China (2007), in the year 2006, the consumer price index in occupants was 4.6% greater than the previous year (2005) and the house occupier consumer price index was 2.7% greater than the previous year while house owners consumer price index also increase to about 3.7% greater than the previous year (2005) (Fig III). 

However, there is often a rise in the sales of housing price index; there was about 5.5% increase in 2006 against the previous year (2005) and in the year 2006, the housing price index was 6.4% greater than the previous year (2005) while there was an increase 4.6% in year 2006 against the previous year (2005) in industrial/office building price index. The rent payment price index was also increased annually; there was an increase of about 1.4% between year 2006 and the previous year (2005). In 2006, the land businesses price index was 5.8% greater than 2005. 

The consumer price index in 2008 moved up to 6.3% in July from the previous year after moving up by 7.1% in June. Inflation rate; The national bureau of statistics of China states that in early 2006, the inflation rate was 1.9% and later moved up to 2.8% by the end of the same year, it also moved up with a wide margin by end of the following year (2007) to 6.5% and it arrived at the highest level of about 8.7% in February 2008 and there was a fall in the recent times to about 6.3% in July 2008 Interest rate; In the end of the year 2007, China moved its interest rate standard up for sixth time that same year, this is one of the method to control inflation and also to prevent the China economy from collapsing which is refer to as the fourth largest economy. However, there is a reduction in demand deposits rate, this is to inspire the citizens to tie up their cash over a period of time (preferable a longer period) instead of make it available to diverting their cash into securities and property.

The bank of China states that the interest rate in August 2008 rose to 2.56%. Exchange Rate; The exchange rate as stated by the People’s bank of China in 2008, it has sustained the RMB remains fundamentally the same, from the month of June 2008 after an increase of 4.2% and 2.3% within the first quarter of the year and during the second quarter of the same year, it moved up to 0.4% in the 7th month of 2008 which shows the currency is build up to 6.8180 alongside the US dollar for few months.

Political Factors

Political system; the China state council (2007), the political system in China was created and it has been growing through the long-term existence of the Chinese revolution and reforms. The political system accept a multi-party system and the political mentor was headed and controlled by the Communist Party of China (CPC), it is not the same with all other multi-party in the western part of the countries and some countries practises one party system. Chinese political system can be attributed as a socialist political party system and the major structure of China’s socialist democratic politics.

Economic System; Sometimes ago, Chinese economy was practising socialist economy; this is a situation whereby the government own and dictate all production procedure. At the end of the reform which ended 1978, it was close to market economy just after privatization all the state controlled businesses and expose to the western part of the countries. Subsequently, china economy grows better due to the frequent Chinese government reforms.

Technological Factors

The technology has come of age and the internet has a positive impact on the financial market, since the internet is very easy to accessible and resourceful, individuals and organisations might possibly trade the financial derivatives via internet. The use of internet for trading not only save time but it is very effective and efficient. The introduction of technology has reduced the problems of the financial market and all the transactions of the financial derivatives such as non existence of regulators on trading activities and lack of adequate information due to the destruction of the financial system.

It is important for financial derivatives managers to have a good knowledge of the computer and the supervisory body should take more responsibility on the business of the financial derivatives. Certainly, technology has improved and developed the growth on financial derivatives in China’s financial market and the world as a whole.

The Financial System Analysis

The China economy is transforming from the conventional planned economy to the market economy. Temporarily, it has experience similar industrialization procedure as shown in most developing nations. Its objective is to create a self regulating of fiscal oriented financial institutions and also to discover the commercial activities of the financial markets, which will accept sole functions for its excesses and loss and all the various risks involved.

China accepts the opposite way to regular reform. During this reform, market-oriented foundation on the contest of the micro-business system has been essentially formed, it is not essential anymore for financial institutions to embrace the state owned businesses; it is no longer necessary that financial systems take up the responsibilities of the financial policy. The financial institutions will have to confront the world competition since China economy operates an open financial market. This brings new ideas and concept to the growth of china’s financial institutions. 

The macro economy aspect of the economy shows interest rate and exchange rate have since gain freedom and there is a transformation to the integrated operation from the divided operation. Direct financing has also emerged from the structural perspective after over writing the indirect financing. According to the important changes in the financial market transformation process, in the year 1990, two (2) local stock exchange were created in China known as The Shanghai Stock Exchange and Shenzhen Stock Exchange and the two stock exchange has grown excellently since their creation (Fig IV).

The Southern Tour led by Deng Xiaoping in 1992, experienced a rapid growth in the Foreign Direct Investment (FDI), an unlawful act of the banking sector which emerge from the few new state government controlled by commercial banks, and the re-appearance of the shanghai stock exchange which became the main financial point of China. 

The interbank lending and the bond markets were introduced in 1994 and 1997 respectively, in the market, the bank debit and credit card performed brilliantly; subsequently in 1997, the Asian Financial Crisis, financial sector transformation has concentrate on local-owned banks and also pays so much attention to the limitations of NPL. China was admitted into WTO in December 2001, which shows the new beginning of China financial system and this led to the creation of China capital account and adopted a fluctuating exchange rate which is required by WTO, raising context from foreign financial institutions and often and huge measure capital flows appears. In recent years, the RMB foreign exchange rate was announced by the People’s Bank of China, the RMB rate grow rapidly, subsequently, the China economy is fast growing compare to what it used to experience in the past, the economy is likely to sustained relatively high development. 

The China financial institutions have the possibilities to attain a speedy development with additional implementation of financial institutions transformation. Franklin & et al (2003) stated that most countries stock markets are bigger than China stock market, graph this includes the condition of market capitalization and the over-all value traded as part of GDP. The banking system in china is very significant in terms of measurement relative to the stock markets.

The banking institution in China is bigger than its financial markets and this supremacy by banks over the market solid and its stock markets are truly relatively more resourceful than the banks when measured with other countries. Thus, China’s financial is governing by a huge but inefficient banking sector. 

China is been refer to as a huge developing country; China has appeal to a number of foreign investments, such as FDI, joint ventures etc… China’s FDI inflows are greater than the remaining Asian nations, most developing nations and world as a whole, but the outflows are less compare to this particular sectors. The attainment of WTO takes China the low price foreign assets and technology but free assets flows and foreign context and speculation shown risk, crisis in both the banking and foreign exchange/stock market crisis which resulted in a huge in 1997 for the developing economies in Asia. To avoid such crisis, the Chinese government commissioned a number of principles to develop the financial system with the use of both fiscal policy and trade policy changes.

(Franklin, Jun & Qian 2005).

The Features Of Financial Derivatives

The value of financial derivatives is enslaved to the basic implement; Financial derivatives arise from the conventional financial products, because they appear to derivate they can only be dependent. The worth of financial derivatives is focus to a particular extent of the conventional financial instruments. Since the products arise from the essential instruments, the worth of financial derivatives will focus on the impact of the differences of the essential instruments values, the cost of stock index futures will be focused on the influence of stock index.

Warrants will move with the volatility of the share price, it is a distinct feature of financial derivatives and there is a purpose for the hedging role. Financial derivatives responsibilities include the prevention of risk; there is numerous numbers of fresh financial products that arise from financial innovation, which often promote the growth of the entire financial market. Conventional financial instruments are delayed behind the recent financial instruments; despite all its functions in the authentic issuance of these financial instruments of firms own financial risk. Furthermore, all financial hazards are joined together in the conventional instruments; it is very hard of decomposition. With the decomposition of financial hazards constrains, the financial derivatives with the assistance of the financial markets transactions can assist in preventing risk so as to accomplish the trade off of the income and risk. 

The structure of financial derivatives is complex; Assessing the structure of financial derivatives with the fundamentals of financial instruments, the main features of financial derivatives emerge to be very complex due to the fact that financial derivative have problems on the understanding and functions of the options and swaps, this is because of the combination of several technologies which makes financial derivatives more difficult in order for financial derivative to have the difficulty of the structure. This has led to the planning of financial derivative that requires an improved mathematical procedure, a huge number of policies making by practising the modern scientific procedure and the technology age which can boost the functions of financial markets. It will involve the use on false intelligence and mechanization technology in the growth and structure of financial derivatives.

Temporarily, the limitation makes the difficulty on the knowledge of the financial derivatives of the regular investors; this has resulted to incomplete use of financial derivatives by the shareholders. 

The design of financial derivatives is flexible; Financial derivatives is light structured in the plan and innovation of financial derivative, this is because so many portfolio of the fundamental financial instruments can establishes so many changes financial derivatives. The structure of the financial derivatives can rely on different participants needs therefore the structure of the financial derivatives are very light structure. The financial derivatives possess a leverage function; Most times during the functions of the financial derivatives, it will perform its operation of financial leverage.

It can simply manage the financial market. The leverage operation can expand the use of cash and to increase the earnings while the leverage responsibilities of financial derivatives will prevent some big risks. The transaction of financial derivatives is particularly; the exact nature of the financial derivatives trading can be shown in two ways, firstly, the transaction mediators mainly focus in big level investment banks and other financial institutions. This is known as concentricity. Secondly, it is flexible, from the market allocation, it clear that few of the transaction are perform over-the-counter, that is, the user via the core investment banks as mediators to take part in derivatives transaction, the transactions of the financial derivatives are non-standardized, it reveals that financial derivatives are very light in nature.

Influences Of Financial Derivative Impact On The China Futures Market

The financial derivative will improve the scope of the future market in china and minimise the risks involve. Lately, the China future market consist only commodity futures while finance future does not exist. This is distantly from foreign future market and not in agreement with requirement of the growth of the future market.

The presentation of the financial derivatives will occupy all the spaces in the China futures market; it will accomplish the promises of the financial market. This will leverage the present hazard and decrease the chances of risk; this will attract more shareholders to invest in financial market. Financial derivatives will improve the commodity futures market price and discovery the hedging functions; there are 2 fundamental features of price discovery and hedging in the china commodity future market. The presence of distortions in the bear of the financial and exchange hazards by the traders, in contrast with the prices of the foreign market. The China’s futures market price consists of capital and the exchange rate risk superior.

From the introduction of financial derivatives market, the capital and exchange risk can be undermined without any effect. 

This will only bring down the price of trading of the futures market, in order to boost the effectiveness of the commodity future markets. It also assists the china’s commodity futures market to meet up with the global standards and this will reveal the real commodity costs. Financial derivatives will raise the growth of market volume for futures market and widening the design of the investors; In addition to the introduction of financial derivation, the China’s future markets will turn out to be more ideal and very effective.

Currently, despite the high in demand of financial derivatives, this will bring together the sum of the futures market and more shareholders will invest so much in the futures market via the advancement of the risk management of the entire financial market. This will expand the size of the market for futures trading. Financial derivative will increase the level of futures employed; As a result of the distinct features of the financial assets, the businesses that exist in financial derivatives are very complex. Consequently, the beginning of financial derivatives will boost the conditions for the futures industry workers, it develops a huge good standard of the professional and this will boost the growth of the futures industry in the nearest future.

Chapter 6
Conclusion And Recommendations
Conclusion

Finally, financial derivatives are growing rapidly in world financial market and it is necessary to supervise the financial derivatives. There are various factors that influence financial derivatives, regardless of so many benefits from the use of financial derivatives. It often present many risk from the use of the financial derivatives.

They are several supervision of the financial derivative which often creates separate results on the financial market. The level of the supervision will automatically control the safety and legal of the financial market. For effective growth of the financial derivatives in the financial market, there is need for more supervision method on the financial derivatives in order to maintain the growth of financial market in the global market. China is a fast growing country, the financial derivatives is fresh section in the financial market which has benefitted both the shareholders and the people of China. There are various types of financial derivatives in the china’s financial market they include; stock index futures, foreign exchange futures, the national debt future, warrant and convertible bonds.

However, some of these financial derivatives are barred due to the untidiness they bring to the financial market excluding the stock index futures which is refer to as a proper growth tendency. 

Generally, the supervision of financial derivatives in China include many functions which include; the risk management which is often refer to as the core section of the financial derivatives which manage all the financial derivatives risk such as legal risk management, liquidity risk management, operation risk management, market risk management, credit risk management. Another function of the financial derivatives is the internal control, this deal with the internal activities of the financial market which also plays a major role in the supervision of the financial derivatives. The introduction of the guidelines for financial derivatives operations is another function of the financial derivatives which is introduced to provide safety measure for financial derivatives.

Subsequently, the SLEPT analysis (Social factors, Legal factors, Economic factors, Political factors and Technological analysis) of the China financial market and environs, which expose the exact level of the China financial market and the fast growth of the China financial market and the economy as a whole. 

The features of financial derivatives in China are that the worth of financial derivatives is subjected to the fundamental implement; the financial derivatives have the responsibility to shun risk. Financial derivatives are structured to be difficult, the design is also very light and accommodating, the financial derivatives also have the leverage operations and certain trade activities of financial derivatives. With the nature of the financial market and the supervision of financial derivatives, this research analyzed the effect of the financial derivatives impact on the China futures market.

It also presents the introduction of financial derivatives which will play a vital role in the organization of Chinese futures market and this will decrease the total risk, the growth of the financial derivatives will develop the functions of the commodity futures market which will directly boost the market price and invent the hedging functions, with the use of financial derivatives this will widening the volume of the futures market and improve the structure of the shareholders, and the trading activities of financial derivatives will increase the level futures employed.

Recommendations

According to the rapid growth of the economic worldwide and financial internalization, the financial derivatives businesses have been very popular in the financial market. There are various methods of supervision of financial derivatives from different countries this attributed to the difficult features of the financial derivatives, although the financial derivatives is in the early stage in china and the financial derivatives cannot be shun. It is proposed that Chinese government could create a combine supervision method.

The equal/combination supervision of the financial derivatives is necessary for internal growth; the search for combined supervision system to the regulation is to combine supervision system of organising between the internal structure and co-ordination; an equal supervision system has a defined comparative advantage. It is however recommended that the Chinese financial derivative market should have a standard and homogenous supervision system to protect any possibility of risk that may occur in the financial derivatives.

Limitations Of The Study

In the course of the research work with relationship with a case study, there are some certain research limitations which include; Lack of data; the research focuses on theoretical analysis and there are no relevant data to back it up such as a presentation on market survey. The research work study the China’s financial market views, reports and journals and also study the views, reports and journals of financial derivatives used in China. The China supervisory method is basically theoretical and they lack data to support the analysis.

There are no recent data to back up all the analysis of China’s economy.

Suggestion For Further Study

For further study, it is however recommended to rely on certain Examples of limitations; this research work focuses on the findings on the China’s financial market; some materials were examined about the china’s future market and China’s financial market. This research work registered most of the financial derivatives used in China but they are no any exact examples this because the collection of the examples are complicated. The research paper examines a number of supervision of the financial derivatives in China’s financial institutions but there are no samples to analyse the operations of the supervision of the derivatives, all these are the limitations of the research study.

Examples on the China’s financial market, China financial derivatives and the relevant supervision that is been used in China financial derivative. The shareholders and the financial market itself will play a vital role in getting the examples of the financial market and financial derivatives. The research also recommends that the researcher needs to get recent data that can back up the analysis in order to explain the China economic system perfectly.

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