SUBMITTED TO

Pcrpstakaan

Univorsiti "Telnologi MARA Kampus Machaug

A DISSERTATION SUBMITTED TO DEPARIMENT OF FINANCE, FACULTY O1 BUSINESS AND MANAGEMENT,

UNIVERSITTTEKNOLOGI MARA

IN PARTIAL FULFILLMENT OF TUE REQUIREMENT FOR T HE BACHELOR OF BUSINESS ADMINISTRATION (HONS) FINANCE

A STUDY ON THE CONVERGENCE OF

FUTURES AND CASIH PRICES AT MATURITY : EXPERIENCE OF KLSE COMPOSITE INDEX FUTURES AND KILiBOR FUTURES

SUBMITTED TO

DR ROSALAN BIN HAJI ALI ADVISOR OF FIN 650

PREPARED BY :

NAZLEEN BT ISMAII

98005013

BBA (HONS) FINANCE

FACULTY OF BUSINESS AND MANAGEMENT UNIVERSITI TEKNOLOGI MARA

AT DUNGUN CAMPUS

APRIL 2000

KAN

A C H N O W L E D G E M E N T

Bismillah-Ilir-Rahman-Nir-Raiim

Praise be lo Allah, 1 ord of the Universe, A Praise that befits iis maght arnd suilnes His race. Peace and blessing be upon His generous Messenger, lis lamily ad companions, for gvng me the strcngth to complete my project paper it is not possible lo

acknowledge individually thc debis that I owe to their enormous coniribution in preparing

this project paper

would i1ke to express my deepest grautude and appreciation to my advisor, Dr

Rosalan Hj Ali for his guidance throughout preparing the present research paper whichI

considered all that as something beyond repayment. My special gratitude to Prolessor Iir

Ishak Ab. Ghani, Mr Ong Toon Yeow and Cik Aida for their cooperation, guidance and

help in providing information needed for this project

Deepest gratitude and personal appreciation for my beloved parents, Ercik ismail Bin Hi Yusof and Puan Zawiah Bt Senik, brothers and sisters for their love and encouragement

Lastly, I would like to express my gratitude to those who have been invoived

directly and indirectly in compleung this projcct I really appreciate and forever will be

indebted to them. May this proJect be beneficial to all. THANK YOU.

Perpustaknan Universiti Teknoiogi MARA

Kampus Machang.

ASTUDY ON TUE CONVERGENCE OF FUTURES AND CASH PRICESAI MATURITY: EXPERIENCE F KI.SE CIFUTURES AND KLIBOR FUIURES

ABSTRACT AUTHOR

:Nazleen Bt lsmal

KEYWORDS : Price Convergence, C'ash, Fuures, Basrs, KLSE Conposite lndex,

KiLIBOR, F'air Value, Overpriced, Underpriced, Arbitraging, Market

licieney, Mispricing

he main objective of this project paper is lo get better understanding on iinancial futures market activity with reference to the convergence ot cash and futures price ior KLSE Composile Index Futures and KLIBOR Fulures. This study tnes to determine the

convergence of cash and iutures price at maturity using the basis. From that, the

eificiency of the market will be determincd Besides that, this study will explore on the

arbitraging activity that exists due io mispricing. The theoretical model of fair valuc is

applied on the monthly basis for Composite lndex and quarterly basis for KLIPOR in order to establish an arbitrage opporlunily. The daa of Composite Index prices cover the period from 15 December 1995 to 31 December 1999 and for KLIBOR pnces cover irom

1996 to 1999

The lindings show that what ihe iraders experience in practice actualiy doesn't really correlate wth the thecory staled. This staleinent is made due lo the valuè of basis between cash and futures whereby the cash and futures prices do not converge at all at

UNIT

naturtty. The price discrepanties between cash and futures give an opportuniay to an

arbitrageur to do arbitrage This study conclude that the prces of cash and luiures do not

convergeal malurily as what if Is stated in the theory but the market is still eflicient if the value

of

the bas1s falls

ⁱⁿ

the stated

range and

there

^is

also

^an

arbitrage opportunity

^{tor an}

arbitrageur

T A B L E O F C O N T E N r S

Acknowledgement

Abstract

Tabie Of Contents

V

List Of Tables

VI

List Of Abbreviations

X

Chapter 1: Introduction

1.1

Background Of the Study 1.2

Problem Statements

13

Objectives Of The Study

4 Scope Of The Study

1.5

Significance Of The Study

1.6 Limitation Of The Study

9

i7 Organization Of The Stud, 10

Ch&pter 2:

Literature Review

2.1

Introduction

2

13 2.2

Understand1ng Financial Futures

2.2.1 The ^{Futures Contract}

14

2.3 Development Of The

Derivatives Market ln The ^World 24

24

^Oerview

Of Financial

^Fulures

Trading

ⁱⁿ

Malaysia 6

V