Equity Derivatives Market Of Japan Finance Essay - Free Essay Example

What are Derivatives? Derivatives are financial instruments, in fact an agreement between two parties. This has a value determined by something called as underlying. It is a financial contract with a value linked to the expected future price movements of the asset it is linked to such as a share or a currency. There are several kinds of derivatives, with most commonly used ones being Futures, Options and Swaps. But since a derivative can be placed on any kind of security, hence there can be endless scope of these derivatives. The derivative market equity includes the financial instruments such as futures, options and swaps. The equity derivatives are stocks or stock indices whose prices depend on the prices of the underlying equity instrument. The equity derivatives are traded in the futures and options exchanges or in the over the counter markets. Equity Futures, Options and Swaps A Futures contract is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality at a specified future date at a price agreed today (the futures price). The contracts are traded on a futures exchange. Futures contracts are not direct securities like stocks, bonds, rights or warrants. They are still securities, however, though they are a type of derivative contract. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. The price is determined by the instantaneous equilibrium between the forces of supply and demand among competing buy and sell orders on the exchange at the time of the purchase or sale of the contract. In many cases, the underlying asset to a futures contract may not be traditional commodities at all that is, for financial futures, the underlying asset or item can be currencies, securities or financial i nstruments and intangible assets or referenced items such as stock indexes and interest rates. On the other hand, Options are contracts that give the buyer or seller the right and not the obligation to buy or sell the underlying asset at a fixed price at a future date. The call option gives the right to buy while the put option gives the right to sell. The buyer of the call option can gain by an increase in the price of the underlying asset without buying the underlying asset. Conversely the put option holder benefits from the fall in the price level of the underlying asset. A Swap is a derivative in which counterparties exchange certain benefits of one partys financial instrument for those of the other partys financial instrument. The benefits in question depend on the type of financial instruments involved. For example, in the case of a swap involving two bonds, the benefits in question can be the periodic interest (or coupon) payments associated with the bonds. Specifically, the two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way they are calculated.[1] Usually at the time when the contract is initiated at least one of these series of cash flows is determined by a random or uncertain variable such as an interest rate, foreign exchange rate, equity price or commodity price. The cash flows are calculated over a notional principal amount, which is usually not exchanged between counterparties. Consequently, swaps can be in cash or collateral. Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on changes in the expected direction of underlying prices. An equity swap is a special type of total return swap, where the underlying asset is a stock, a basket of stocks, or a stock index. Compared to actually owning the stock, in this case you do not have to pay anything up front, but you do not have any voting or other rights that stock holders do have. An Interest Rate Swap is another type of swap where 2 companies take out loan and swap their interest payments. This type of swap is usually done so that the comparative advantage of one company helps the other and vice versa. Few other type of swaps are Currency Swaps (exchanging the payments of in one currency for payments in others), Commodity Swaps (One party makes a periodic f ixed payment; the other makes a payment that is pegged to the current price of some commodity), Credit Default Swap (Swap of a fixed payment in exchange for compensation for a loss in a loan). This is one of the most traded derivatives in Japan. The Japanese Derivative market In spite of the markets recovery lagging behind the other Asian markets, the Japanese Derivatives Market has a lot of potential and traders may want to consider learning to trade the Japanese derivatives market for the reasons set out below: Japan has vast potential as its problems are cultural customs and domestic policies and not expertise and structural, so immediate improvements and progress can be made once the internal domestic issues are resolved. It is still the largest derivative market in the Asia and South-East Asian region with eight exchanges and more than 2,300 listed companies, a diverse range of products that include bonds, ETF, Reits, interest rates, currencies, and a wide range of derivative instruments. There is good liquidity in many of the derivative products as mutual and hedge funds based in the US, Euro and UK and the Asia Pacific region are still interested in investing and trading these products in the Japanese markets. There is transparency in the markets which is essential for investing and trading by foreign investment firms and individual investors and traders. Information is also easily available from the stock companies and the major exchanges and is provided in English. The market is quite mature and the volatility is generally tolerable and within most retail traders risk management as the highs/lows of the stocks and stock indices is within acceptable levels. Most of the volatility can be attributed to fluctuation of the yen which is a favourite currency with hedge funds who would borrow it because of the low interest rate and reinvest it in other currencies and even equities for higher returns; in addition it is very sensitive to the US dollar which itself is quite volatile. Although the market is vulnerable to the occasional earthquake tremors but to date it has only felt the tremors and have not seen anything of the magnitude that it did in the 1995 Kobe earthquake that shook the country and the markets. Stable political environment the political climate is quite stable internally and externally, and this is very crucial for investments and trading especially when derivatives are actively traded. Japan is recently showing signs of economic recovery and has good potential for economic growth as the DJP intends to increase trade agreements with the Asian and Asia Pacific countries which it is neglected for many years. Futures and Options markets of Japan In the late 1970s and early 1980s, radical changes in the international currency system and in the way the Federal Reserve managed the U.S. money supply produced unprecedented volatility in interest rates and currency exchange rates. As market forces shook the foundations of global financial stability, businesses wrestled with heretofore unimagined challenges. Between 1980 and 1985, Caterpillar, the Peoria-based maker of heavy equipment, saw exchange-rate shifts give its main Japanese competitor a 40 percent price advantage. Meanwhile, even the soundest business borrowers faced soaring double-digit interest rates. Investors clamored for dollars as commodity prices collapsed, taking whole nations down into insolvency and ushering in the Third World debt crisis. Futures are standardized contracts that commit parties to buy or sell goods of a specific quality at a specific price, for delivery at a specific point in the future. The concept of buying and selling for future delivery is not in itself new. In thirteenth-and fourteenth-century Europe, buyers contracted for wool purchases one to several years forward. Cistercian monasteries that produced the wool sold forward more than their own production, expecting to buy the remainder on the market (presumably at a lower price) to satisfy their obligation. Because futures contracts offer assurance of future prices and availability of goods, they provide stability in an unstable business environment. Futures have long been associated with agricultural commodities, especially grain and pork bellies, but they are now more likely to be used by bankers, airlines, and computer makers than by farmers-at least in North America and Europe. In Japan, by contrast, commodity futures trading dwarfed financial futures. This does not mean that commodities were more important than finance in the Japanese economy, of course. Financial futures got a slow start in Japan because Japanese regulations discouraged them. Traders who wanted to trade such futures had to-and did-trade them elsewhere. Thus, the first futures on Japans Nikkei stock index traded in Singapore, and the first yen futures traded in Chicago. Over-The-Counter markets of Japan Over-the-counter equity derivatives (OTCEDs) profoundly impact a wide array of investors from small retail investors in Europe who are looking for yield, to the largest corporations, investment banks, asset managers, and hedge funds that are looking for diversification of portfolios, protection from volatility, and specific strategies to gain exposure to equity markets. OTCED is a highly client-driven market segment. By and large, most of the trading occurs between dealing banks and investment managers, corporations, hedge funds, and high-net worth individuals. OTCEDs are truly a global phenomenon; they are actively traded in Europe, the Americas (Canada, Latin and South America, the United States) and Asia. Many of the issues that arise with OTCEDs stem from the global nature of the business, the very wide-ranging nature of participants, and the myriad of products that exist. According to the Bank for International Settlements (BIS), Europe leads the trading in equity derivatives with 55% of the global market. The United States represents 27%, Japan follows with 7%. Other parts of the Americas have approximately 5% and Asia ex Japan about 3%. In Japan, the largest market in the region, the interest rate swap market grew by 47% between June 2007 and June 2009. Embedded is the Credit Default Swaps data for Bank of Japan. You can notice that there have been significant jump from December, 2004 till June, 2010. Derivative instruments traded in various Japanese markets Listed below are the various instruments that are traded in various markets of Japan. OSAKA SECURITIES EXCHANGE(1): Futures: Nikkei 225 Futures CONTRACT SPECIFICATIONS Underlying index Nikkei Stock Average (Nikkei 225) Contract months 5 months in the March quarterly cycle: Mar, Jun, Sep, Dec (Maximum trading period: 1 year 3 months) Contract unit Nikkei 225 x  ¥1,000 Minimum fluctuation  ¥10 (value per tick:  ¥10,000 per contract) Daily price limits Standard price Daily limit up/down less than  ¥7,500  ¥1,000  ¥7,500 less than  ¥10,000  ¥1,500  ¥10,000 less than  ¥12,500  ¥2,000  ¥12,500 less than  ¥17,500  ¥3,000  ¥17,500 less than  ¥22,500  ¥4,000  ¥22,500 less than  ¥27,500  ¥5,000  ¥27,500 less than  ¥32,500  ¥6,000  ¥32,500 less than  ¥37,500  ¥7,000  ¥37,500 less than  ¥42,500  ¥8,000   Ãƒâ€šÃ‚ ¥42,500 or more  ¥9,000 About 16% of the standard price (previous days settlement price) Last trading day The business day preceding the second Friday of each contract month (When the second Friday is a non-business day, it shall be the preceding business day.) Trading in a new contract month begins on the business day following the last trading day. Settlement Cash Settlement Final settlement price Special Quotation (SQ calculation is based on the total opening prices of each component stock of Nikkei 225 on the business day following the last trading day) Trading hours 9:00 11:00, 12:30 15:10, 16:30 23:30 JST Trading system ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Auction Trading: Fully Automated Computer System (individual auction) ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ J-NET Derivatives Trading: Inter-month Spread Trading Available Available for trade in the U.S. Yes Margin    Give-up Available Position-Transfer Available Nikkei 225 mini (Trading in Nikkei 225 mini started on July 18, 2006) CONTRACT SPECIFICATIONS Underlying index Nikkei Stock Average (Nikkei 225) Contract months 2 months in the March quarterly cycle: Mar, Jun, Sep, Dec (Maximum trading period: 6 months) Contract unit Nikkei 225 ÃÆ'Æ’-  ¥100 Minimum fluctuation  ¥5 (value per tick:  ¥500 per contract) Daily price limits Same as daily price limits of Nikkei 225 Futures which have the same last trading day Last trading day The business day preceding the second Friday of each contract month (When the second Friday is a non-business day, it shall be the preceding business day.) Trading in a new contract month begins on the business day following the last trading day. Settlement Cash Settlement Final settlement price Special Quotation (SQ calculation is based on the total opening prices of each component stock of Nikkei 225 on the business day following the last trading day.) Trading hours 9:00 11:00, 12:30 15:10, 16:30 23:30 JST Trading system Fully Automated Computer System Inter-month spread trading Available J-NET Derivatives Trading Available Available for trading in the U.S. Yes Margin Calculated based on SPAN ® Risk is netted out between Nikkei 225 mini and Nikkei 225 Futures. Give-up Available Position-Transfer Available Nikkei 300 Futures CONTRACT SPECIFICATIONS Underlying index Nikkei Stock Index 300 (Nikkei 300) Contract months 5 months in the March quarterly cycle: Mar, Jun, Sep, Dec (Maximum trading period: 1 year 3 months) Contract unit Nikkei 300 x  ¥10,000 Minimum fluctuation 0.1 point (value per tick:  ¥1,000 per contract) Daily price limits Standard price (points) Daily limit up/down(points) less than 150 20 150 less than 175 25 175 less than 200 30 200 less than 250 40 250 less than 300 50 300 less than 350 60 350 less than 400 70 400 less than 450 80 450 less than 500 90 500 or more 100 About 16% of the standard price (previous days settlement price) Last trading day The business day preceding the second Friday of each contract month (When the second Friday is a non-business day, it shall be the preceding business day.) Trading in a new contract month begins on the business day following the last trading day. Settlement Cash Settlement Final settlement price Special Quotation (SQ calculation is based on the total opening prices of each component stock of Nikkei 300 on the business day following the last trading day.) Trading hours 9:00 11:00, 12:30 15:15, 16:30 23:30 JST Trading system ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Auction Trading: Fully Automated Computer System (individual auction) ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ J-NET Derivatives Trading: Inter-month Spread Trading Available Available for trade in the U.S. Yes Margin    Give-up Available Position-Transfer Available RN Prime Index Futures Overview of RN Prime Index: Russell Investments and Nomura Securities Co., Ltd have developed a new index- The Russell/Nomura Prime Index (RN Prime Index) RN Prime has the following characteristics: 1,000 stocks selected from equity markets across Japan. Market capitalization-weighted with free-float adjustments Data history backdated to December 30, 1996. The RN Prime Index consists of the 1,000 largest stocks in terms of free-float adjusted market capitalization, selected from among all listed stocks on all markets in Japan. Therefore, The RN Prime Index is highly representative of what is really happening in the Japanese stock market. Free-float adjusted market capitalization is calculated based on free float shares, which are available for trading in the market at any time. Stocks which are not available for trading in the market, such as cross-holdings between companies and stocks held by major shareholders, stocks not realistically available for purchase, are excluded from consideration. Since the price movement of shares with low free-float positions will have a lesser effect on index pricing, RN Prime is a benchmark index suited for passive investment strategies. Specification of RN Prime Index Number of component issues 1,000 Exchanges Tokyo, Osaka, Nagoya, Fukuoka, Sapporo Free float adjustment Yes Scheduled Reconfigurations Annually (The first trading day in December) Inclusion of Newly listed stocks Quarterly Share price used for index calculation The price in the most actively traded market Starting date of the index calculation December 30, 1996 CONTRACT SPECIFICATIONS Underlying index Russell/Nomura Prime Index (RN Prime Index) Contract months 5 months in the March quarterly cycle: Mar, Jun, Sep, Dec (Max, 1 year and 3 months) Contract unit RN Prime Index ÃÆ'Æ’-  ¥10,000 Minimum fluctuation 0.5 points Daily price limits Standard price (points) Daily limit up/down(points) Less than 500  ± 80 500 less than 750  ± 120 750 less than 1,000  ± 160 1,000 less than 1,500  ± 240 1,500 less than 2,000  ± 320 2,000 less than 2,500  ± 400 2,500 less than 3,000  ± 480 3,000 less than 3,500  ± 560 3,500 or more  ± 640 Circuit Breaker Yes Settlement 1.  Ãƒâ€šÃ‚  Settlement by closing sales or purchases 2.  Ãƒâ€šÃ‚  Settlement by final settlement index (Special Opening Quotation) Trading hours 9:00 11:00, 12:30 15:10, 16:30 23:30 JST Trading system ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Auction Trading: Fully Automated Computer System (individual auction) ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ J-NET Derivatives Trading: Inter-month Spread Trading Available J-NET Derivatives Trading Available (Minimum Fluctuation:0.1point, Minimum Contract Units:100 units) Margin Calculated by using SPAN ® (developed by Chicago Mercantile Exchange) In addition, Inter-Month spread trading on the above futures is also available to be traded. Options: Nikkei 225 Options CONTRACT SPECIFICATIONS Contract Put and call options based on Nikkei Stock Average (Nikkei 225) Expiration months 12 consecutive months from the March quarterly cycle plus 3 near-term months which do not overlap the March cycle Contract unit Nikkei 225 x  ¥1,000 Strike prices  ¥500 intervals in integer multiples of  ¥500 based on Nikkei 225 (For the nearest 3 months,  ¥250 intervals in integer multiples of  ¥250) Minimum fluctuation  ¥20 or less:  ¥1 Over  ¥20 up to  ¥1,000:  ¥5 Over  ¥1,000:  ¥10 Daily price limits Previous days last Daily limit Nikkei 225 up/down less than  ¥7,500  ¥1,000  ¥7,500 less than  ¥10,000  ¥1,500  ¥10,000 less than  ¥12,500  ¥2,000  ¥12,500 less than  ¥17,500  ¥3,000  ¥17,500 less than  ¥22,500  ¥4,000  ¥22,500 less than  ¥27,500  ¥5,000  ¥27,500 less than  ¥32,500  ¥6,000  ¥32,500 less than  ¥37,500  ¥7,000  ¥37,500 less than  ¥42,500  ¥8,000   Ãƒâ€šÃ‚  Ãƒâ€šÃ‚ ¥42,500 or more  ¥9,000 About 16% of the previous days last Nikkei 225 Exercise type European. The option may be exercised only at its expiration (the second Friday of each expiration month). Last trading day The business day preceding the second Friday of each expiration month (When the second Friday is a non-business day, it shall be the preceding business day.). Settlement Cash settlement of the difference between the strike price and the Special Quotation on the expiration date Final settlement price Special Quotation (SQ calculation is based on the total opening prices of each component stock of Nikkei 225 on the business day following the last trading day.) Trading hours 9:00 11:00, 12:30 15:10, 16:30 23:30 JST Trading system ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Auction Trading: Fully Automated Computer System (individual auction) ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ J-NET Derivatives Trading: Available for trade in the U.S. Yes Margin    Give-up Available Position-Transfer Available Nikkei 300 Options CONTRACT SPECIFICATIONS Contract Put and call options based on Nikkei Stock Index 300 (Nikkei 300) Expiration months 6 months from the March quarterly cycle plus 2 near-term months which do not overlap the March cycle Contract unit Nikkei 300 x  ¥10,000 Strike prices 25-point intervals in integer multiples of 25 points based on Nikkei 300 for expiration months in the March quarterly cycle (5-point intervals when the remaining trading period becomes four months) 5-point intervals in integer multiples of 5 points for other expiration months Minimum fluctuation 0.1 point (value per tick:  ¥1,000 per contract) Daily price limits Previous days last Daily limit Nikkei 300 (points) up/down (points) less than 150 20 150 less than 175 25 175 less than 200 30 200 less than 250 40 250 less than 300 50 300 less than 350 60 350 less than 400 70 400 less than 450 80 450 less than 500 90   Ãƒâ€šÃ‚  Ãƒâ€šÃ‚  Ãƒâ€šÃ‚  Ãƒâ€šÃ‚  Ãƒâ€šÃ‚  500 or more 100 About 16% of the previous days last Nikkei 300 Exercise type European. The option may be exercised only at its expiration (the second Friday of each expiration month). Last trading day The business day preceding the second Friday of each expiration month (When the second Friday is a non-business day, it shall be the preceding business day.). Trading in a new expiration month begins on the business day following the last trading day. Settlement Cash settlement of the difference between the strike price and the Special Quotation on the expiration date Final settlement price Special Quotation (SQ calculation is based on the total opening prices of each component stock of Nikkei 300 on the business day following the last trading day.) Trading hours 9:00 11:00, 12:30 15:15, 16:30 23:30 JST Trading system ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ Auction Trading: Fully Automated Computer System (individual auction) ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ ¢ J-NET Derivatives Trading: Available for trade in the U.S. Yes Margin    Give-up Available Position-Transfer Available TOKYO COMMODITY EXCHANGE INC(2) : Futures: Nikkei-TOCOM Commodity Index (Futures) Gold Standard (1kg) Gold Mini (100g) Silver Platinum Standard (500g) Platinum Mini (100g) Palladium Aluminium Gasoline Kerosene Gas Oil Crude Oil Rubber Options: Gold Options (Call) Gold Options (Put) TOKYO FINANCIAL EXCHANGE INC(3) : Futures: Three-month Euroyen futures CONTRACT SPECIFICATIONS Trading unit  ¥100,000,000 (Notional principal amount) Price Quotation 100 minus rate of interest Tick size value 0.005 ( ¥1,250) Contract months 20 quarterly months and 2 serial months Note1: Serial months are the months other than March, June, September and December. For example, as of April 1 , the serial months to be listed are Aplil and May, as of May 1, May and July, as of June 1, July and August. Last trading day Two business days prior to the third Wednesday of the contract month Final settlement date The first business day following the last trading day Final settlement Cash settlement Note1: The final settlement price is calculated to the third decimal place. To calculate, round up the figure on the fourth decimal place if it is five or over and round-off if it is less than five. For example, if TIBOR is 0.12786%, the final settlement price is 99.872(100 minus 0.128). Over-Night Call Rate futures CONTRACT SPECIFICATIONS Listing date 12.3.2007 Underlying asset Average Uncollateralized Overnight Call Rate (Final results) released by the Bank Of Japan (BOJ) over the interval between the BOJ Monetary Policy Meetings (MPMs) which TFX designates(*) Trading unit  ¿Ãƒâ€šÃ‚ ¥300,000,000 (Notional principal amount) Price quotation 100 minus rate of interest Tick size Value 0.005  ¿Ãƒâ€šÃ‚ ¥ 1,250( ¿Ãƒâ€šÃ‚ ¥300,000,000 ÃÆ'Æ’- 0.005% ÃÆ'Æ’- 30/360= ¿Ãƒâ€šÃ‚ ¥1,250) Contract Month First 6 calendar months Last trading day The last day of the BOJ MPM which TFX designates Final settlement day The second business day following the last trading day Final Settlement Cash Settlement Final settlement price 100 minus the average Uncollateralized Over-Night Call Rate (final results) in the contract month released by BoJ over the interval between the BOJ MPMs which TFX designates, rounded to the nearest 3rd decimal place Spot-Next Repo Rate futures CONTRACT SPECIFICATIONS Listing date 12.3.2007 Underlying asset Average GC Spot-Next Repo Rate (Tokyo Repo Rate) released by the Bank Of Japan (BOJ) over the interval between the BOJ Monetary Policy Meetings (MPMs) which TFX designates(*) Trading unit  ¿Ãƒâ€šÃ‚ ¥300,000,000 (Notional principal amount) Price quotation 100 minus rate of interest Tick size Value 0.005  ¿Ãƒâ€šÃ‚ ¥ 1,250( ¿Ãƒâ€šÃ‚ ¥300,000,000 ÃÆ'Æ’- 0.005% ÃÆ'Æ’- 30/360= ¿Ãƒâ€šÃ‚ ¥1,250) Contract Month First 6 calendar months Last trading day Two business days prior to the last day of the BOJ MPM which TFX designates Final settlement day The first business day following the last trading day Final Settlement Cash Settlement Final settlement price 100 minus the average GC Spot-Next Repo Rate in the contract month released by BOJ over the interval between the BOJ MPMs which TFX designates, rounded to the nearest 3rd decimal place Options: Options on Three-month Euroyen futures CONTRACT SPECIFICATIONS Underlying asset Three-month Euroyen futures Trading unit One unit of Three-month Euroyen futures (Euroyen futures)  ¥100,000,000 (Notional principal amount) Price quotation Quoted in Euroyen futures points (0.005) Strike price interval 0.125 Tick size Value 0.005 ( ¥1,250) Contract Month 5 contract quarterly monthsÃÆ' £Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬(March, June, September, December) Exercise style American Type Last trading day Two business days prior to the third Wednesday of the contract month Final settlement day The first business day following the last trading day TOKYO GRAIN EXCHANGE INC(4) : Listed commodities: Corn Futures Non-GMO Soybeans Futures Azuki (Red Beans) Futures Arabica Coffee Futures Raw Sugar Futures TOKYO STOCK EXCHANGE INC(5) : Futures: CONTRACT SPECIFICATIONS Product Parameter TOPIX Futures Mini TOPIX Futures TOPIX Core30 Futures TSE REIT Index Futures Target Index TOPIX TOPIX TOPIX Core30 TSE REIT Index Date of Listing 03-09-1988 16-06-2008 Contract Months March, June, September, December cycle (five contract months traded at all times) March, June, September, December cycle (three contract months traded at all times) First Trading Day The business day following the last trading day of the option contract month. Last trading Day The business day prior to the second Friday (or the preceding Thursday if the second Friday is a holiday) Trading Units 10,000 yen ÃÆ'Æ’- TOPIX 1,000 yen ÃÆ'Æ’- TOPIX 1,000 yen ÃÆ'Æ’- TOPIX Core30 1,000 yen ÃÆ'Æ’- TSE REIT Index Minimum Fluctuation 0.5 points 0.25 points 0.5 points 0.5 points Quote Parameters (*T1) Daily Price Limit (*T2) Circuit Brake In case when any of the futures contract month increases (or decreases) over a certain range,ÃÆ' £Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬all of the contract month trading will be halted for 15 minutes. (*T2) When the brake on TOPIX Futures is executed, also did. (*T2) (*T2) Payments and Receipts Settlement of open position by offset transaction On the next business day following the day of offset transaction Settlement of open position by final cash delivery On the 2nd business day following the last day of trading Final Settlement Cash settlement based on Special Quotation (S.Q.) on the 2nd business day following last trading day S.Q.Calculation Calculated based on the opening price for each TOPIX index component stock on the business day following the last trading day ToSTNeT Trading (Off-Auction Trading) Available Inter-month spread trading Available Give Up Available Regulations of the market Reduce the daily price limit Change the price range for temporary trading halt Advance the date and time by which a margin must be deposited Increase clearing and/or brokerage margin Reduce assessment rates of securities used for margin deposits in lieu of cash Restrict or suspend trading (including trading by Trading Participants for their own account); and/or Limit the amount of open long and/or short positions. (*T1) Quote Parameters Special Quote Price Quote Parameters under 750  ± 4 points 750 or more under 1,250  ±6 points 1,250 or more under 1,750  ±8 points 1,750 or more under 2,250  ±10 points 2,250 or more under 2,750  ±12 points 2,750 or more under 3,250  ±14 points 3,250 or more under 3,750  ±16 points 3,750 or more  ±18 points (*T2) Daily price limit and Circuit brake Previous days closing price Daily price limit Circuit brake Level 1 Circuit brake Level 2 under 750  ± 100 points 50 points. 75 points 750 or more under 1,000  ± 150 points 75 points 110 points 1,000 or more under 1,250  ± 200 points 100 points 150 points 1,250 or more under 1,750  ± 300 points 150 points 225 points 1,750 or more under 2,250  ± 400 points 200 points 300 points 2,250 or more under 2,750  ± 500 points 250 points 375 points 2,750 or more under 3,250  ± 600 points 300 points 450 points 3,250 or more under 3,750  ± 700 points 350 points 525 points 3,750 or more  ± 800 points 400 points 600 points REGULATORY BODIES GOVERNING FINANCIAL MARKETS OF JAPAN Financial institutions in Japan are regulated mainly for the purpose of protecting banks investors and depositors. Regulators monitor financial institutions through regulatory reports and periodic direct inspections. Japans financial sector is supervised by three main bodies: 1. Financial Services Agency (FSA) 2. Securities and Exchange Surveillance Commission (SESC) 3. Bank of Japan (BOJ) Certain reports are also required by other organisations for public disclosure. Tokyo Stock Exchange (TSE) Osaka Securities Exchange (OSE) Financial Services Agency (FSA) (6) The Financial Services Agency (FSA) is part of the Japanese government. It is controlled by the Minister of Finance and the FSA is the main regulator for banks in Japan. The role of the FSA is to maintain a stable financial system and to build a strong financial system in Japan. The FSA maintains a smooth flow of investment funds to support the economic development of the market and it protects investors deposits, securities and insurances. Its main responsibilities are: inspection and supervision of financial institutions private financial system planning monitoring and supervision of securities trading. The FSA is also responsible for ensuring the solvency of individual financial institutions. The FSA has legal authority over all financial institutions, including foreign banks operating in Japan. The FSAs inspection is designed to ensure sound and appropriate management of the bank (from Article 24 to 27 of the Banking Law, Article 25). If banks do not comply with documentation submission deadlines it may result in legal penalties. Banking Law prohibits false notification (No. 13 of Article 3, Chapter 1) resultin gin Suspension of operations (Article 26) Revocation of license (Article 27) in worst case scenarios. Securities and Exchange Surveillance Commission (SESC) (7) Securities and Exchange Surveillance Commission (SESC) was established to monitor fair trading for the Securities and Exchange Commission (Japanese Version SEC) under the FSA, as part of the FSA body. The SESC is the main regulator for securities in Japan. It conducts daily market surveillance and inspections of financial instruments and firms. Additionally the SESC investigates administrative monetary errors and inspects disclosure documents to avoid securities fraud. In cases where misconduct impairs the fairness of trading are found, legal penalties would be given. Functions of the SESC: Market surveillance Inspections of financial instruments business operators Administrative monetary penalties investigation Disclosure documents inspection Enforcement investigation and filing criminal charges Cooperation with overseas regulators Policy proposals Efforts to reach out to market participants and investors Bank of Japan (BOJ) (8) The Bank of Japan (BOJ) is the central bank of Japan, and is responsible for setting the bank rate. The BOJs contribution is stated under Bank Law Article 37 to 39 (temporary lending to financial institutions, controlling financial industry credit, managing the smooth settlement system of funds) for the sound development of the national economy in Japan. Unlike the FSA, the BOJ has no legal position of enforcement to financial institutions. The BOJs appraisal of financial institutions is the financial agreement (Appraisal contract) between the BOJ and the bank. Therefore there are no legal penalties from the BOJ. However, the BOJ can publicise factual based content from the appraisal to put pressure on the financial institutions. Thus to avoid the risk of ill reputation banks are likely to comply. Other regulators Other regulators to which financial institutions submit reports are: The Financial Futures Association of Japan (FFAJ) Japan Securities Dealers Association (JSDA) Japanese Bankers Association (JBA) Submission of reports to these organisations is mostly for statistical purposes than regulatory requirements. Data from regulatory reports is consolidated by type, such as banks, local banks, securities etc and disclosed publicly. The Regulations Major Japanese laws, regulations and rules for banking businesses are: Banking Law Financial Instruments and Exchange Law (FIEL) Foreign Exchange and Foreign Trade Act The Japan Finance Corporation Law Foreign Exchange Order INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION (ISDA) At the Global level, there is another trade organization of the participants for the over-the-counter derivatives. This is ISDA (International Swaps and Derivatives Association). With its Head Quarters in New York, ISDA has created standardized contracts to enter into derivatives market. ISDA, which represents participants in the privately negotiated derivatives industry, is among the worlds largest global financial trade associations as measured by number of member firms. ISDA was chartered in 1985, and today has over 830 member institutions from 57 countries on six continents. These members include most of the worlds major institutions that deal in privately negotiated derivatives, as well as many of the businesses, governmental entities and other end users that rely on over-the-counter derivatives to manage efficiently the financial market risks inherent in their core economic activities. Since its inception, ISDA has pioneered efforts to identify and reduce the sources of risk in the derivatives and risk management business. Among its most notable accomplishments are: developing the ISDA Master Agreement; publishing a wide range of related documentation materials and instruments covering a variety of transaction types; producing legal opinions on the enforceability of netting and collateral arrangements (available only to ISDA members); securing recognition of the risk-reducing effects of netting in determining capital requirements; promoting sound risk management practices, and advancing the understanding and treatment of derivatives and risk management from public policy and regulatory capital perspectives. Recent Developments of the Overnight-Index-Swap market and Future As short-term interest rates have become higher and more volatile since the end of the quantitative easing policy in March 2006, an interest rate swap, referred to as an OIS (Overnight Index Swap), which exchanges the uncollateralized overnight call rate over a specified period and a certain fixed interest rate, has begun to be traded actively. The use of the OIS enables financial institutions to conduct more finely tuned risk management than other conventional hedging tools. The OIS also provides an effective way to monitor market perceptions about the Bank of Japans monetary policy. For the time being, participants in the Japanese OIS market are almost entirely limited to overseas financial institutions. With growth in needs to hedge interest rate risks and to conduct arbitrage transactions, an increasing number of financial institutions are likely to enter the market, thus making the market more liquid. Transaction volume has remained low since the establishment of the market in mid-1997. In Japan, the OIS market was launched in mid-1997, but it was not until quite recently that it started to grow. The main reasons for this delayed growth are as follows: 1) Overnight interest rates remained at effectively zero percent during the period from the introduction of the zero interest rate policy (February 1999) through the end of the QEP (March 2006), except for certain periods. 2) Under these circumstances, short-term interest rates also remained at extremely low levels. These market conditions discouraged financial institutions from entering the market. It is because they did not need to hedge against short-term interest rate risks, nor did they find profitable arbitrage opportunities. Transaction volume began to grow as market participants began to anticipate the end of the QEP. The OIS transaction volume began to grow as market participants began to anticipate the end of the QEP. Active OIS transactions reflect market participants expectations of the timing and pace of the future rises in the policy target rate following the end of the QEP. Factoring in these expectations, the level and volatility of the OIS interest rates rose gradually (Graph1). Graph 6.1 Recent Developments of the Credit Default Swap market and Future Sovereign Credit Default Swaps (CDS) transactions have expanded rapidly, as seen in the increase of more than 30 percent in the amount outstanding of CDSs over the past year (Graph7.1). This expansion can be attributed to the following factors. First- Transactions with more attention to public-sector risks than private-sector ones increased toward the spring of 2009 post implementation of large-scale fiscal stimulus measures to stabilize the financial sector and economic stimulus packages after the failure of Lehman Brothers. And second Activity in the sovereign CDS market increased again, as concerns over sovereign risk in some European countries intensified from the autumn of 2009. Meanwhile, a rapid recovery in stock prices and a marked narrowing in corporate bond spreads have been observed in financial markets around the world, and firms demand for hedging credit risk has not appeared to increase significantly. Therefore, the amount outstanding of CDSs to hedge the firms credit risk has changed little. Graph 7.1 In other words, the rapid expansion in the sovereign CDS market over the past year generally has not spread to the credit-related transactions of the corporate sector. It should be noted that even after the rapid expansion, the amount outstanding of sovereign CDSs still amounts to less than 20 percent of that of corporate CDSs. The growth rate of the amount outstanding of sovereign CDSs by country has risen markedly in Japan, the United States, and the United Kingdom (Graph 7.2). Graph 7.2 Market participants can benefit from utilizing the OIS in the following ways. First, market participants who rely on overnight funding can more directly manage the risk of a rise in overnight rates by utilizing the OIS than the alternative derivatives for 3-6 month floating rates. In this respect, the OTC scheme may be more desirable since it would match the start date and trading terms to their hedging targets. The OIS is also attractive as a tool for arbitrage transactions that do not expand balance sheets. As mentioned above, arbitrage transactions between the OIS and short-term bonds, such as FBs, have already been conducted actively. In addition, some market participants may prefer the OIS to short-term cash bonds for constructing short-term positions since they do not need to expand their balance sheets, and hence can avoid risks from fluctuations of repo-funding costs. In these ways, growth of the OIS market is likely to provide hedging tools against overnight interest rate risks and expand arbitrage opportunities. Thus, it is likely to make the money markets more liquid, and thus to contribute to forming a smoother yield curve over the short-term maturity zone. Market expectations about future overnight rates implied in interest rate derivatives As mentioned above, the OIS and other similar derivatives, whose underlying assets are overnight rates, provide an effective way to extract market perceptions about monetary policy stance since these derivatives involve direct trading in market expectations about future overnight rates. In the euro area and the United States, central banks and market analysts often estimate the probabilities of monetary policy changes implied in these instruments and make use of them as one of their monitoring tools. In practice, the probabilities of a change in the policy target rate up to a few months ahead are usually estimated under the assumptions that risk premiums due to future uncertainties are negligible and that the forward rate in each month depends solely on expectations about possible changes in the policy target rate during the same month. As the Japanese money markets will become more active and short-term interest rates will become more volatile, demands for hedging and arbitrage transactions are expected to grow further. Japanese banks have large amounts of short-term yen positions, including overnight positions, demand or short-term time deposits, and short-term loans. Their profits may become unstable if short-term interest rates become volatile due to possible mismatch of terms among these positions. In such instances, the OIS could be useful as an ALM17 tool. Also, market participants whose yen funding availabilities are limited by credit lines18 can make shortterm positions using the OIS without incurring risks from funding costs, as well as without expanding balance sheets. Furthermore, given the trend toward increased issuance of government bonds including FBs, the repo market, and overnight repo market in particular, has been expanding as a funding market for those bonds. These developments suggest that dema nds for the OIS transactions will increase in the near future. Some issues toward further development Some Japanese financial institutions are now considering starting the OIS transactions. The issues to be examined upon starting OIS transactions include: 1) They need to clarify their actual ALM needs for finely-tuned risk management based on overnight interest rates, 2) They need to weigh the potential merits and the costs of the OIS transactions including operational costs and system installation costs, and 3) They need to examine concrete methods for evaluating their positions on a mark-to-market basis. Regarding the third issue, a number of market participants in the euro area are using the EONIA Swap Index19 for mark-to-market evaluation of their positions, which has been released as the benchmark interest rate on a daily basis for the EONIA swap since June 2005. The high reliability of the EONIA Swap Index is regarded to have contributed to higher liquidity in the EONIA swap market. The introduction of such an index for the Japanese OIS market or the provision of continuous and reliable indications by market brokers may encourage Japanese financial institutions to enter the OIS market.