Academic journal article Journal of Financial Management & Analysis

Financial Derivatives: Empirical Analysis of Factors That Affect the Demand for Rights (Derivatives) in the Nigerian Stock Market

Academic journal article Journal of Financial Management & Analysis

Financial Derivatives: Empirical Analysis of Factors That Affect the Demand for Rights (Derivatives) in the Nigerian Stock Market

Article excerpt

Introduction

The major engine of growth and development of any economy is the capital market. The capital market accommodates certain institutions for the creation, custodianship, distribution and exchange of financial assets. An economy without a capital market cannot grow, since the market is responsible for long-term growth, capital formation and its allocation to development uses efficiently1.

Derivatives market is central complimentary and significant to the development of capital market in an economy. That instrument in derivative market, which confirms the deal between the investor and the dealer is called derivative. It is an elegant way to shift risk exposures, raise capital, convert one asset class to another, invest directly, and change frozen assets to liquid ones and more. Derivatives however are a type financial instrument that few understand and fewer still appreciate.

In the early 1970s and increasingly in the 1980s and 1990s, the world became a risky place for financial institution, thus making managers of financial institutions become more concerned with reducing the risk their institutions face. As financial innovations continually evolve to make less severe investment risks, coercive regulations intended to restrict banks activities have tended to lag behind such innovations, on account of the existence of genuine fears about the potential boomerang of derivatives and its associated hazardous effects on the economy as a whole. That is why most financial derivatives traded today are the simplest form of derivatives. These are otherwise referred to as plain vanilla.

The Abuja Stock Exchange in Nigeria was incorporated on June 17,2001 as a public limited liability company to serve as the country's second stock exchange. The pace of listing on the exchange was, however, too slow for the capital market role it was set up to play. Consequently, the Stock Exchange was unable to record any trading activity as a result of which the Federal Government took the decision to scrap the fledgling Stock Exchange on August 9,2001. It was then converted to a Commodity Exchange in that year.

Managerial Practices and Use of Derivatives

Despite the fact that firms have been using derivatives for decades, little is known about managerial practices in the use of derivatives. Global investors have become more sophisticated and companies have sought improved ways of managing assets. The increases in the volatility of financial markets and financial assets, coupled with risk exposures of firms have prompted financial managers to seek ways to mitigate exposures to such risks. There is the need for a facility through which corporate investors can efficiently transfer unwanted market risks to those in a better position to assume such risks. This is where derivatives come into the picture.

The relationship established in a derivative instrument unlike the purchase of equity requires constant monitoring for signs of unacceptable changes in view of the fact that the number of corporate failures associated with derivates trading makes an in-depth understanding of the workings of this instrument imperative. Such understanding expectedly will be immensely useful in the prevention of corporate failures associated with derivatives trading. Accordingly it is appropriate to examine the factors that bear on the demand for derivatives and/or its supply. This is the focus of this paper. That is all the more appropriate when considered against the backdrop of the increasing importance of derivatives and the growing acceptance of this instrument in individual and corporate transactions. Our focus in this paper is, however, limited to examining the factors that bear on the demand for rights, a form of financial derivative that could be bought and sold on the stock market.

Derivatives have become increasingly popular and important in the finance world. In the views of Hull2, there is now active trading in credit derivatives, electricity derivatives, weather and insurance derivatives, in addition to the many new types of interest rates and foreign exchange products which have been created. …

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