Tài liệu Derivatives markets in the world and solutions for derivatives market development in vietnam

1 INTRODUCTION 1. The reasons for choosing the research topic A derivative is defined as “a financial instrument whose value depends on the values of other, more basic, underlying variables” (John C. Hull, 2009) or “a financial instrument whose promised payoffs are derived from the values of underlying assets” (Rene M. Stulz, 2004. In the world, derivatives were formed a long time ago and have been widely used nowaday. According to BIS statistical data, the notional amounts outstanding of derivatives in 2014 were appoximately 670.000 billion USD, in which the notional amounts oustanding of OTC derivatives were ten times higher than exchange-traded ones. Derivatives market is considered the most active market in the world with daily turnover in the tens of trillions of US dollars. Only for foreign exchange market , the daily average turnover in 2013 reached 6.671 billion USD, wich was accounted for nearly 19% of total market. Derivatives are initially considered risk management tools against fluctuations of input and output prices faced by manufacturing, trade or investment firms. In the early time, the underlying assets of the derivative contracts are mainly agricultural products such as rice, corn, cotton,. .. and the primary purpose of these derivatives instruments is to hedge the price movements of underlying assets. But along with the growth of the world economy, the underlying assets have become more and more diversified, from input products (crude oil, steel, nonferrous metals, cotton) ... to financial products (foreign exchange, securities, indices, interest rates ...). Nowadays, these instruments have been widely used by financial and non- financial firms, corporations, investors in the world not only for managing unwanted change in material price, interest rate and exchange rate and reducing the volatility of their cash flows, but also for arbitrage and speculation. Speculation would not necessarily do any harm to the derivative market but instead help to increase its liquidity. Liquidity and trading volume of international derivatives market would not permit anyone monopoly or manipulate derivatives price. Traded derivatives can be a good source of information for the valuation of underlying assetstherefore market prices of assets can be more reliable for producers to decide on supply and for consumers to know their demand. According to a survey held in 2003, 92% of the 500 biggest firms in the world utilize derivatives to hedge price risks (Deutsche Borse Group, 2008). While the majority of derivatives users are bigger groups or financial institutions, smaller firms as well as individuals still constitute a considerable part of the derivatives market which is 20% of all transactions (BIS, 2011). Many countries around the world have issued more policies and regulations to manage and develop derivatives market. These findings suggest that there is a high demand for derivative products irrespective of user type. In the market economy, the price, exchange rate, interest rate fluctuate continously depending on law of supply and demand and thus the risk may occur much more. Especially in the global economic integration, the risk of price fluctuations may happen anytime to investors and, so the development of the derivatives market should become an important and effecitive shield to minimize price risks for market participants. Meanwhile in Vietnam, the definition of derivatives is not really popular and many individual investors, enterprises have a moderate knowledge about these instruments. It is believed that the derivatives only take benefits including hedging, arbitrage and speculation. However, others argued that derivatives usage is like the gambling instead of bringing such benefits. Vietnamese firms, previously, accepted explanations that unfavorable and unpredictable movements of prices were the market objective factors and not under the control of management. In other words, the fluctuations in 2 commodity price, exchange rate, interest rate were known as force majeure. Nowadays, many firms in Vietnam expect management to be able to identify and manage those risks. Vietnam has been a nascent market for derivatives instruments compared to other developed ones in the world. Only some commercial banks in Vietnam regularly perform derivatives transactions with non-financial firms, so derivative market size is very moderate and the list of underlying assets are so poor, including some agricutural products (coffee, rubber) and foreing exchange. In the world the derivatives transactions for agricultural products maily performed through many commodities exchanges, meanwhile Vietnam Commodity Exchange, which was founded in 2010 has not been an intermediary for manufacturers and exporters yet in finding price risk management tools, as well as has not become effective investment channel for investors. The Vietnamese manufacture and exporter who are in need of price hedging still have to perform derivatives transactions through the world large commodity exchanges. As for the firms with revenues and expenditure in foreign currency, they surely face frequent exchange rate fluctuations. Therefore if the foreign exchange derivative market develops in Vietnam, these businesses will be supplied a full range of hedging tools as needed. According to Bodnar’s study about the firms behaviors in case of facing foreign exchange risks, the derivatives usage for hedging reached the highest proportion (over 70%). In Vietnam the foreign exchange derivatives are mainly overthe-counter traded, but the notional amounts outstanding is still quite modest. Some other derivatives instruments like foreign currency options (foreign- domestic currency options) had been lauched as experimental transactions for a short time and had stopped so far. Vietnamese enterprises do not have the opportunity to use the effective foreign exchange risk management tools that has been applied by many firms around the world. The weakness of Vietnamese derivatives markets has been becoming an enormous challenge for Vietnamese commercial banks and firms in the period of global financialeconomic integration. Therefore, nowadays the issue of derivatives market development in Vietnam becomes more imperative than ever. So if derivative market is not stimulated to develop in the near future in Vietam, its firms will lose the opportunity to derivative instruments for hedging, arbitrage and speculation which a majority of big companies around the world has been using. Regarding those reasons, I decided to choose the topic "Derivatives markets in the world and solutions for derivatieves market development in Vietnam” for my dissertation. 2. The research purpose The purpose of the dissertation is to systematize of theories related to the foreign exchange derivative, to analyze the current development of the foreign exchange derivative markets of in the world from which to draw experiencial lessons for development of foreign exchange derivatives market in Vietnam. In order to reach these aims, the basic research tasks have been set up as follows: - to systematize of theories related to the foreign exchange derivative instruments, foreign exchange derivatives market and conditions for its development in Vietnam. - to analyze the current development of the foreign exchange derivative markets of in the world, especially three typical foreign exchange derivatives have been chosen to more deeply analyze. These 3 markets are Japan, India and China, which are representative of different types of derivative markets, from a nascent and developing markets to developed one; - to analyzes the establishment and development of the Vietnamese foreign exchange derivative market in order to evaluate its achievements and limitations. - to forecast and define the development trends of world foreign exchange derivatives market as well as Vietnamese one; simultaneously to carry out the investigation on derivatives usage by Vietnamese firms and some interviews with derivatives experts about the conditions of derivatives market development in Vietnam and thereof to suggest some solutions to more develop this market in the near future. 3. The research object and scope: - The research object: Within the scope of this dissertation, the research object that has been limited is the market of foreign exchange derivatives. On the rationale of foreign exchange derivative markets in the world and their formation and development I have focused on the current situation of foreign exchange derivative market in Vietnam. - The research scope: There has been plenty of underlying assets for derivatives instruments, thereof the content of research on derivatives market should be wide and disconcerted if research ojbect has not been limited. For that reason, the dissertation focuses only on foreign exchange derivatives instruments and market. Actually, the demand for usage of foreign exchange derivatives may arise with any firms in any fields (import-export, trading, investment, manufacturing, services). In the meantime forex derivatives market in Vietnam just has been a nascent and developing one. On the other hand, according to research by Bodnar (2011), in the field of foreign exchange the firms tended to use derivative instruments for hedging rather than any risk management tools. - The research’s time scope: The dissertation focuses on research the foreign exchange derivatives market in the world and Vietnam from 2008 to 2014. Nevertheless, depending on the requirements of some specific contents, such as the analysis of the derivatives market history, the data for previous years has been used. Some statistical data that has been rounded can be a little bit different but do not affect on the findings of dissertation. 4. Research methods To complete the dissertation, I have used a combination of research methods, as follows: - To collect numerous research that has been carried out by both international and local economists regarding the topic of foreign exchange derivatives market. From those sources, the writer applies the summarizing, synthesis and comparison methods to pick out the most suitable model and rationale on derivatives market that can be used for research foreign exchange derivatives markets in the world and Vietnam. Besides, I have taken part in many national and international workshops related derivatives market development market in Vietnam to collect and update the information and data. - To carry out the survey with questionnaire on derivatives usage by firms in Vietnam. I investigated into 135 firms, which are in different fields within Binh Duong province, Dong Nai province and Ho Chi Minh City, ones of Vietnam’s most dynamic economies, over the period from June 2013 to November 2013. The participants in the survey are managers or officers from import-export or sales 4 departments. Besides general questions, the questionnaire can be divided into two main parts: (1) the application of derivatives by the firms and (2) the demand for derivative products and difficulties faced by the firms. Among the 120 answers received from the survey, there have been 105 reliable ones that would be analyzed by Microsoft Excel. - To carry out some in-depth interviews directly or by mail/telephone with experts in foreign exchange derivatives trading (The Joint Stock Commercial Bank for Investment and Development of Vietnam-BIDV), with expert in foreign exchange transactions (Vietnam Joint Stock Commercial Bank for Industry and Trade- Vietinbank), with assistant of Board management (The Joint Stock Commercial Bank for Foreign Trade of Vietnam- VCB) and with director corporate bond investment, financial market-wholesale banking (Vietnam Maritime Commercial Joint Stock Bank -Maritime Bank). They are reliable sources of information which are used to cross-check to ensure the accuracy of the data and information collected from the survey. - To make statistical description, evaluation on the world and Vietnam’s foreign exchange derivatives markets, analyze the conditions of derivatives market development in Vietnam and thereof to suggest some solutions to more develop this market in the near future. Interpretation and inductive methods are used to make the dissertation clearer and more understandable from the reader’s view point. - To forecast and define the development trends of world foreign exchange derivatives market, the model ARIMA and SPSS software have been used to analyze data on the notional amounts outstanding from 1998 to 2014 collected from BIS quarterly, semi-annual, annual and triennial reports . 5. Literature review 5.1 International research papers As mentioned above, a derivative is known as a financial instrument whose value depends on the values of underlying assets” (Rene M. Stulz, 2004). In other definitions, a derivative is sometimes called an asset, a security or a contract; in any way, the common characteristic is that its value derives from the values of something else, known as the underlying. A derivative is a contract between two or more parties where they agree on the predetermined price of the underlying asset and the expiry date. The contract is binding to at least one party (it depends on the type of derivatives: forwards, futures, swaps or options), which means no matter how the price of the underlying moves, this party has to settle the contract at the predetermined price. Derivatives are mostly known in the forms of futures, forwards, options and swaps. They are initially used only for risk management; however profit from price speculation has now attracted more arbitragers and speculators to enter the derivatives market. There have been several studies on the role of derivatives, as well as their effect on the whole market, on the economy and on firms. Among these are the World Economic and Financial Surveys of International Monetary Fund (2002), Peter M. Garber (1998), research of Albert Market Solutions Ltd. (2003), Randall Dodd (2001, 2004), Eric Ghysels and Junghoon Seon (2005), Anna J. Schwartz (2009). The first three surveys showed the positive role of derivatives in financial market, even in emerging markets such as Asia. The last three surveys focused on the negative effect of derivatives, particularly their role in financial crisis. Besides, there have also been some studies on the firms’ usage of and attitudes towards derivative instruments, especially derivatives use by non-financial firms. Among these are the surveys of the Greenwich Associaties (1996), Treasury Management Association (1996) and 5 particularly two large-scale surveys conducted by the Wharton School: Bodnar, Hayt, Marston, and Smithson (1995) and Bodnar, Hayt, Marston (1996). These researches have provided insight into the use of derivatives by US non-financial firms for hedging and other goals. Meanwhile, some studies focused on use of derivatives by another country’s firms. For example, Yahagida and Inui (1995) surveyed Japanese firms, Downie, McMillan, and Nosal (1996) surveyed Canadian firms, and Price Waterhouse (1995) surveyed international firms on derivative usage and other related issues. Bodnar M.Gordon and Gunther Gebhardt (1998) conducted a comparative study of derivative usage in risk management by U.S and German non-financial firms. Graham R. John, and Daniel A.Rogers (2002) provided evidence on why firms use derivatives. Gordon M.Bodnar, Erasmo Giambona, John Gramham, Campbell R.Harvey (2011) continued to study derivative use by firms with much more expansive coverage, both in terms of the risk areas as well as the global scale of the sample. Moreover, Rene M.Stulz (2004) discussed the extent to which derivatives posed threats to firms and to the economy and also indicated who used derivatives and why. Related to derivatives market development conditions, the white paper "Derivatives market development" by Market Aberta solutions Ltd (Vancouver, Canada) published in 2003 has already mentioned some key elements in establishment a new derivatives market as market participants, legal regulations, however, the studies only stop at the profiles of the elements that make up the market, not to mention and analysis to these conditions. In the research report The world's commodity Exchanges: Past - Present - Future of UNCTAD (2006) has referred to the conditions established a new exchange rather than focus on stimulating factors for the exchange development, especially derivatives exchange. Some other studies only emphasize to legal systems as an important factor for derivatives market, such as Paul Latimer (2008) reffered to legal factor in the derivative transactions in Australia, Hui (2012) analyzed legal regulations in foreign exchange derivative market in China. 5.2 Research papers in Vietnam In Vietnam there have been some studies in derivatives and foreign exchange derivatives, as the foreign exchange derivative usage for hedging (Ho Thuy Ai, 2007), the stimulation for derivatives application in Vietnam (Viet Bao, 2007), some accounting solutions for developing Vietnam’s derivatives market (Nguyen Thi Thanh Huong (2007), the stimulation for derivatives application in Vietnam’s forex market (Nguyen Thuy, 2008), the experience drawn from emerging economies to develop derivatives markets Pham Thu Thuy (2011), the situation of foreign exchange derivative transactions in Vietnam (Dinh Thi Thanh Long, 2014). However, there have not been any deep and comprehensive research on foreign exchange derivative development, as well as evaluating CCPS conditions to develop this market in Vietnam. There also have been some graduate master’s thesises related to foreign exchange derivative instruments and their usage in Vietnam, such as Bui Thi Xuan (2010), Le Thi Khanh Phuong (2009), Vu Tran Thanh Long (2012). Huynh Thi Huong Thao (2014) studied on derivative instruments for the management of credit risk in commercial banks in Vietnam, not on foreign exchange derivatives. Proceedings of Workshop on Developing and expanding list of traded commodities through commodity exchanges during the integration period, held the Ministry of Industry and Trade and MUTRAP (2012) mainly focused on developing commodity derivatives exchange. Pham Nguyen Hoang's study (2011) referred to the conditions of formation and development of the derivatives exchange in Vietnam, 6 however, only exchange for futures contracts. These conditions are: (1) the legal systems, (2) economic and financial conditions, (3) technical conditions. The research findings of Pham Nguyen Hoang (2011) and the Market Aberta solutions Ltd (Canada) (2003) is the important hypothesis on the conditions for derivatives market development. On that hypothesis, I have selected and analyzed carefully the conditions for the foreign exchange derivatives market development. These above research papers analyzed derivatives instruments and markets, but there have been no one of them which comprehensively addressed the conditions for foreign exchange derivatives markets development of conditions in Vietnam, particularly in the context of Vietnam’s integration into the global economy. Thus, there has not been yet any research paper among those ones mentioned above which comprehensively and deeply refers to the derivatives usage by firms in Vietnam nowadays as well as the conditions for the Vietnam’s foreign exchange derivatives market development on basis of experiential lessons drawn from the other derivatives markets in the world. 6. The structure of the research The three main parts of this dissertation are: Chapter one: Rationale for derivatives and foreign exchange derivative market Chapter two: Development status of foreign exchange derivatives markets in the world and Vietnam Chapter three: Solutions and recommendations for developing foreign exchange derivatives market in Vietnam 7. The new research findings: - Systematising the rationale for derivatives and foreign exchange derivatives market, such as derivatives’ definition, form, characteristic, nature; find out the conditions for Vietam’s foreign exchange derivatives market development, particularly in the context of international financial and economic integration. - Analyzing and evaluating derivatives markets and foreign exchange derivatives markets in the world with insights of Japanese, Indian and Chinese derivatives markets, from which the valuable experience lessons have been drawn for Vietnam’s one. Besides, the important factors affected on the developments of Vietnam’s foreign exchange derivatives market have also been found out and objectively assessed depending on the primary data collected from the firms survey and questionnaires experts in foreign exchange derivatives transactions in the Vietnam’s commercial banks. - Based on objective assessment of conditions for the development of foreign exchange derivatives market in Vietnam, I have recommended the specific and feasible solutions to better develop this market in the future with the context of international financial intergration in Vietnam. 7 CHAPTER 1: RATIONALE FOR DERIVATIVES AND FOREIGN EXCHANGE DERIVATIVES MARKET 1.1 Derivatives In the 1940s, Chicago became one of the biggest commercial centers in the United States; therefore, wheat growers all over the world came to Chicago to sell their products. If the price went up, farmers were willing to boost production; if the price dropped, they tried to sell all stocks, leading to the lack of storeroom for wheat. Traders also faced the potential risk of price fluctuations. Hence, it was essential to find a solution to minimize these risks. With advance agreement on price, buyers and sellers could prevent the risks from future price volatility. In 1848, Chicago Board of Trade (CBOT) was founded with an aim to gather farmers and traders in cereal trading. The Board standardized quantity and quality of the products, which enabled easier pricing for parties and boosted trading of goods. A few years later, the first type of future contract (to-arrive contract) was introduced. This ‘to-arrive’ contract allowed sellers to deliver goods at a predetermined future time. In 1973, the Chicago Board Options Exchange (CBOE) started to trade call options of 16 types of shares. In reality, options had been traded before that; however only until 1973 did CBOE successfully apply their standardized contracts. Meanwhile, put options were first traded in the exchange in 1977. Now CBOE supplies options of over 1,000 types of shares with different share indexes. From agricultural products at first, now any kind of goods and services can become underlying assets in derivative transactions. In the world, derivative has been a familiar term to many investors, speculators, financial institutions and non-financial institutions. The word ‘derivative’ is rooted from the word ‘derive’; hence derivative can be defined as a financial instrument whose value is derived from the value of underlying variables or underlying assets; or a financial instrument whose earning is derived from the earnings of other financial instruments. In this case, derivative is considered as a tool. In Vietnam, 2010 Law on Credit Institutions (clause 23, article 4) explains derivative as financial instrument whose value depends on expected fluctuations in value of a financial asset such as exchange rates, interest rates, foreign currencies, money. In terms of language, derivative or derivatives are used in those documents as a noun, and most of the definitions accept derivative as a financial tool while the others consider it as an asset or a security or contract. Despite differences and inconsistency in descriptions, all definitions agree derivative’s value is derived from the value of other instruments or assets. From the author’s point of view, a derivative should be considered a tool as since it was invented, the derivative itself has become a means for its users to prevent the risks relating to price volatility. Derivative should not be seen as an asset because if so, derivative must generate positive earnings like other assets while in reality, derivative may generate negative value. Moreover, derivative is not the same as security due to their difference in nature. Securities like shares or bonds are aimed at fund raising or capital increase while derivatives are for hedging on prices. Derivative instruments contain the owner’s rights to future benefits, which will give rise to demand for such benefits such as demand for exchange, transfer and sale of derivatives. A derivative market is formed when the demand for exchange, transfer and sale of derivatives increases. Derivatives will now be expressed in the form of a contract, which stipulates the obligations committed by one or the 8 parties to the contract. The price of the underlying asset of the derivative contracts are determined and agreed upon at the time of conclusion of the contract; however the implementation of commitments often occurs after a certain time period so the market price of the underlying assets or the value of the underlying variables will then change. This change will alter future cash flows of the derivatives, or in other words future earnings of the derivatives will also change accordingly. In short, derivatives are a financial instrument whose future income depends on the change of the underlying variables, such as commodity prices, exchange rates, interest rates, stock indexes or other kinds of indicators. Derivative instruments include the four most basic types: forwards, swaps, futures and options. Forwards are financial instruments applied to purchase a certain quantity of the underlying assets at a specified time in the future at a price agreed in advance. Futures can be seen as a special form of forwards, the standardized form which can be traded on an organized market. Futures are agreements for sale of underlying assets in the future at a predetermined price and when traded in the market, they will be expressed in the form of futures contracts. Swaps are considered a series of agreements between two counterparties to exchange future cash flows. In swaps, one party will normally pay the random outcome; the other can make fixed payments or other floating or variable payments. Options is an agreement in which the buyer pays the seller an amount called the option fee to have the option (but not the obligation) to buy or sell a certain product at a predetermined price at specified time in the future or at any time from the date of signing the contract until a specified time in the future. Derivatives play an important role in the economy. First, the derivative instruments are used to manage price risk. The creation of derivative instruments enabled the trade or exchange of future risks. Manufacturers, import and export businesses, financial institutions and non-financial institutions, investors may use derivative instruments, such as forwards, futures, swaps etc. to protect themselves from the price risks of raw materials, commodities, exchange rates, interest rates etc. in order to reduce damage to the future cash flows. These benefits are important factors making derivative financial instruments become more popular: 92% of the 500 world largest companies have used derivative instruments to manage price risks (Deutsche Borse, 2008). Second, derivative instruments are exploited for arbitrage. If there is a price discrepancy between the underlying asset of the derivative contracts and the spot price of the underlying asset at the same time, the investors will have the opportunity to arbitrage by buying at a low price and simultaneously selling high. Third, derivative instruments are used for the purpose of speculation. The original purpose of derivative instruments is hedging the price, but it is speculation that attracts more participants in the derivatives market. According to the Bank for International Settlement (BIS), only a small part of futures contract ends with the physical delivery, which means the majority of futures transactions will be for the purposes of arbitrage and speculation. Fourth, derivative instruments traded in the market are effective sources of information to determine the price of underlying assets. When the derivative instruments are traded, their prices are formed and this information will then be used to determine the price of the underlying asset. Information on price will help balance between production and consumption: based on market supply and demand, producers as well as consumers will decide on the quantity to produce or consume at the market price. Fifth, derivative instruments help to enhance the efficiency of financial markets in general. Derivatives market makes market signals less distorted. Market participants have the fair opportunity to access information, thus preventing monopoly or price manipulation and indirectly enhancing the efficiency of financial 9 markets in general. Despite their important role in the economy, derivative instruments also have some drawbacks that investors should consider before deciding to engage in derivatives transactions. 1.2 The market for foreign exchange derivatives Market is simply a place to exchange or trade goods. However, in fact, with the development of information technology, buyers and sellers do not need to meet directly at a certain location to make an agreement on the exchange of goods, or in other a geographical location is no longer needed for the sale or purchase of goods. Therefore, the market concept is not necessarily tied to a specific geographical place. Derivative market can be seen as a mechanism or set of agreements on sale of promises, commitments to the transfer of assets and payments with the prescribed conditions. In broad terms, foreign exchange are the entire foreign money, payment methods in foreign currencies, valuable papers denominated in foreign currencies, gold, precious stones (Le Van Tu, 2009), also including domestic currency used in international payments (under Vietnam Foreign Exchange Ordinance 2006). However, other payment means constitute only a small proportion compared with foreign currencies hence within this thesis, foreign exchange is understood as foreign currencies. Based on the concept of derivatives markets, combined with the concept of foreign exchange, we can define the market for foreign exchange derivatives as the derivatives market whose underlying asset is foreign currencies, or as the mechanism or set of agreements on purchase of promises, commitments to the transfer of foreign currencies and payments under prescribed conditions. The transactions on foreign exchange derivatives market include: FX forward transactions are transactions where both parties commit to buy and sell an amount of foreign currency at an exchange rate determined at the time of signing the contract and the delivery/payment will be made at a specified time in the future. FX futures transactions are transactions in which two parties agree to buy and sell a certain amount of foreign currency at the exchange rate determined at the time of signing the contract and the transfer of foreign currency and payment will be made at a future date. In essence, FX futures transactions are similar to FX forward transactions but traded on the exchange market. Swaps are commonly used in forex trading under two forms: (1) foreign exchange swaps and (2) currency swaps. Forex swaps are transactions where one party agrees to sell a certain currency at a certain time to the other party and simultaneously commits to repurchase that currency at another time in the future at the predetermined exchange rate. In FX swap transactions there could be the actual exchange between two currencies (only exchange the principal amount) at two times agreed in the contract at the predetermined exchange rate. Thus, foreign exchange swaps include 2 contracts, combining a spot foreign exchange contract with a forward exchange contract (spot - forward swap) or a combination of two forward exchange contracts having different value dates (forward-forward swap). Currency swaps are commitments of both parties to exchange interest flows of various currencies in a certain period, and also to exchange the principal amount at maturity of the currency swap contract at the rate agreed in advance (BIS, 2015); or the principal amount will be exchanged at two predefined time: beginning of the contract and contract maturity (principal amount for both currencies must be predetermined). 10 Forex options transactions are transactions in which the buyer of the option has the right but not the obligation to perform the transactions committed to the seller, while the option seller is obliged to conduct transactions committed when the buyer require sat the pre-agreed exchange rate. In order to get the option to buy / sell foreign exchange, the buyer has to pay a premium cost to the seller. Option buyer (holder) is the person who pays the premium cost to get the option and has the right to ask the seller to exercise the option at the buyer’s disposal. Option seller (writer) is the recipient of the premium cost paid by the buyer, thus has an obligation to exercise the option when the buyer requests. Exercise or strike rate is the rate used if the buyer requests to exercise the option. In the case of the call option, the strike rate is the rate at which option holder has the right to buy the underlying currency from the option seller. In the case of put option, the strike rate is the rate at which option holder has the right to sell the underlying currency to the option writer. There are 2 kinds of option contracts: call options and put options. Call option contracts are contracts in which the buyer has the right, but not the obligation, to purchase an amount of foreign currency at a predetermined price and within a specified timeframe. Put option contract are contracts in which the buyer has the right, but not the obligation, to sell an amount of foreign currency at a predetermined price and within a specified timeframe. Joining the derivatives market are various participants with different purposes. However, the main market participants are exchange rate hedgers, arbitrage traders or speculators. Hedgers use derivatives to limit risks from the fluctuating market factors. The main purpose of this group is not the profit from the use of derivative instruments, but to minimize or prevent the risk and make sure they get the profit they deserve. Arbitragers simultaneously perform 2 or more derivative transactions to seek the profit from the difference in transaction prices. Arbitrage activities bear virtually no risk. They take advantage of the inefficiency of the market in which at the same time, the price of the same asset differs in two or more markets. This group plays an important role in the operation of the market because they detect inefficiencies in price, enabling quick and necessary adjustments. Speculators use derivatives to bet with the up and down movements of the market. Speculative trading is risky to implement, but can bring high profit if speculators have good judgment of market trends. Their purpose of using derivatives is not for hedging but to make a profit. However, determining the purposes of market participants is difficult, because in many cases the owner can change the original purpose of hedging or arbitrage into speculation. The market participants include financial institutions, non-financial institutions, individual investors, companies or corporations. Based on the level of centralization, derivatives market is divided into exchange market and offexchange market or over-the-counter. In addition, the market can be categorized according to the type of derivative instruments: forwards market, futures market, options market and swaps markets. 1.3 The conditions for the development of foreign exchange derivative market (1) Demand for foreign exchange derivative instruments Like any other market, conditions for the birth and development of the foreign exchange derivative market start from the demand to use derivative instruments from the buyers and sellers. The history of derivative instruments in the world shows that they were born firstly due to the needs of the buyers and sellers to hedge the price of underlying assets. Gradually, these derivative instruments were developed to be more diverse in types to meet the needs of investment, speculation and arbitrage trading. 11 In countries with a developed financial market, investors may use derivative instruments as one of the effective investment tools. (2) Underlying assets Foreign exchange that is underlying asset of foreign exchange derivatives market is the foundation for the development of this market. Without foreign exchange market, there will be no foreign exchange derivative market. The value of foreign exchange derivative instruments are based on the fluctuations in the exchange rate between the currency pairs, hence developing the foreign exchange market is an important part in developing the foreign exchange derivative market. For a foreign exchange derivative market to thrive, the domestic currency of that country has to be easily convertible and actively traded in the market. (3) The legal basis for foreign exchange derivative transactions Any market requires controlling rules to make the market activities transparent, equitable and ensure the rights of the participants. The foreign exchange derivative market is clearly more complex and difficult to manage than the foreign exchange market, thus demanding a comprehensive and consistent legal system. Most countries have a system of legislation to regulate transactions in the derivative market. Objects transacted in the foreign exchange derivative market are not simply currency but the financial instruments related to the rights to buy and sell foreign currencies. These rights need to be legalized; more specifically, in the legislations ruling derivative activities, there should be a clear definition of the rights and obligations arising from derivative transactions and the enforcement mechanisms. Moreover, for foreign exchange derivative transactions in the exchange market, there are intermediaries other than the buyers and sellers. Activities of intermediaries must also be monitored and tightly regulated to ensure they comply with all the obligations in the market. In case of violations, the exchange will have to adjust and monitor to stabilize the market and on behalf of the government to provide a comprehensive legal framework to regulate derivative activities. In Vietnam, the foreign exchange derivative transactions are managed directly by the State Bank; therefore, most of the laws governing these operations in Vietnam were issued by State Bank of Vietnam. (4) Facilities, techniques and human resources conditions Material and technical facilities are important factors in the development of derivative markets, both exchange market or over-the-counter. It includes modern infrastructure and technology, especially information technology, trading floor systems, warehouses, systems of commodity standards and contracts. For exchange market, the prerequisite is to build trading floor systems and organize the set of standards applied to contract forms traded on the exchange. However, a favorable condition in developing foreign exchange derivative market compared to the commodity derivative market is that it does not require large warehouses for storage of goods, or supporting logistic services for delivery at maturity of derivative contracts. But in return, the traders on the forex derivative market have to be equipped with the computer network with specialized software on the market analysis and valuation of forex derivative instruments, and with connections between the floor and the members, among the floors, the board system which shows the transactions listed in the market. 12 The foreign exchange market in general and the forex derivative market in particular is relatively complex in technical terms and also new to the nascent market like Vietnam; hence human resources should be taken more seriously. Therefore, the development of the foreign exchange derivative market needs staff, professionals, technicians, members of the exchange knowledgeable about derivative transactions and capable of analyzing and forecasting the market trend, sensible to information and more importantly enthusiastic and ethical in order to implement the transactions and also better control the risks for enterprises and banks. (5) The foreign exchange derivative instruments Like all derivatives with other underlying assets, in the field of foreign exchange, the derivatives also include four main categories: forwards, futures, swaps and options. Besides, on the over-the-counter forex derivative market, there exist other new products, known as the exotic derivative instruments which are built based on the basic instruments, but have special properties to suit specific needs. Every year, there are a variety of newly invented and amended instrumentswhile some other instruments disappear because they are no longer suitable and do not meet the customers’ needs. 1.4 The need for development of derivative markets in the contex of Vietnam’s international economic and financial integration Nowadays, nations’ economies tend to come together through economic globalization. No country can develop in isolation from the world; therefore, every country aims at opening up the economy, leading to the flow of goods, services and capital between countries. The increasing demand for foreign exchange has set agood start for the development of the foreign exchange market, creating the diversity of the underlying assets for the foreign exchange derivative market. Having become an official member of the World Trade Organization since 11/1/2007, Vietnam must implement the commitments on opening up the economy, which includethe commitment to open banking market and financial services. Specifically, in banking, Vietnam has made commitments to open for the fields such as "foreign exchange,exchange rate and interest rate instruments, including products such as swaps, forwards ". Vietnam has removed all controls over current transactions, easedcapital transfers from foreign investors and foreign borrowing by resident entities and only applied control measures to foreign exchange in exceptional circumstances in order to maintain financial and national currency security. Exchange rate fluctuationswith market demand and supply will increase risks for importers and exporters, investors as well as banks and force them to use hedging measures, the most popular of which is through the foreign exchange derivative instruments. Thus, the liberalization of foreign exchange will promote development of foreign exchange market and create momentum for foreign exchange derivative market. In the mutual relationship, foreign exchange derivative instruments will facilitate Vietnam’s development and further integration into the international economy and financial market. Development of derivative market means Vietnam is on track with the trends of many developed countries. The connection between domestic foreign exchange derivative market and international foreign exchange derivatives market will narrow the gap among the economies and financial markets, creating a healthy competitive environment for banks in the field of providing derivative products, while creating opportunities formanufacturers, domestic investors to have access to the derivative instrumentsin the world market. 13 Besides, in the process of international integration, foreign exchange derivative market of Vietnam will also face difficulties from external causes, such as the impact of the global and regional financial and economic crisis and fluctuations in exchange rates or foreign currency interest rates due to economic shocks or the foreign exchange management policies. Vietnam continues to pursue socialist -oriented market economy with the obligation to implement the commitments on opening upmarkets in financial and banking sector, hence will have torespect and acknowledgethe inherent elements and rules of the market economy, and not to stay outside the general development trend of the world foreign exchange derivative market. Therefore, the establishment of derivative markets in Vietnam sooner or later is inevitable. In fact, nowadays, most Vietnamese importers and exporters participate in the market not for the purpose of hedging the exchange rate, partly because of their poorawarenessofexchange rate volatility and hedging; on the other hand, due to strict regulation and supervision of the state bank in exchange rates and their variables so importers and exporters only jointhe market with foreign currency trading activities based on payments arising from underlying foreign trade contract. In the foreign exchange market of Vietnam, the participants are mainly commercial bankswho are allowed to deal in foreign exchange. Vietnam commercial banks act as market makers and are always ready to listthe two-way prices (bid rate and ask rate) of foreign currency to meet the needs of customers. This activity will create profits for banks based on the difference between buying and selling prices of foreign currency. In addition, commercial banks themselves also need to engage in currency derivatives or interest rate derivatives in order to balance the foreign exchange status, lower the risk of interest rate or exchange rate fluctuations . According to the interviews with derivative expertsfrom some commercial banks in Vietnam, the current proportion of foreign exchange derivative and currency derivative transactions in commercial banks is rising and accounts for about 10- 20% of the underlying currency transactions; in which customers who are other commercial banks constitue a relatively high proportion (Nguyen Thi Quynh Nga, 2014). Currently, the regulations related to currency derivative transactions, interest rates derivative transactions and foreign exchange derivative transactionsstill do not admit other purposes other than hedging for participants; however, in the future,Vietnam has to take into account the investment trends through currency, interest rate and foreign exchange derivatives. With the strong growth of derivative instruments in the international financial markets and the requirements of international economic integration and modern development of Vietnam banking activities, derivative instruments gradually appeared in Vietnam market: First were currency derivative instruments (forwards, swaps), followed by interest rate derivatives (swaps, options), commodity derivatives and most recently credit derivatives. Demand for derivatives in Vietnam market has grown increasinglydiverse. During the implementation process, the banks are allowed to provide derivative instruments with built-in business processes and risk prevention measures and to sign framework contracts with foreign partners to implement reciprocal transactions provided to customers; monthly report on the implementation of theproducts to the state bank. The provision of derivatives by commercial banks has beenrelatively effective with ensured safety, which will be the foundation for the development of currency derivative instruments in the future. 14 CHAPTER 2: DEVELOPMENT STATUS OF FOREIGN EXCHANGE DERIVATIVE MARKETS IN THE WORLD AND VIETNAM 2.1 Development status of foreign exchange derivative markets in the world The average daily transaction value of forex derivative market in 2013 reached USD 6,671 billion, almost 3 times higher than in 2004 and 1.5 times higher than in 2007. This shows that the forex derivative market is very active with relatively high growth speed. In particular, the United Kingdom is the market leader with sales of USD 1,263 billion every day, accounting for nearly 19% of total market turnover. However, if considering separately each of the marketdivisions (exchange and over-thecounter), the proportion and order of foreign exchange derivative transactions are not the same. Exchange market of forex derivatives has modest sales compared to other markets such as interest rates (the overwhelming proportion of over 90%) or stock indexes and accounts only about 2% of the total value of the contracts traded during the period from 2008 to 2014. In 2008, the forex derivative market (in terms of nominal value) hit the minimum value, which could be due to the financial crisis stemming from the US. However, the size of the forex derivative market after that increased and reached USD 314.4 billionin 2010. The upward trend continued during the period from 2011 to 2013 at an average speed of about 10 % per year, followed by a slight decrease in 2014, reaching USD 377.2 billion. On the global OTC derivative market, considering both indicators:nominal value and market value, foreign exchange derivatives ranked second behind interest rate derivatives (interest rate derivatives always overwhelmingly accounted for about 60-70%). By the end of December 2014, the nominal value of foreign exchange contracts stood at nearly USD 76 trillion, or about 12% of the OTC derivativemarket and also the highest value in the whole period from 2008 to 2014. The market value of the foreign exchange derivative instruments in 2008 wasUSD 4,084 billion, while the nominal value was only USD 50,043 billion compared with USD 2,495 billion market value and USD 75,880 nominal value in2014 (BIS, 2015a). This suggests forex derivative marketin 2008 contained many unstabilities and risks. After the financial crisis, the derivatives in general and forex derivatives in particular were more stable, reflecting the smaller ratio between the market value and the nominal value than the crisis period. Considering the structure of foreign exchange derivative instruments, forex forwards and swaps accounted for nearly half the nominal value of all valid foreign exchange contracts. In 2014, the market value of currency swaps was USD 1,351 billion, while the market price of the entire forex derivative market was USD 2,945 billion (BIS, 2015a). In forex derivative market, non-financial customers account for about 12.7% while financial customers account for 87.3% (BIS, 2015a). Although the proportion of financial customer s don’t rise in comparision with non-financial customers, the number of manufaturing and trading firms using derivatives increase over time as the financial market turblance is more and more frequent (Bodnar, 2011). According to statistics, enterprises in developed countries like Japan, Australia, United Kingdom and United States have the world highest rate of using derivatives. In terms of enterprises type, about 78% financial enterprises use derivatives, while 56% non-financial enteprises do, in which the rate for material manufacturer is 71%, goods manufacturers 67%, and service supplier 46%. Legal documents regulating derivative transactions in general and forex derivative transactions in particular is considered as the essential condition to promote and secure a stable development of 15 derviative market system in every country. Research has shown that countries with developed derivative market like Japan, United States, Australia, United Kingdom all have strong legal systems which are always updated in response to the market changes. Most countries aim to enhance supervising and solving systematic risks in the finance and banking field, securing transparency and limiting risks of derivatives. Besides, the G20 signed an agreement on improving supervision to derivative market in general and over-the-counter division in particular to secure a stable development for the whole market. 2.2. Foreign exchange derivatives market in some countries Three sample markets are chosen to demonstrate the diversity in the formation and operating process of current derivative market in different countries, ranging from a well- established market like Japan, to a fairly establised market like India with certain initial achievements, to a newly emerged market like China. Besides, practical lessons from these three markets are observed through a thorough analysis from their formation to the development stage. Followings are some lessons for Vietnam: Firstly, while respecting the law of markets, the State still play the key and decisive role in promoting the development of derivative market through the timely promulgation of legal documents to suit the context and economic performance of each country in each period. Secondly, it is advisable to prioritize some specific derivatives and underlying assets that are suitable for each development stage and economic performance of the country. However, a wide diversity of derivatives is always necessary to satisfy all customer demands. The development of underlying assets market need to be focused upon as a premise to the development of derivative market. Thirdly, derivative market is a free market yet subject to the regulation of law. These two features must be balanced, therefore it is advisable to set up a complete and consistent legal framework, improve the market’s transparency to ensure effective growth and development for the derivative market. Due to the complexity and diversity of OTC derivative market, the management of this market must be focused right from the beginning. Fourthly, training derivative experts and enacting regulations that help the market operates smoothly and effectively. As for newly emerged markets, the authorities do not encourage or even limit the speculative transactions, meanwhile strongly encourage transactions with risk hedging purpose. Through investigating the world forex derivative market and in some others countries, it is advisable that Vietnam choose forwards as the first derivative priority to develop. In the case of China, it chose simple derivatives to develop in the early stage of its derivative market: forwards for OTC market and futures for exchange traded market; and only deployed more complicated derivatives like options, swaps and other exotic instruments later on. Besides, to really boost demand for derivatives, enterprises themselves must change their awareness of derivatives and build a new business philosophy about investment. One feature of derivative market among others is “to bet” on the future price movement based on forecast which is probabilistic; therefore, future transactions may result in a profit or loss. Given that, the gambling characteristic of derivative market is unavoidable and more obvious than the trading of goods in the spot market. This calls for the spread of a new business philosophy: “investing, not gambling”, especially in countries that ban or limit casinos. 16 2.3 The development of foreign exchange derivative market in Vietnam. Foreign exchange derivative market in Vietnam is just the nascent one. Many enterprises are still strangers to derivatives and most enterprises have never used these tools, despite the fact that derivatives started to appear in Vietnam financial market as early as the 1990s. Foreign exchange derivatives in Vietnam mostly are applied through the State bank’s experimental derivatives transaction programme in commercial banks. In Vietnam foreign exchange market, spot transactions still account for the overwhelming proportion of over 90% of the total market volume, while derivative transactions account for only under 10%. In 2011, foreign exchange derivative market in Vietnam enjoyed the biggest growth of 26.7% compared to the previous year; yet only accounted for about 9.5% of total market value. This is contrary to the situation in the world foreign exchange market, where derivative transactions account for above 60%. Forward contract is considered to be the simplest, most easily applied and, according to research on the development of derivatives in many countries, earliest-born derivative. In Vietnam, as early as the 1990s, forward contract has been applied in currency transactions in commercial banks. At that time, there was no legislation on foreign exchange foward contracts; however, banks still performed such transactions based on the Law on Credit Institutions, Article No 7 which allowed banks to trade currency products. Forward contracts and swaps are most popular among currency derivative transactions currently executed at banks; in which currency foward contracts normally outweigh currency swaps in terms of value, especially in year 2008 (68.7%), 2011 (78%). Other derivatives like currency options, currency futures, interest rate options are only traded at some banks in limited volume and low frequency. Sample trading of domestic currency options in Vietnam was suspended in 2009 and it is unclear about when commercial banks will start trading domestic currency options again. Certain progresses by Vietnam foreign exchange derivative market are as follows: Firstly, foreign exchange derivative market has just started to form but it already made considerable progresses compared with goods derivative or security derivative markets. Secondly, most derivative sub-markets already have legal normative documents on derivative transactions, though not really thorough and complete yet. Thirdly, foreign exchange and interest rate derivative market is pretty active. Fourthly, some banks have started to launch new derivative products like interest rate forward contracts (Techcombank), goods price forward contracts and options (Military bank), or agency services for foreign exchange futures (Vietcombank). On the other hand, after ten years of being officially and legally authorized, the market still reveals some deficiencies and limits that need to be improved in order to promote the use of derivatives in Vietnam in the future. Firstly, derivative transactions still account for a modest proportion in Vietnam total foreign exchange market, just below 10% even in the year 2011 when derivative transactions volume peaked. Secondly, through the above analysis, it appears that Vietnam foreign exchange derivative market has only launched products and not really boosted the use of such products yet. 17 Thirdly, regulations relating to currency and derivatives trading are slowly updated and falling far behind the market changes. Fourthly, the market liquidity is low due to the limited number of market participants. Fifthly, the range of derivatives currently traded at some commercial banks is narrow, offering limited benefits to customers; as a result, the number of participating enterprises is just moderate. This situation is due to the following reasons: Firstly, Vietnam still maintains a floating exchange rate regime yet regulated within an fluctuation amplitude; therefore, using derivatives to hedge against exchange rate fluctuation risks little practical meaning. Secondly, many firms are still hesistant in learning about new financial tools. Thirdly, experts at Vietnam commercial banks all reckon that the fear of being charged with responsiblity when the hedge tools fail is very popular, which is the main hinderance for banks to provide derivative products to enterprises. Fourthly, understanding of derivatives is limited and uneven among market participants. Fifthly, the State Bank continously promulgated new legal documents to monitor the foreign exchange derivative transactions; however most of the legislation aim to stabalize the market rather than to develop it. 18 CHAPTER 3: SOLUTIONS AND RECOMMENDATIONS FOR DEVELOPING FOREIGN EXCHANGE DERIVATIVES MARKET IN VIETNAM 3.1. Foreign exchange derivatives market size and development trend forecast The ARIMA model with SPSS software and the statistics from the Bank for International Settlements about foreign exchange derivatives from 1998 to 2014 have been used to forecast the size of the world foreign exchange derivative market to the year 2020. The forecast expects the size of exchange traded foreign exchange derivatives market to reach 487.71 billion dollars in 2015 and approximately 510 billion dollars in 2020. Similarly, according to the forecast, total volume of effective contracts on over-the-counter derivatives market will reach approximately 77,027 billion dollars in 2015 and become a giant market with total volume of around 100,000 billion dollar in 2020. The general trend for the world foreign exchange derivatives market up to 2020 is stable growth. Vietnam derivative market is in its very early development stage; statistic figures about foreign exchange derivative transactions are not collected continually over the years, as a result the model ARIMA cannot be used to make a forecast for Vietnam foreign exchange derivative market like the world market. According to the statistic collected from 2008 to 2014 about the volume of foreign exchange derivative transactions, foreign exchange derivative market is growing albeit not significantly and stably. As a result, the market size is forecasted based on interviews with experts on foreign exchange derivative in Vietnam commercial banks. According to experts, the growth rate of Vietnam foreign exchange derivative market is still low at around 5-10% per year. Foreign exchange derivative transactions volume in Vietnam was 98,788 billion VND in 2014 (data collected from consolidated financial statements of Vietnam commercial banks). As a result, the foreign exchange derivatives transactions volume is forecasted to range from 123,485 to 148,182 billion dollars in 2020. Furthermore, three other development trends for the foreign exchange derivatives market are noted: (1) over-the-counter market is still the center of the global foreign exchange derivatives market, (2) derivatives markets consolidation trend, (3) derivatives market products standardization trend. 3.2. Perspective of developing foreign exchange derivative market in Vietnam Developing foreign exchange market is accentuated in the Communist Party’s documents: “Continue to complete the regime for currency, credit and foreign exchange; Gradually open the banking service market in response to domestic socio-economic development demand and international commitments; Boost the State Bank’s role in monitoring policies, managing the currency, credit and foreign exchange, inspecting and supervising with a view to curbing inflation, stabilizing macro environment and contributing to economic growth...” “...Flexibly monitoring interest rate and exchange rate policies on market principle (Strategy for socio-economic development 2011-2020). Besides, in the Proposed project for developing derivatives market, it is clearly stated that in the long run currency derivatives transactions will be rallied on the Stock exchange like stock and goods derivatives. This is indeed a big progress of Vietnam in its effort to build the stock derivatives market in particular and the derivatives market in general. 3.3. Analyszing of key conditions to develop foreign exchange derivatives market in Vietnam 19 After analyzing proper conditions to develop foreign exchange derivative market in Vietnam, the following observations are noted: (1) Demand for foreign exchange derivative instruments According to a poll, 49.5% enterprises blame their poor access to derivatives on banks and enterprises that don’t advertise about this tool, and consider this the biggest objective reason, despite the confirmation of surveyed banking experts they already well advertise derivatives tool. It is therefore suggested that banks re-evaluate the effectiveness of their marketing activities on derivatives and make a better progress. (2) Underlying assets: The essential underlying asset for foreign exchange derivatives is free convertible foreign currencies, which are an important condition to diversify derivatives and develop foreign exchange derivatives market. Foreign exchange derivatives market’s development is essentially based on a developed underlying foreign exchange market. In spot foreign exchange market and in international settlements, the US Dollar transactions still account for a big proportion, around 60%. Besides free convertible foreign currencies, Vietnam Dong is also used in forward and swap contracts but with many limitations namely in adverse transactions between State bank and commercial banks, or in options contract. (3) The regime and the legal basis for foreign exchange derivative transactions A market economy is the prerequisite condition for the formation of different derivatives transaction demand. Stock exchange in general and future options exchange in particular is an property of a market economy. A market economy with its value system and economic rules is the most essential basis to form spontaneous or systematic demand for future transactions and their inherent properties. Therefore, continued effort to boost and complete a market economy will secure living conditions for foreign exchange derivatives market. (4) Facilities, techniques and human resources conditions: Today, Vietnam commercial banks’ facilities, information technology and tools mostly respond to derivative transactions demand. According to the survey, facilities, information and technical infrastructure conditions currently poorly respond the the development demand of traded exchange derivative transactions. Human resources in foreign exchange derivatives dealing in commercial banks of Vietnam still lack expertise knowledge and practical experience. (5) The foreign exchange derivative instruments: Derivatives in Vietnam are not as diversified and abundant as the world but have to a certain extent responded to enterprises’ initial demand, like forward, swap, future and options. Forward and swap are quite popular on the currency, interest rate and foreign exchange derivatives market; while future and option are limitedly used. 3.4. Solutions to develop foreign exchange derivatives market in Vietnam Solution 1: Commercial banks to further focus on derivatives introducing and marketing to firms According to my survey results, it is not that Vietnam enterprises have no demand for derivatives. The fact is they are poorly informed about derivatives and barely understand their nature. The objective reason for this situation is the insufficient effort by banks and enterprises to advertise and inform about derivatives tools. As for banks who offer derivatives products , more should be done about 20 introducing – explaining – presenting to their customers about benefits and limitations of those tools, suggesting specific application of derivatives in different situations when their customers need to hedge against risks. Solution 2: Commercial banks to diversify derivatives structrure Forward and swap are currently most popular in Vietnam foreign exchange derivatives market, while options are in very limited use. To improve this situation, commercial banks should research and ask for permission from the State bank to deploy exotic options that suit Vietnam’s economic condition and meet demand for risk management of the hedgers and investors. Solution 3: Commerical banks to focus human resources development Due to the nature of foreign exchange derivatives dealing, dealers are not only required to have good knowledge about the practice, good understanding of financial market, sharp and active intellect, but also acquire business ethics. Therefore, commercial banks need to care about human resources recruitment; organize in-depth training via short training courses domestically and abroad which improve the staff’s skills and expose them to the active and modern environment of international derivatives market; have proper treatment policies to attract and retain the talented; regularly update staff knowledge and improve their business ethics. Solution 4: To complete information technology infrastructure Banks can learn from overseas banks to build information technology system, acquire most advanced telecommunication computer systems or technical applications, set up proper data management software to assist themselves in decision making and advising their clients about derivatives. Solution 5: Commercial banks to enhance risks management in foreign exchange dealing Together with the standardization of the model, organizational structure, operating process of foreign exchange dealing departments, commercial banks can apply foreign exchange derivatives themselves, and they themselves need an effective risks management policies in foreign exchange dealing. Solution 6: Boost foreign-exchange-related banking services Foreign exchange derivative dealing is amongst many other business practices of commercial banks and is closely related to other practices like spot, international settlement, payment guarantee. As a result, boosting other banking services that relate to foreign exchange will indirectly attract customers to foreign exchange derivatives products better. Solution 7: Enterprises to actively learn about derivatives According to my survey, many enterprises don’t have a clue about derivative, not to mention derivatives application in hedging against interest rate and exchange rate risks. Therefore, enterprises themselves have to actively and excessively learn about and update knowledge about derivatives to hedge against risks; which will consequently diversify the participants in the market, increase market liquidity, help developing Vietnam foreign exchange derivatives market. Solution 8: To change the mindset of “loss” in derivatives market.