3-Year KTB Futures Success Factors & Outlook 2003 Taipei Interest Rate Futures Conference November 20-21, 2003 Jungho Kang, Ph.D Korea Futures Exchange

I. Market Overview II. 3-Year KTB Futures Market III. Underlying Market IV. Key Features V. Success Factors VI. Outlook

I. Market Overview - Growth 0 2,000 4,000 6,000 8,000 10,000 12, Jan~Oct ,521 7,920 11,691 (in 1,000 contracts) 3

I. Market Overview – Key Products (Figures: Jan.~ Oct. 2003) ContractsTotal Trading Volume Average Daily Trading Volume KOSPI200 Options2,344,34911,380 KOSPI200 Futures 52, year KTB Futures 8, USD/KRW Futures 1,239 6 KOSDAQ50 Futures (in 1,000 contracts) 4

II. 3-Year KTB Futures – Volume Growth Total VolumeAverage Daily Volume ,833 1, ,538,507 6, ,323,430 37, ,777,991 52,680 Jan~Oct ,755,732 42,504 (in contract) 5

II. 3-Year KTB Futures – Global Status (Source: FIA, January~June 2003) (in 1,000 contract) RankContract(Maturity)VolumeExchange 1Euro Bund(10)129,320Eurex 2Euro Bobl(5) 78,297Eurex 3T-Note(10) 66,531CBOT 4Euro Schatz(2) 59,605Eurex 5T-Note(5) 33,204CBOT 6T-Bond(30) 30,452CBOT 7T-Bonds(3) 9,190SFE 8KTB(3) 5,452KOFEX 9Long Gilt(10) 4,883Euronext-Liffe 10JGB(10) 4,501TSE 6

II. 3-Year KTB Futures – Users (I) Institutions 85.8 Individuals 6.1 Foreigners 8.1 Institutions 76.9 Individuals 21.1 Foreigners ( in %)

II. 3-Year KTB Futures – Users(II) User TypeInstitutions2000Jan~Oct InstitutionsFCMs Securities Companies Banks ITCs Insurance Companies Other Financial Institutions Other Corporations Total Foreigners Individuals Total (in %) 8

II. 3-Year KTB Futures - Specification Underlying Asset3-year Treasury Bond(8% coupon rate) Trading Unit KRW 100 million( ≒ USD 85,000) Contract MonthsThe first two consecutive months in the quarterly cycle(March, June, September, December) Price QuotationKRW 100 nominal value, to two decimal points Minimum Price Fluctuation0.01, representing a value of KRW 10,000 Last Trading DayThe exchange trading day immediately preceding the final settlement day Final Settlement DayThird Wednesday of the contract month Settlement MethodCash settlement 9

III. Underlying Market - Overview Various government measures to promote the government bond market → considerable rise in KTB trading volume over the past few years Improved liquidity → simplified the types of government bonds and focused on KTBs Screen-based, electronic trading market for government bonds(IDB, October 2002) → steep increase in exchange- traded volume 10

III. Underlying Market - Primary Maturity year KTB year KTB year KTB year KTB Total (in trillion won) (Source: Ministry of Finance and Economy) (1)The government stopped issuing 1-year KTBs as part of measures to lengthen maturities of government bonds. (2)The January-October volume plus the planned issue amount 11 (2) (1)

III. Underlying Market- Secondary Jan.~Sept OTC Exchange Total (in trillion won) * Source: Korea Securities Dealers Association(KSDA), Korea Stock Exchange(KSE), Korea Securities Computer Corp. 12

IV. Key Features – Cash Settlement Low liquidity → price manipulation such as “short squeeze”. The government plan to balance the budget(1999) → future liquidity concerns Monthly issue → disperses liquidity Oligopolistic secondary market → market manipulation(a few ITCs and banks have significant market control) Irregular issuing practices(1999) → predictability issues 13

IV. Key Features – Basket System Basket system was adopted to come up with fair final settlement yield. Final settlement price is determined, based on the average yield of a basket of selected treasury bonds. KOFEX designates a basket comprising a single or multiple number of bonds prior to the listing of a new contract and the basket remains fixed until the expiry date of the contract. 14

IV. Key Features – Final Settlement Price(I) Primary Dealer KSDA * Korea Securities Dealers’ Association KOFEX 19 primary dealers quote yields of the component bonds in the basket at 10:00, 10:30, 11:00, 11:30 AM. Excluding the highest and the lowest five quotes, KSDA calculates the simple average yield for each bond at each fixing time. ① mid value of the first three fixing values at 10:00, 10:30, 11:00 AM ② average value of ① + fixing value at 11:30 AM ③ average yield( ② ) → final settlement price Primary Dealer 15

16 IV. Key Features – Final Settlement Price(II) Bonds10:0010:3011:0011:30 A6.218%6.217%6.213%6.215% B6.155%6.153%6.148%6.149% C6.845%6.840%6.835% Fixing Value6.406%6.403%6.399%6.400% Series Name : KTB312 Last Trading Day: Dec Average Yield: 6.402% Settlement Price: Average (1)Of the 19 quotes received for a bond, the top and bottom five quotes are excluded and the remaining 9 quotes are averaged. (2)mid value of the first three fixing values at 10:00, 10:30, and 11:00 AM (3)The final settlement yield = average of the mid value(2) and the fixing value at 11:30 AM. Rounded up to three decimal points. (2) (3) (1)

V. Success Factors - Product Design √ Cash settlement → reduces possibility of market manipulation such as short squeeze and provides easy market access √ Specification → designed to best reflect the underlying market conditions and to meet the needs of market users - contract size: 100 million won(face value of KTBs) - underlying asset: 3-year KTB → in tandem with the shift of the benchmark to 3-year KTBs from 3-year corporate bonds 17

V. Success Factors – Market Conditions √ Increased bond issue → increased liquidity - issue amount: 6.8 trillion won in 1997 → 34.6 trillion won in 2002 √ Low interest rate trend from H → rally in bond market √ Flight to quality → risk-free treasury bonds in high demand due to unstable financial market conditions √ Fungible issue → increase liquidity of underlying bonds(more efficient price discovery: easier to find fair value of underlying bonds) 18

V. Success Factors – Government Actions √ The government increased bond issue and began to issue bonds regularly → enhanced market predictability √ Primary Dealer System(July 1999) √ Marking-to-Market System(July 2000) → increased hedging demand √ Screen-based secondary bond market(IDB)(October 2002) → greatly increased exchange-traded volume & market transparency 19

VI. Outlook √ Good growth potential: Korea’s government bond market is still at an early stage of development. - Increased awareness of risk management → potential hedging demand - The government’s commitment to foster the bond market √ Synergies with other interest rate products √ Foreign participation is anticipated to increase once the Korean government bond is designated as “exempted securities” (plan) 20

21 Thank you