You are on page 1of 18

DERIVATIVES

What are deri vati ves ?

• Deri vat ive- is a product whose


value is derived from the MORE
BASIC VARIABLE
These basic variable are called
UNDERLYING
• Derivative is a security, the value
of which depends on the value of
another asset. The asset in which
its value depends is called the 
underlying asset.
underlyin g asse t
• An underlyi ng asset is the asset
on which the price of a derivative
 depends. Most traded derivatives
(i.e. those traded on exchanges) are
settled for cash
• FO R EXAMPLE- . equity, FOREX
commodity, or any other asset
• Ex- say an agreement with your
neighbor for 2 bags of sugar next
week
FEATURES OF
DERIVATIVE
• A SECURITY
• CONTRACTUAL AGREEMENT
• LOCK THE PRICE OF UNDERLYING
ASSETS
TYPE OF DERIVATIVE
MARKET
• OTC DERIVATIVE MARKET
• EXCHANGE TRADED DERIVATIVE
MARKET
OTC
• OVER THE COUNTER MARKET
• PRIVETLY NEGOTIATED
DERIVATIVE CONTRACT.
• Self Regulatory Organization
Types of deriv ativ e
cont racts

• FORWARDS
• FUTURES
• OPTION
• SWAPS
Forward contracts..
• Agreement to buy and sell an assets on
specified date on specified price
• LONG P OS ITIO N- The party agreeing to
buy the underlying asset in the future
assumes a long position
• SHOR T PO SIT ION -  the party agreeing
to sell the asset in the future assumes a 
short position.
• DELIV ER Y P RIC E- The price agreed
upon is called the delivery price OR
forward price.
Feature
• Bilateral contract
• Customization not standardize
• Private agreement
• Settlement by delivery of the
product
• if party wish to reverse the contract
then he has to contract with the
same counter party which result
high price
• Weakness- centralization,
Illiquidity, counter-party risk
Futures contracts..
• Futures contracts are organised/ standar dis ed
cont ract s ( quantity, quality, time, unit of price
quotation & minimum price change, location)
• These contracts, being standardised and traded on
th e ex change s are very liquid in nature.
• In futures market, clearing cor porati on/ hous e
pr ov id es th e s ettlement guar antee .
 Every futures contract is a forward contract.
 As with options, almost all futures traded on
exchanges are settled by payment of their value
on the day they expire rather than by delivery of the 
underlying asset.
 Require margin payment
Forward / Futures
Features
Contracts
Forward Contract Futures Contract
Operational Not traded on Traded on exchange
Mechanism exchange
Contract Differ from trade to Contracts are standardised
Specifications trade. contracts.
Counterparty Risk Exists Exists, but assumed by
Clearing Corporation/
house.
Liquidation Profile Poor Liquidity as Very high Liquidity as
contracts are tailor contracts are standardised
maid contracts. contracts.
Price Discovery Poor; as markets are Better; as fragmented
fragmented. markets are brought to the
common platform.
INTEREST RATE
FUTURE
• WH AT AR E INTER EST RAT E FU TUR ES?
• Buying an interest rate futur es  contract
allows the buyer of the contract to lock in a
future investment rate; not a borrowing rate as
many believe. Interest rate futures are based off
an underlying securitywhich is a debt obligation
and moves in value as interest rates change.
• When interest rates move higher, the buyer of
the futures contract will pay the seller in an
amount equal to that of the benefit received by
investing at a higher rate versus that of the rate
specified in the futures contract. Conversely,
when interest rates move lower, the seller of the
futures contract will compensate the buyer for
the lower interest rate at the time of expiration.
Option..

Option is a right given by option


seller to the option buyer to buy or
sell a specific asset at a specific
price on or before a specific date.
Option..
• Call Option - Option to buy.
• Put Option - Option to sell.
• American Option - An option
which can be exercised anytime
on or before the expiry date.
• European Option - An option
which can be exercised only on
expiry date.
Future & Option Market Instruments

The F&O segment of NSE provides trading


facilities for the following derivative
instruments:
2. Index based futures
3. Index based options
4. Individual stock options
5. Individual stock futures
Operators in the derivatives market

•Hedgers - Operators, who want to transfer a


risk component of their portfolio.
•Speculators - Operators, who intentionally
take the risk from hedgers in pursuit of profit.
•Arbitrageurs - Operators who operate in the
different markets simultaneously, in pursuit of
profit and eliminate mis-pricing.
Swap
• A Swap may be defined as"cash settled
over the c ounte r d erivative ". The
Swaps are considered as the sim plest
form of over-the-counter derivative or
OTC. Swap is considered as an
agreement, which takes place between
two contracting members whereby there
is exchange of "tw o stre ams o f cash
flo w". The main factor, which is taken
into consideration, is that the values of
the exchanging assets should be equal.
• If an investor is entitled to get
returns from equities, instead of
liquidating the returns, the
investor may swap the returns
into any financial instrument,
which involves less risk and that,
which yields flow of cash income
LIQUIDATE

on aRETURN
fixedON basis.
EQUITY LESS RISKY
ASSETS
SWAP
INVESTER

You might also like