The term derivatives indicates that it has no independent value ie., its value is entirelyderived from value of underlying asset. The underlying asset can be securities,commodities, bullion, currency, indices, live stock etc. Derivative means a forward,future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfilment to the value of a specified real or financial asset or to anindex of securities.There are many types of financial instruments that are grouped under the termderivatives, but options/futures and swaps are among the most common.
BASIC FEATURES OF DERIVATIVES
1.As derivatives are not physical assets , transactions are setteled byoffsetting/squaring transactions. The difference in value of derivative is cashsetteled.2.There is no limit on number of units transacted in derivative market because thereis no physical asset to be transacted.3.Derivative markets are usually the screen based /computarised.4.Derivatives are secondary market securities and and cannot help raising funds to afirm.5.Derivative market is quiet liquid and transactions can be effected easily.6.Derivative provides a hedging against different risks.
The participants in a derivatives market
use futures or options markets to reduce or eliminate the risk associatedwith price of an asset.
use futures and options contracts to get extra leverage in betting onfuture movements in the price of an asset. They can increase both the potentialgains and potential losses by usage of derivatives in a speculative venture.
are in business to take advantage of a discrepancy between prices intwo different markets. If, for example, they see the futures price of an asset gettingout of line with the cash price, they will take offsetting positions in the two marketsto lock in a profit.