Introduction to Derivatives Derivative is a product/contract which does not have any value on its own i.e.

it derives its value from some underlying. Forward contracts A forward contract is one to one bi-partite contract, to be performed in the future, at the terms decided today. (E.g. forward currency market in India). Forward contracts offer tremendous flexibility to the parties to design the contract in terms of the price, quantity, quality (in case of commodities), delivery time and place. Forward contracts suffer from poor liquidity and default risk.

Future contracts Future contracts are organised/ standardised contracts, which are traded on the exchanges. These contracts, being standardised and traded on the exchanges are very liquid in nature. In futures market, clearing corporation/ house provides the settlement guarantee.

Every futures contract is a forward contract. They : are entered into through exchange, traded on exchange and clearing corporation/house provides the settlement guarantee for trades. are of standard quantity; standard quality (in case of commodities). have standard delivery time and place.

Forward / Future Contracts Features Forward Contract Future Contract

Operational Mechanism

Not traded on exchange

Traded on exchange

Contract Specifications

Differs from trade to trade.

Contracts are standardised contracts.

Counterparty Risk

Exists

Exists, but assumed by Clearing Corporation/ house.