FORWARD AND FUTURE DERIVATIVES

RESEARCH REPORT SUBMITTED IN PARTIAL FULFILLMENT OF THE

COURSE LAW RELATING TO INVESTMENT, SECURITIES, CORPORATE
FINANCE AND COMPETITION FOR OBTAINING THE DEGREE B.B.A LL.B
(Hons.) DURING THE ACADEMIC YEAR 2021-22.

SUBMITTED BY: - NIHARIKA BHATI

ROLL NO. – 1839
9th SEMESTER
SUBMITTED TO: - MR. ABHISHEK KUMAR
(ASSISTANT PROFESSOR OF LAW)

SEPTEMBER, 2021
CHANAKYA NATIONAL LAW UNIVERSITY
NYAYANAGAR, MITHAPUR, PATNA
800001
 TABLE OF CONTENTS

Declaration.......................................................................................................................................3

Acknowledgement...........................................................................................................................4

Research Methodology....................................................................................................................5

1. Introduction..............................................................................................................................6

2. Forward Derivatives...............................................................................................................10

3. Future Derivatives..................................................................................................................13

4. Difference Between Forward And Future Derivatives...........................................................16

5. Areas For Further Improvement Of Derivative Market.........................................................18

6. Conclusion..............................................................................................................................20

Bibliography..................................................................................................................................21
 DECLARATION
I hereby declare that the work reported in the BB.A.LL.B. Project Report entitled “Forward
and Future Derivatives” submitted at Chanakya National Law University, Patna is an
authentic record of my work carried out under the supervision of Asst. Prof. Mr. Abhishek
Kumar. I have not submitted this work elsewhere for any other degree or diploma. I am fully
responsible for the contents of my Project Report.

(Signature of the Candidate)

Niharika Bhati
Chanakya National Law University, Patna
 ACKNOWLEDGEMENT
I take this opportunity to express my profound gratitude and deep regards to my guide Mr.
Abhishek Kumar for his exemplary guidance, monitoring and constant encouragement
throughout the course of this thesis. The blessing, help and guidance given by him time to time
shall carry me a long way in the journey of life on which I am about to embark.
I am obliged to staff members of Chanakya National Law University, for the valuable
information provided by them in their respective fields. I am grateful for their cooperation
during the period of my assignment.
Lastly, I thank almighty, my parents, brother, sisters and friends for their constant
encouragement without which this assignment would not be possible.

Thank you!
 RESEARCH METHODOLOGY
Method of Research:
For the purpose of research, the researcher has used the Doctrinal Method of Research. The
Research is entirely a Library-based Research, where the researcher has made use of books, law
journals, magazines, law reports, legislations, internet websites, etc., for the purpose of research.

Aims and Objectives:

The Researcher aims to study in detail about the concept of Derivative Trading in India with
special emphasis on its types Forward and Future derivatives.

Research Questions:
The researcher seeks to answer the following answers in this project:
1. What do we mean by Derivatives?
2. What are the types of Derivatives?
3. What do we mean by Forward and Future Derivatives?
4. What is the difference between Forward and Future Derivatives?

Method of Writing:
The method of writing followed in the course of this research paper is primarily analytical.

Scope and Limitations of the Study:

Though the researcher will try her level best not to leave any stone unturned in doing this project
work to highlight various aspects relating to the topic, but the topic is so dynamic field of law,
the researcher will sight with some of unavoidable limitations. The limitations encountered by
the researcher were the paucity of time.
 1. INTRODUCTION
In the present highly uncertain business scenario, the importance of risk management is much
greater than ever before. The last two decades have witnessed many-fold increase in the volume
of international trade and business due to the wave of globalization and liberalization sweeping
across the world. This has led to rapid and unpredictable variations in financial assets prices,
interest rates and exchange rates, and subsequently, to exposing the corporate world to an
unwieldy financial risk. Increased financial risk causes losses to an otherwise profitable
organization. This underlines the importance of risk management to hedge against uncertainty.1
Derivatives are risk management tools that help an organization to effectively transfer risk. The
derivatives provide an effective tool to the problem of risk and uncertainty due to fluctuations in
interest rates, exchange rates, stock market prices and the other underlying assets. The derivative
markets have become an integral part of modern financial system. 2 Derivative thus is merely a
contract between two or more parties. Its value is determined by fluctuations in the underlying
asset.
Section 2(ac) of Securities Contract Regulation Act (SCRA) 1956 defines Derivative as:
a) A security derived from a debt instrument, share, loan whether secured or unsecured, risk
instrument or contract for differences or any other form of security;
b) A contract which derives its value from the prices, or index of prices, of underlying
securities.
The International Monetary Fund (2001) defines derivatives as “financial instruments that are
linked to a specific financial instrument or indicator or commodity and through which specific
risks can be traded in financial markets in their own right.3

 Benefits of Derivatives
1. They help in transferring risks from risk adverse people to risk oriented people.
2. They help in the discovery of future as well as current prices.4
3. They catalyze entrepreneurial activity.

1
Dr. Kamleshgakhar and Ms. Meetu, “Derivatives market in India: evolution, trading mechanism and future
prospects” available at: www.indianresearchjournals.com.
2
http://www.schuermaninsurance.com/futures/forward- contracts-vs-futures.asp
3
https://www.imf.org/external/pubs/ft/fd/2000/finder.pdf
4
http://www.ehow.com/info_8454326_advantages- disadvantages-forward-contracts.html
 4. They increase the volume traded in markets because of participation of risk adverse
people in greater numbers.
5. They increase savings and investment in the long run.

 Participants in Derivatives Market

1. Hedger: A hedger is a trader who enters the derivative market to reduce a pre- existing risk.
In India, most derivatives users describe themselves as hedgers and Indian laws generally
require the use of derivatives for hedging purposes only.5
2. Speculators: A speculators buy and sell derivatives to book the profit and not to reduce their
risk. They wish to take a position in the market by betting on future price volatility of an
asset. Speculators are attracted to exchange traded derivative products because of their high
liquidity, high leverage, low impact cost, low transaction cost and default risk behavior. 6 It is
the speculators who keep the market going because they bear the risks, which no one else is
willing to bear.
3. Arbitrageur: The third participant, arbitrageur is basically risk-averse and enters into the
contracts, having the potential to earn riskless profits.7 It is possible for an arbitrageur to have
riskless profits by buying in one market and simultaneously selling in another, when markets
are imperfect (long in one market and short in another market). Arbitrageurs fetch enormous
liquidity to the products which are exchange traded. The liquidity in-turn results in better
price discovery, lesser market manipulation and lesser cost of transaction.8
Hedgers, speculators and arbitrageurs all three must co-exist. In simple words, all the three type
of participants are required not only for the healthy functioning of the derivative market, but also
to increase the liquidity in the market. The market would become mere tools of gambling without
the hedgers, as they provide economic substance to the market.9 Speculators provide depth and
liquidity to the market. Arbitrageurs help price discovery and bring uniformity in prices.

5
https://rmoneyindia.com/research-blog-beginners/participants-derivatives-market/
6
https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/derivatives-market/
7
https://investinganswers.com/dictionary/a/arbitrageur
8
Supra Note 5
9
http://anandvijayakumar.blogspot.com/2012/01/participants-in-derivative-market.html
 Classification of Derivatives Market
Derivative markets can broadly be classified as:
1. Commodity Derivative Market
2. Financial Derivative Market
As the name suggest, commodity derivatives markets trade contracts for which the underlying
asset is a commodity. It can be an agricultural commodity like wheat, soybeans, rapeseed, cotton,
etc. or precious metals like gold, silver, etc. 10 Financial derivatives markets trade contracts that
have a financial asset or variable as the underlying. The more popular financial derivatives are
those which have equity, interest rates and exchange rates as the underlying.11 The most
commonly used derivatives contracts are forwards and futures which are based on the time of
completion of obligation.

 The Regulatory Framework for Derivatives

Securities Contract (Regulation) Act, 1956 (SCRA) is enacted to prevent undesirable transactions
in securities. Section 2(d) of the SCRA expressly defines “option in securities” to mean a
contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in
future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in
securities.12 The definition makes it clear that it is not the contract for sale of securities but a
contract for sale of a right to sell securities in future.
The Central Government vide Notification dated 27/6/1969 (1969 Notification) issued under
Section 16 of the SCRA (which empowers the Central Government to prohibit certain contracts
in specified securities), had prohibited all kinds of contracts for sale or purchase of securities
except spot delivery contract or contract for cash or hand delivery or special delivery in any
security under SCRA. Any other contract could only be entered into with the permission of the
Central Government. The 1969 Notification sought to restrict forward contracts. In 2000, the
1969 Notification was rescinded.
Securities Laws Amendment Act 1999 with effect from 22/2/2000 amended the definition of
“securities” in SCRA to include “derivatives”.13
10
https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/derivatives/
11
https://www.indianivesh.in/kb-blog/types-of-derivatives
12
https://www.moneycontrol.com/glossary/options-and-futures/what-is-the-regulatory-framework-of-derivatives-
marketsin-india_2003.html
13
Rajani B Bhatt and V. N. Suresh, “Decisive Scrutiny of Regulatory Framework for Derivatives Products in Indian
It inserted the definition of “derivatives” which reads:
“Derivative” includes –
a) a security derived from a debt instrument, share, loan whether secured or unsecured, risk
instrument or contract for differences or any other form of security;
b) a contract which derives its value from the prices, or index of prices, of underlining
securities. By the aforesaid amendment, section 18A was inserted in SCRA providing that
a derivative contract shall be valid if they are settled in the stock exchange.
Thus, the enactment of Securities Law (Amendment) Act, 1999 and repeal of the 1969
notification provided a legal framework for securities based derivatives on stock exchanges in
India, which is coterminus with framework of trading of other securities allowed under the Act.
Derivatives are not commodities, or stocks but are a special class of securities under the Act. 14
The Act also clarified that, notwithstanding anything contained in any other law for the time
being in force, contracts in derivatives shall be legal and valid only if such contacts are traded on
a recognized stock exchange and settled on a clearing entity of the recognized stock exchange in
accordance with the rules and bye-laws of such stock exchange.15

2. FORWARD DERIVATIVES
A forward contract is an agreement between two parties – a buyer and a seller to purchase or sell
something at a later date at a price agreed upon today. Forward contracts, sometimes called
Stock Market”, International Journal of Commerce Vol 8, 2020, pg 47.
14
Ms. Shalini H S1 and Dr. Raveendra P V, “A Study of Derivatives Market in India and its Current Position in
Global Financial Derivatives Markets”, IOSR Journal of Economics and Finance (IOSR-JEF)Volume 3, Issue 3, pg
38.
15
Smita Singh, “How Derivatives are regulated in India”, available at: https://blog.ipleaders.in/how-are-
derivativesregulated-in-india/.
forward commitments, are very common in everyone life. Any type of contractual agreement that
calls for the future purchase of a good or service at a price agreed upon today and without the
right of cancellation is a forward contract.16 Forward is just a contract to deliver at a future date
(exercise date or maturity date) at a specified exercise price. In forwards, no money changes at
the time of deal. At the time the forward contract is written, a specified price is fixed at which
asset is purchased or sold. This specified time is referred as delivery price.17
For Example: Suppose on January 1, 2012 an Indian textile exporter receives an order to supply
his product to a big retail chain in the US. Spot price of INR/US exchange rate is Rs. 45/dollar.
After six months, the exporter will receive $1 million (Rs 4.5 crore) for his products. Since all
his expenditure is in rupee term therefore he is exposed to currency risk. Let’s assume that his
cost of production is Rs. 4 crore. To avoid uncertainty, the exporter enters into a six-month
forward contract with a bank (with some fees) at Rs. 45 to a dollar. So the exporter is hedged
completely. If exchange rate appreciates to Rs. 35 after six months, then the exporter will receive
Rs. 3.5 crore after converting his $1 million and the rest Rs. 1 crore will be provided by the bank.
If exchange rate depreciates to Rs. 60/dollar then the exporter will receive Rs. 6 crore after
conversion, but has to pay Rs. 1.5 crore to the bank. So no matter what the situation is, the
exporter will end up with Rs. 4.5 crore.

Features of Forward Contract

The basic features of a forward contract are given in brief here as under:
 Bilateral: Forward contracts are bilateral contracts, and hence, they are exposed to
counter- party risk. More risky than futures: There is risk of non- performance of
obligation by either of the parties, so these are riskier than futures contracts.18
 Customized contracts: Each contract is custom designed, and hence, is unique in terms of
contract size, expiration date, the asset type, quality, etc.
 Long and short positions: In forward contract, one of the parties takes a long position by
agreeing to buy the asset at a certain specified future date. The other party assumes a
short position by agreeing to sell the same asset at the same date for the same specified

16
https://corporatefinanceinstitute.com/resources/knowledge/finance/forward-contract/
17
https://www.agiboo.com/commodity-knowledge-center/commodity-trade-risk-management/derivatives/
18
https://www.investopedia.com/articles/active-trading/102313/why-forward-contracts-are-foundation-all-
derivatives.asp
 price. A party with no obligation offsetting the forward contract is said to have an open
position. A party with a closed position is, sometimes, called a hedger.19
 Delivery price: The specified price in a forward contract is referred to as the delivery
price. The forward price for a particular forward contract at a particular time is the
delivery price that would apply if the contract were entered into at that time. It is
important to differentiate between the forward price and the delivery price. Both are
equal at the time the contract is entered into. However, as time passes, the forward price
is likely to change whereas the delivery price remains the same.
 Synthetic assets: In the forward contract, derivative assets can often be contracted from
the combination of underlying assets, such assets are often known as synthetic assets in
the forward market. The forward contract has to be settled by delivery of the asset on
expiration date. In case the party wishes to reverse the contract, it has to compulsorily go
to the same counter party, which may dominate and command the price it wants as being
in a monopoly situation. Pricing of arbitrage based forward prices: In the forward
contract, covered parity or cost-of-carry relations are relation between the prices of
forward and underlying assets. Such relations further assist in determining the arbitrage-
based forward asset prices.20

Basic terms used in Forward Contract

 Spot contract or cash contract: Contracts where delivery is made immediate within a
short settlement period.
 Spot market: Market where immediate buying and selling take place i.e. time ‘t’ between
selling and buying process is equal to zero and the price is known as spot price21.
 Delivery price: Quoted price in the forward process.
 Long position: The party who agrees to buy in the future is said to hold long position.
 Short position: The party who agrees to sell in the future is said to hold a short position.
 The underlying asset: Any asset in the form of commodity, security or currency that will

19
Times of India, “What are Forward Contracts?”, Sept 11,2017, available at:
https://timesofindia.indiatimes.com/business/faqs/market-faqs/what-are-forward-contracts/articleshow/domain
20
https://www.investopedia.com/articles/active-trading/102313/why-forward-contracts-are-foundation-all-
derivatives.asp
21
https://www.elearnmarkets.com/blog/forward-contract-definition-example-basics-risks.
 be bought and sold when the contract expires.22
 Future spot price: The spot price of the underlying asset when the contract expires.
 The forward price: It is the agreed upon price at which both the counter parties will
transact when the contract expires.

Pay Off from Forward Contract

The gain attained or the loss incurred by the holder of a forward contract at delivery date. In
general, the payoff from a long position in a forward contract (long forward contract) on one unit
of its underlying asset or commodity is23:
Payoff short position = ST - K
Where, ST is the spot price of the underlying at maturity of the contract and K is the delivery
price agreed in the contract. The holder of the long position is obligated to buy the underlying,
trading at sport price ST, for the delivery price K.
Conversely, the payoff from a short position in a forward contract (short forward contract) on
one unit of its underlying is: Payoff long position = K - ST. The holder of the short position is
obligated to sell the underlying, trading at sport price ST, for the delivery price K.

3. FUTURE DERIVATIVES
A futures contract is an agreement between a buyer and a seller where the seller agrees to deliver

22
https://www.investopedia.com/articles/active-trading/102313/why-forward-contracts-are-foundation-all-
derivatives.asp
23
http://www.financialencyclopedia.net/derivatives/tutorials/forward-contract-payoff.html
a specified quantity and grade of a particular asset at a predetermined time in futures at an agreed
upon price through a designated market under stringent financial safeguards. 24 A futures contract,
in other words, is an agreement to buy or sell a particular asset between the two parties in a
specified future period at an agreed price through specified exchange. For example, the S&P
CNX NIFTY futures are traded on National stock exchange. This provides them transparency,
liquidity, anonymity of trades and also eliminates the counter party risks due to the guarantee
provided by National Securities Clearing Corporation limited.25
The standardized items in any Futures contract are:
• Quantity of the underlying asset
• Quality of the underlying asset
• The date & month of delivery
• The units of price quotation & minimum change in price (tick size)26

Types of Future Derivatives

Depending on the type of underlying asset, there are different types of futures contract available
for trading:
Interest rate futures: Interest rate futures are traded on the NSC. These are futures based on
interest rates. In India, interest rates futures were introduced on August 31, 2009. In this case, the
underlying asset would be a debt obligation, debts that move in value according to changes in
interest rates (generally government bonds). Companies, banks, foreign institutional investors,
non-resident Indian and retail investors can trade in interest rate futures. 27 Buying an interest rate
futures contract will allow the buyer to lock in a future investment rate.

Foreign currency futures: They trade in the foreign currencies, thus also known as Exchange rate
futures. The MCX-SX exchange trades the following currency futures:
• Euro-Indian Rupee (EURINR),
• Us dollar-Indian rupee (USDINR),

24
https://www.investopedia.com/terms/f/futures.asp
25
Dr. Kamleshgakhar and Ms. Meetu, “Derivatives market in India: evolution, trading mechanism and future
prospects” available at: www.indianresearchjournals.com
26
Shilpi Sharma, :Everything you need to know about derivative trading”, available at:
https://medium.com/@shilpisharma717/everything-you-need-to-know-about-derivatives-trading-826b08b1c738
27
http://www.sharemarketschool.com/futures-types-of-contracts/
 • Pound Sterling-Indian Rupee (GBPINR) and
• Japanese Yen-Indian Rupee (JPYINR).

Stock index futures: Understanding stock index futures is quite simple if you have understood
individual stock futures. Here the underlying asset is the stock index. For example – the S&P
CNX Nifty popularly called the ‘nifty futures’. Stock index futures are more useful when
speculating on the general direction of the market rather than the direction of a particular stock.
It can also be used to hedge and protect a portfolio of shares. 28 So here, the price movement of an
index is tracked and speculated. One more point to note here is that, although stock index is
traded as an asset, it cannot be delivered to a buyer. Hence, it is always cash settled. Both
individual stock futures and index futures are traded in the NSE.

Bond index futures: These are based on particular bond indices, that is, indices of bond prices. As
we know that prices of debt instruments are inversely related to interest rates, so the bond index
is also related inversely to them.29 Example is the Municipal bond index futures based on US
Municipal bond that is traded on the Chicago board of trade (CBOT).

Cost of living index futures: This is also known as Inflation futures. These futures contracts are
based on a specified cost of living index, for example, consumer price index, wholesale price
index, etc. these futures can be used to hedge against the unanticipated inflation which cannot be
avoided. Hence such future contracts can be very useful to certain investors like provident funds,
pension funds, mutual funds, etc.30

Payoff of Future Derivatives

The payoff of futures contract on maturity depends on the spot price of the underlying asset at
the time of maturity and the price at which the contract was initially traded. There are two
positions that could be taken in futures contract31:
Long position: One who buys the asset at the future price take the long position. In general, the

28
https://www.agiboo.com/commodity-knowledge-center/commodity-trade-risk-management/derivatives/
29
Tatikonda, M.V. (1999), “An empirical study of platform and derivative product development projects”, Journal of
Product Innovation Management, Vol. 16, pp. 3-16.
30
https://www.elearnmarkets.com/blog/understanding-derivative-market/
31
https://ebrary.net/802/economics/payoff_futures_risk_profile.
payoff for a long position in a futures contract on one unit is ST-F where, F is the traded future
price and ST is the spot price of the asset at expiry of the contract. This is because the holder of
the contract is obligated to buy the asset.32
Short position: One who sells the asset at the future price takes the short position. In general the
payoff for the short position in a futures contract is F- ST Where, F is the traded future price and
ST is the spot price of the asset at expiry of the contract.33

4. DIFFERENCE BETWEEN FORWARD AND FUTURE DERIVATIVES

A forward contract is a customized contractual agreement where two private parties agree to

32
M. Rubani, “A Study of Derivative Market in India”, International Journal of Business Administration and
Management. ISSN 2278-3660 Volume 7, Number 1 (2017), page 201.
33
Dr. Kamleshgakhar and Ms. Meetu, “Derivatives market in India: evolution, trading mechanism and future
prospects” available at: www.indianresearchjournals.com.
trade a particular asset with each other at an agreed specific price and time in the future. Forward
contracts are traded privately over-the-counter, not on an exchange. A futures contract, often
referred to as futures — is a standardized version of a forward contract that is publicly traded on
a futures exchange. Like a forward contract, a futures contract includes an agreed upon price and
time in the future to buy or sell an asset — usually stocks, bonds, or commodities, like gold.
The main differentiating feature between futures and forward contracts — that futures are
publicly traded on an exchange while forwards are privately traded — results in several
operational differences between them.34 This comparison examines differences like counterparty
risk, daily centralized clearing and mark-to-market, price transparency, and efficiency. Some
other differences are as follows:
Definition
A forward contract is an agreement between two parties to buy or sell an asset (which can be of
any kind) at a pre-agreed future point in time at a specified price. Whereas, a futures contract is a
standardized contract, traded on a futures exchange, to buy or sell a certain underlying
instrument at a certain date in the future, at a specified price.35

Structure & Purpose

Forwards are customized to customer needs. Usually no initial payment required. Usually used
for hedging. Whereas Future are Standardized. Initial margin payment required. Usually used for
speculation.36

Transaction method
Forwards are Negotiated directly by the buyer and seller Whereas, Futures are Quoted and traded
on the Exchange.

Risk
Forward contracts are subject to counterparty risk, which is the risk that the party on the other
side of the trade defaults on their contractual obligation. Whereas in futures exchange's

34
https://www.motilaloswal.com/blog-details/Know-the-Difference-between-Forward-and-Futures-Contract/1079
35
https://www.diffen.com/difference/Forward_Contract_vs_Futures_Contract
36
https://keydifferences.com/difference-between-forward-and-futures-contract.html
clearinghouse guarantees transactions, thereby eliminating counterparty risk in futures contracts.
Of course, there is the risk that the clearinghouse itself will default, but the mechanics of trading
are such that this risk is very low.37

Closing a Position
To close a position on a futures trade, a buyer or seller makes a second transaction that takes the
opposite position of their original transaction. In other words, a seller switches to buying to close
his position, and a buyer switches to selling. For a forward contract, there are two ways to close a
position — either sell the contract to a third party, or get into a new forward contract with the
opposite trade.38

5. AREAS FOR FURTHER IMPROVEMENT OF DERIVATIVE MARKET

Derivatives markets generally are an integral part of capital markets in developed as well as in
37
https://www.motilaloswal.com/blog-details/Know-the-Difference-between-Forward-and-Futures-Contract/1079
38
https://keydifferences.com/difference-between-forward-and-futures-contract.html
emerging market economies. These instruments assist business growth by disseminating
effective price signals concerning exchange rates, indices and reference rates or other assets and
thereby render both cash and derivatives markets more efficient. These instruments also offer
protection from possible adverse market movements and can be used to manage or offset
exposures by hedging or shifting risks particularly during periods of volatility thereby reducing
costs.39 By allowing for the transfer of unwanted risk, derivatives can promote more efficient
allocation of capital across the economy, increasing productivity in the economy.
The present regulatory framework in India is based on the L.C. Gupta committee report on
derivatives and J.R. Varma group reports on risk containment measures for derivatives products.
The L.C. Gupta committee report provided a perspective on division of regulatory responsibility
between the exchange and SEBI. It recommended that SEBI’s role should be restricted to
approving the rules, bye-laws and regulations of derivatives exchange and approval of proposed
derivatives contracts before commencement of trading.40 However despite the committee’s
reforms, there are still certain areas where there is scope for improvement. Some of these are
mentioned below.
1. Strengthening of financial infrastructure
While the Indian regulatory framework for derivatives is mostly consistent with the international
practices, some elements of financial infrastructure need to be strengthened. Like the bankruptcy
and insolvency laws should clearly prescribe providing due concern to rights of securities
holders on winding up or on insolvency of intermediaries and multilateral netting procedures.41
2. Declaring transactions in derivatives as non-speculative
There are no specific tax provisions for derivatives transactions under the Income Tax Act, 1961.
However, some provisions have indirect relevance for derivatives transactions. Under section
73(1) of the Income Tax Act, 1961 any losses on speculative business are eligible for set off
against profits and gains of speculative business only, up to a maximum of eight years. The
section 43(5) of the Income Tax Act, 1961 defines a speculative transaction where the contract
for purchase or sale of any commodity, including share, is settled otherwise than by actual
delivery. In the absence of a specific provision regarding taxability of income from derivatives in

39
Dr. Kamleshgakhar and Ms. Meetu, “Derivatives market in India: evolution, trading mechanism and future
prospects” available at: www.indianresearchjournals.com.
40
https://www.marketsmedia.com/improvements-derivatives-market-reduce-clearing-risk-2/
41
Ashutosh vashishtha and Satish Kumar, “Development of Financial Derivatives Market in India”, International
Research Journal of Finance and Economics ISSN 1450-2887 Issue 37 (2010), pg. 35.
the Income Tax Act, 1961, it is apprehended that derivative contracts are treated as “speculative”
in nature and therefore, the losses, if any, will not be allowed to be set-off against any other
income of the assessee, but only speculative income, up to a maximum of eight years. However,
derivative contracts are not undertaken for purchase/sale of any commodity, stock or scrip, but
are a special class of securities under the SCRA. Derivatives contracts, particularly, the index
futures are always cash settled (because delivery of an index is impossibility). At least one of the
parties to a derivatives contract is a hedger or an arbitrageur. 42 Therefore, treating derivatives
transaction as speculative would amount to penalizing hedging transactions, which the securities
laws seek to promote. These must be taxed as normal business income or capital gains at the
option of the assessee. This would be fiscally more prudent since it would avoid arbitrary
exercise of discretion and possible resultant litigation.
3. Transparency of derivatives transactions and financial stability
The accounting practices for derivatives are not consistent across countries it is important that an
institution sufficiently describes the accounting treatment of its derivatives holdings. These
qualitative disclosures may include the methods used to account for derivatives, criteria for each
accounting method used (for example criteria for recognizing hedges), policies and procedures
followed for netting, as- sets and liabilities of derivatives transactions, methods used to
determine the fair value of traded and non-traded derivatives instrument, nature and justification
for reserves for valuation adjustments against instruments or portfolios. 43 In order that
disclosures are consistent with innovations in risk measurement and management techniques,
institutions should also make disclosures produced by their internal risk measurement and
management systems on their risk exposures and their actual performance in managing these
exposures.44

6. CONCLUSION
All markets face various kinds of risks. This has induced the market participants to search for
42
Ms. Shalini H S1 and Dr. Raveendra P V, “A Study of Derivatives Market in India and its Current Position in
Global Financial Derivatives Markets”, IOSR Journal of Economics and Finance (IOSR-JEF)Volume 3, Issue 3, pg
38
43
Supra note 39.
44
M. Rubani, “A Study of Derivative Market in India”, International Journal of Business Administration and
Management. ISSN 2278-3660 Volume 7, Number 1 (2017), page 208.
ways to manage risk. The derivatives are one of the categories of risk management tools. As this
consciousness about risk management capacity of derivatives grew, the markets for derivatives
developed. By allowing for the transfer of unwanted risk, derivatives can promote more efficient
allocation of capital across the economy, increasing productivity in the economy.
This market is embryonic, which is manifest from the low trading volumes compared with that of
developed capital economies. Still it is felt by market observers that contrary to the initial
promise derivatives never picked up. For this to happen SEBI has to address many issues.
Foremost is clarity on taxation and accounting front. The number of derivatives trading
exchanges should be increased. These instruments are designed to reallocate risks among market
participants in order to improve overall market efficiency. But while the new instruments create
new hedging opportunities, they also entail legal risks because the newer instruments tend to be
more difficult to understand and value than existing instruments and thus, more prone to
occasional large losses. Therefore, it is imperative that SEBI endeavors to create awareness about
derivatives and their benefits among investors. Further, due to its complex nature, tough norms
and high entry barriers, small investors are keeping away from derivative trading.
The Parliamentary Standing Committee on Finance in 1999 observed that because of the swift
movement of funds and technical complexities involved in derivatives transactions, there is a
need to protect small investors who may be lured by the sheer speculative gains by venturing into
futures and options. Pursuant to this object, the present threshold limit of Rs. 2 lakhs has been
prescribed for derivatives transactions. However, the contract size of Rs. 2 lakhs is not only high
but is also beyond the means of a typical investor. The heartening development in this regard is
that the Ministry of Finance has decided to halve the contract size from the current level of Rs. 2
lakhs per contract to Rs. 1 lakh and SEBI will decide when to introduce the reduced contracts.
Therefore, Derivatives bring vibrancy in capital markets and Indian investors can gain
immensely from them. Therefore, it is vital that necessary changes are brought in at the earliest.

BIBLIOGRAPHY
Books and Journals
• Ashutosh vashishtha and Satish Kumar, “Development of Financial Derivatives Market
in India”, International Research Journal of Finance and Economics ISSN 1450-2887
Issue 37.
• M. Rubani, “A Study of Derivative Market in India”, International Journal of Business
Administration and Management. ISSN 2278-3660 Volume 7, Number 1 (2017).
• Ms. Shalini H S1 and Dr. Raveendra P V, “A Study of Derivatives Market in India and its
Current Position in Global Financial Derivatives Markets”, IOSR Journal of Economics
and Finance (IOSR-JEF)Volume 3, Issue 3
• Rajani B Bhatt and V. N. Suresh, “Decisive Scrutiny of Regulatory Framework for
Derivatives Products in Indian Stock Market”, International Journal of Commerce Vol 8,
2020.
• Tatikonda, M.V. (1999), “An empirical study of platform and derivative product
development projects”, Journal of Product Innovation Management, Vol. 16.

Articles and Blogs

• Dr. Kamleshgakhar and Ms. Meetu, “Derivatives market in India: evolution, trading
mechanism and future prospects” available at: www.indianresearchjournals.com.
• http://anandvijayakumar.blogspot.com/2012/01/participants-in-derivative-market.html.
• https://www.elearnmarkets.com/blog/forward-contract-definition-example-basics-risks.
• https://www.elearnmarkets.com/blog/understanding-derivative-market.
• https://www.indianivesh.in/kb-blog/types-of-derivatives.
• https://www.investopedia.com/articles/active-trading/102313/why-forward-contracts-
arefoundation-all-derivatives.asp.
• https://www.motilaloswal.com/blog-details/Know-the-Difference-between-Forward-
andFutures-Contract/1079
• Shilpi Sharma, :Everything you need to know about derivative trading”, available at:
https://medium.com/@shilpisharma717/everything-you-need-to-know-about-
derivativestrading-826b08b1c738.
• Smita Singh, “How Derivatives are regulated in India”, available at:
 https://blog.ipleaders.in/how-are-derivatives-regulated-in-india.
• Times of India, “What are Forward Contracts?”, Sept 11,2017, available
at:https://timesofindia.indiatimes.com/business/faqs/market-faqs/what-are
forwardcontracts/articleshow/domain.

Websites
• http://www.ehow.com/info_8454326_advantages- disadvantages-forward-contracts.html.
• http://www.schuermaninsurance.com/futures/forward- contracts-vs-futures.asp.
• https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/derivatives/.
• https://corporatefinanceinstitute.com/resources/knowledge/trading-
investing/derivativesmarket/.
• https://investinganswers.com/dictionary/a/arbitrageur.
• https://keydifferences.com/difference-between-forward-and-futures-contract.html.
• https://rmoneyindia.com/research-blog-beginners/participants-derivatives-market/.
• https://www.agiboo.com/commodity-knowledge-center/commodity-trade-
riskmanagement/derivatives/.
• https://www.imf.org/external/pubs/ft/fd/2000/finder.pdf.
• https://www.moneycontrol.com/glossary/options-and-futures/what-is-the-
regulatoryframework-of-derivatives-markets-in-india_2003.html.