1. What are Derivative Instruments?

A derivative is an instrument whose value is derived from the value of one or more underlying, which can be commodities, precious metals,
currency, bonds, stocks, stocks indices, etc. Four most common examples of derivative instruments are Forwards, Futures, Options and
Swaps.

2. What are Forward Contracts?

A forward contract is a customized contract between two parties, where settlement takes place on a specific date in future at a price agreed
today. The main features of forward contracts are

 They are bilateral contracts and hence exposed to counter-party risk.

 Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality.
 The contract price is generally not available in public domain.
 The 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 being in a monopoly situation can
command the price it wants.

3. What are Futures?

Futures are exchange-traded contracts to sell or buy financial instruments or physical commodities for a future delivery at an agreed price.
There is an agreement to buy or sell a specified quantity of financial instrument commodity in a designated future month at a price agreed
upon by the buyer and seller. To make trading possible, BSE specifies certain standardized features of the contract.

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4. What is the difference between Forward Contracts and Futures Contracts?

Sr.No Basis Futures Forwards

1 Nature Traded on organized exchange Over the Counter

Contract
2 Standardized Customised
Terms
3 Liquidity More liquid Less liquid
Margin
4 Requires margin payments Not required
Payments
5 Settlement Follows daily settlement At the end of the period.
Can be reversed with any Contract can be reversed only with the same
6 Squaring off
member of the Exchange. counter-party with whom it was entered into.

5.Options: -
In finance, an option is a contract which conveys to its owner, the holder, the right, but not the obligation, to buy or sell
an underlying asset or instrument at a specified strike price on or before a specified date, depending on the style of the option. Options are
typically acquired by purchase, as a form of compensation, or as part of a complex financial transaction. Thus, they are also a form of asset
and have a valuation that may depend on a complex relationship between underlying asset value, time until expiration, market volatility, and
other factors. Options may be traded between private parties in over-the-counter (OTC) transactions, or they may be exchange-traded in live,
orderly markets in the form of standardized contracts.

Types of options: -
(a)Call Option
(b)Put Option

(a)Call Option: - Call options are contracts that give the owner the right to buy the underlying asset in the future at an
agreed price. You would buy a call if you believed that the underlying asset was likely to increase in price over a given
period of time.

(b) Put Option: - Put options are essentially the opposite of calls. The owner of a put has the right to sell the underlying
asset in the future at a pre-determined price. Therefore, you would buy a put if you were expecting the underlying asset to
fall in value.
6.Swaps: - A swap, in finance, is an agreement between two counterparties to exchange financial instruments or cashflows or
payments for a certain time. The instruments can be almost anything but most swaps involve cash based on a notional principal
amount.

Types of Swaps: -

There are 4 major types of swaps agreements

(a)  Interest rate swap

Counterparties agree to exchange one stream of future interest payments for another, based on a predetermined notional
principal amount. Generally, interest rate swaps involve the exchange of a fixed interest rate for a floating interest rate.

(b) Currency swap

Counterparties exchange the principal amount and interest payments denominated in different currencies. These contracts
swaps are often used to hedge another investment position against currency exchange rate fluctuations.

(c) Commodity swap

These derivatives are designed to exchange floating cash flows that are based on a commodity’s spot price for fixed cash flows
determined by a pre-agreed price of a commodity. Despite its name, commodity swaps do not involve the exchange of the actual
commodity.

(d)  Credit default swap

A CDS provides insurance from the default of a debt instrument. The buyer of a swap transfers to the seller the premium
payments. In case the asset defaults, the seller will reimburse the buyer the face value of the defaulted asset, while the asset will
be transferred from the buyer to the seller. Credit default swaps became somewhat notorious due to their impact on the 2008
Global Financial Crisis.