Looking for a Tutor Near You?

Post Learning Requirement »
x

Choose Country Code

x

Direction

x

Ask a Question

x

x
x
For better view click here
x
Hire a Tutor
DISCOVER

Derivatives And Its Types

Loading...

Published in: Banking & Finance | Commerce Subjects
4,310 Views

All About Derivatives. 

Arun K / Coimbatore

4 years of teaching experience

Qualification: M.Com (SNMV Cas - 1998)

Teaches: CA - CPT, CFP, Accountancy, Commerce Subjects, Costing, Economics, B.Com Tuition, Banking & Finance, BBA Subjects

Contact this Tutor
  1. What are Derivatives? A derivative is a financial instrument whose value is derived from the value of another asset, which is known as the underlying. When the price of the underlying changes, the value of the derivative also changes. A Derivative is not a product. It is a contract that derives its value from changes in the price of the underlying. Example : The value of a gold futures contract is derived from the value of the underlying asset i.e. Gold. Underlying Assets Crude Oil Precious Metals Interest Rates Agricultural Commodities Bonds Currency T-Bill Interest Rates Features of Derivatives Traded on Exchange All Transaction in derivatives take place in future specific date Hedging Device-Reduces Risk Derivatives are often leveraged, such that a small movement in the underlying value can cause a Large difference in the value of the derivative Types of Derivatives Contract Futures Forwards Options
  2. • Swap Forwards A forward contract is a customized contract between two entities, where settlement takes place as a specific date in the future at Predetermined price Forwards are also known as Private Contracts Normally traded outside exchange Features of forward contracts • They are bilateral contracts and hence, exposed to counterparty risk. Each contract is customer designed, and hence is unique in terms of contract sixe, expiration date and the asset type and quality. The contract price is generally not available in public domain. On the expiration date, the contract has to be settled by delivery of the asset and if party wishes to reverse the contract. Limitations of Forward contract Forward markets are facing many problems. They are: Lack of centralization of trading, Liquidity and Counterparty risk. The basic problem in the first two is that they have too much flexibility and generality. Counterparty risk arises from the possibility of default by any one party to the transaction. When one of the two sides to the transaction declares bankruptcy, the other suffers Futures Future contract is an agreement between two parties to buy or sell an asset at a certain time in the future, at a certain price. But unlike forward contract futures contract are standardized and stock ex-changed traded.
  3. A Financial contract obligating the buyer to purchase an asset, (or the seller to sell an Asset), such as a physical commodity or a financial instrument, at a predetermined Future date and price. Some of the most popular assets on which futures Contracts are available are equity stocks, indices, Commodities and Currency For example: Sugar cane or wheat or cotton farmers may wish to have contracts to sell their harvest at a future date to eliminate the risk of change in price by that date. There are commodity futures and financial futures. The standardized items in a futures contract are: Quantity of the underlying, Quality of the underlying, The date/month of delivery, The units of price quotation and minimum price change and Location of settlement. Important terms in future contract Spot price: The price at which an instrument/asset trades in the spot market. Future Price: The price at which the futures Contract trade in the future market. Contract cycle: The period over which a contract trades. The index futures contract typically have one month, two months and three months expiry cycles that expire on the last Thursday of the month. Expiry Date: It is date specified in future Contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist. Contract Size: The amount of the asset that has to be delivered under one contract. Basis: Basis is defined as the future price minus spot price. There will be difference basis for each delivery month for each contract. In the normal market, basis will be positive. This reflects that futures price normally exceeds spot price.
  4. Distinction between Forward and Future Contract S.No 1 2 3 4 Options Forward Contract Over the counter in nature Customized contract hence less liquidity No Margin Payment Settlement happens at the end of the period Future Contract Traded on exchange Standardized more liquidity organized contract, stock hence Requires Margin Payment Follows daily settlement American options can be exercised at any time up to the expiration date. European options can be exercised only on the expiration date itself.
  5. Types of Options Call option gives the holder the right to buy the underlying asset by a certain date for a certain price. Put option gives the holder the right to sell the underlying asset by a certain date for a certain price. The price in the contract is known as the exercise price or strike price. The date in the contract is known as the expiration date or maturity. There are four types of participants in options markets: 1. Buyers of calls 2. Seller of calls 3. Buyer of puts 4. Seller of puts Market Players Hedgers — Transfer of Risk component of their portfolio Speculators — Intentionally taking the risk from the Hedgers in pursuit of profit Arbitrageurs — Operating in different markets Simultaneously, in pursuit of profit and eliminate mis-pricing. In India, there are three type of derivatives are available: Segment Underlying Assets Exchange Regulator Equity Derivatives Future and Options Index Derivatives Stock Derivatives NSE / BSE SEBI Commodities Derivatives Futures Bullion - Gold, Silver Energy - Curde Oil, Natural Gas Base Metals - Aluminium, Copper, Currency Derivatives Futures USD - USD0110r EURO JPY - Japanese YEN GBR Great Britain Pound Zinc, Nickel Agri commodiites Cotton, Black Pepper, MCX /NCDEX SEBI / FMC Cardamom, NSE SEBI / RBI

Need a Tutor or Coaching Class?

Post an enquiry and get instant responses from qualified and experienced tutors.

Post Requirement

Related Study Notes

Upload Study Notes

If you have your own Study Notes which you think can benefit others, please upload on LearnPick. For each approved Study Note you will get 100 Credit Points and 100 Activity Score which will increase your profile visibility.

Upload Now
Home > Study Notes > Derivatives And Its Types