History of Derivative:The history of derivatives is quite colourful and surprisingly a lot longer than most people think. Forward delivery contracts, stating what is to be delivered for a fixed price at a specified place on a specified date, existed in ancient Greece and Rome. Roman emperors entered forward contracts to provide the masses with their supply of Egyptian grain. These contracts were also undertaken between farmers and merchants to eliminate risk arising out of uncertain future prices ofgrains. Thus, forward contracts have existed for centuries for hedging price risk. The first organized commodity exchange came into existence in the early 1700s in Japan. The first formal commodities exchange, the Chicago Board of Trade (CBOT), was formed in 1848 in the US to deal with the problem of credit risk and to provide centralised location to negotiate forward contracts. From forward trading in commodities emerged the commodity futures. The first type offuturescontract wascalledto arrive at. Trading infutures beganon the CBOT in the 1860s. In 1865, CBOT listed the first exchange traded derivatives contract, known as the futures contracts. Futures trading grew out of the need forhedgingthepriceriskinvolvedinmany commercialoperations. TheChicago Mercantile Exchange (CME), a spin-off of CBOT, was formed in 1919, though it did exist before in 1874 under the names of Chicago Produce Exchange (CPE) and Chicago Egg and Butter Board (CEBB). The first financial futures to emerge were the currency in 1972 in the US. The first foreign currency futures were traded on May 16, 1972, on International Monetary Market (IMM) a division of CME. Options are as old as futures. Their history also dates back to ancient GreeceandRome.Optionsareverypopularwithspeculatorsinthetulipcrazeofseventeenth century Holland. Tulips, the brightly coloured flowers, were a symbol of affluence; owing to a high demand, tulip bulb prices shot up. Dutch growers and dealers traded in tulip bulb options. There was so much speculation that people even mortgaged their homes and businesses. These speculators were wiped out when the tulip craze collapsed in 1637 as there was no mechanism to guarantee the performance of the option terms.The first call and put options were invented by an American financier, Russell Sage, in 1872. These options were traded over the counter. Options on shares were available in the US on the over the counter (OTC) market only until 1973 without much knowledge of valuation. A group of firms known as Put and Call brokers and Dealers Association was setupinearly1900stoprovideamechanismforbringingbuyersandsellers together.The market for futures and options grew at a rapid pace in the eighties and nineties. The collapse of the Brett on Woods regime of fixed parties and the introduction of floating rates for currencies in the international financial markets paved the way for development of a number of financial derivatives which served as effective risk management tools to cope with market uncertainties. History of Derivative in Pakistan:The Financial Derivatives Business Regulations have been formulated in exercise of the power derived by State Bank of Pakistan under Banking Companies Ordinance 1962 and Foreign Exchange Regulations Act 1947, to permit, regulate, and supervise financial institutions entering into derivative transactions.State Bank of Pakistan (SBP) is the supervisory authority for all banks and Development Finance Institutions (DFIs) engaging in Derivative Business. Financial institutions engaging in derivative business shall obtain the approval of the State Bank of Pakistan and be subject to the supervision and scrutiny of the State Bank of Pakistan.Derivative: As referred to in the Regulations means a type of financial contract the value of which is determined by reference to one or more underlying assets or indices. The major categories of such contracts include forwards, futures, swaps and options. Derivative also includes structured financial products that have one or more characteristics of forwards, futures, swaps and options.Types of Derivative:Following are the types of derivative; Forward contract Future contract Options Swap1. Forward Contact:Aforwardcontractisanagreementtobuyorsellanassetonaspecified foraspecifiedprice. One ofthepartiesto thecontractassumes along position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Othercontract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract.The forward contractsarenormallytraded outside the exchange.Forward Rate Agreement:A Forward Rate Agreement (FRA) is an over-the-counter agreement between two parties in which one party (the seller of the FRA) agrees to lend a specified amount of money for a specified period to the other party (the buyer of the FRA) in a specific currency at a fixed interest rate. In practice, actual lending or borrowing of the underlying principal does not take place; only interest rate is locked in. An FRA removes all uncertainty from cost of borrowing or rate of return on investment.Foreign Currency Forward:A foreign currency forward is an agreement between two parties to exchange some amount of one currency for another at a specified time in the future. The exchange rate is fixed at the time the contract is entered into. The market in which such forward transactions in foreign currencies are carried out is called forward exchange market. The cash flow in the foreign currency forwards takes place at the time of maturity.

2. Future Contract:Infinance,afutures contract isastandardizedcontract,tradedonafutures exchange, to buy or sell a certain underlying instrument at a certain date in the future,at apre-set price. Thefuture date iscalled thedeliverydateorfinal settlementdate. Thepre-set price iscalled thefutures price. The price of the underlying assets on the delivery date is called the settlement price.Afuturescontractgivestheholdertherightandtheobligationtobuyorsell, which differs from an options contract, which gives the buyer the right, but not the obligation, and the option writer (seller) the obligation, but not the right. To exit the commitment, the holder of a futures position has to sell his long position orbuy back his short position, effectively closing out the futures position and its contractobligations. Future contracts are exchange traded derivative. The exchange act as counterparty on all contracts set margin requirements.Interest Rate Future Contract:It is one of the significant financial futures instruments. Both borrowers and lenders face interest rate risk. The borrower, for example, has to notch up a heavy loss if the interest rate increases whereas the lender has to incur a loss in decreasing trend of interest rate. This instrument assists to reduce interest rate risk of lenders and borrowers. There are some interest-based securities like treasury bills, notes, bonds, debentures, euro-dollar deposits and municipal bonds.Foreign Currency Future:This kind of financial futures, as the name indicates, is traded in foreign currencies. Therefore it is also known as exchange rate futures. The rate of exchange changes continuously; different firms are exposed to the exchange rate risk. The assets, liabilities or cash flow of a firm undergo a change in value with the passage of time due to variation in exchange rates. So, exporters, importers, bankers, financial institutions and large companies use foreign currency futures as a hedge against the exchange rate risk. 3. Options:Aderivativetransactionthatgivestheoptionholdertherightbutnottheobligation to buy or sell the underlying asset at a price, called the strike price, during a period or on a specific date in exchange for payment of a premium is known as option. Underlying asset refers to any asset that is traded. The price at which the underlying is traded is called the strike price.There are two types of options i.e. Call Option and Put OptionCall Option:Acontractthatgivesitsownertherightbutnottheobligationtobuyanunderlying asset-stock or any financial asset, at a specified price on or before a specified date isknown as aCall option. The owner makes aprofit provided he sells at a higher current price and buys at a lower future price.Put Option:A contract that gives its owner the right but not the obligation to sell an underlying asset-stock or any financial asset, at a specified price on or before a specified date is known as aPut option. The owner makes a profit provided he buys at a lower current price and sells at a higher future price. Hence, no option will be exercised if the future price does not increase.Putandcallsarealmostalwayswrittenonequities,althoughoccasionallypreference shares, bonds and warrants become the subject of options. 4. Swap:Swapsaretransactionswhichobligatesthetwopartiestothecontracttoexchange a series of cash flows at specified intervals known as payment orsettlement dates. They can be regarded as portfolios of forward's contracts. A contract whereby two parties agree to exchange (swap) payments, based on some notional principle amount is called asa SWAP. In case ofswap, only the payment flows are exchanged and not the principle amount. The two commonly used swaps are; Interest Rate Swap:Interest rate swaps is an arrangement by which one party agrees to exchange his series of fixed rate interest payments to a party in exchange for his variable rate interest payments. The fixed rate payer takes a short position in the forward contract whereas the floating rate payer takes a long position in the forward contract.Currency Swap: Currency swaps is an arrangement in which both the principle amount and the interest on loan in one currency are swapped for the principle and the interest paymentsonloaninanothercurrency.Thepartiestothe swapcontractofcurrency generally hail from two different countries. This arrangement allows the counter parties to borrow easily and cheaply in their home currencies. Under a currency swap, cash flows to be exchanged are determined atthe spot rate at a time when swap is done. Such cash flows are supposed to remain unaffected by subsequent changes in the exchange rates. Financial Swap:Financialswapsconstituteafundingtechniquewhichpermitsaborrowertoaccess one market and then exchange the liability for another type of liability. It also allows the investors to exchange one type of asset for another type of asset with a preferred income stream.