Derivatives Anu

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DERIVATIVES


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What are deri vati ves ?hat are deri vati ves ? Deri vat ive- is a product whosevalue is derived from the MORE

BASIC VARIABLE

These basic variable are called

UNDERLYING

Derivative is a security, the value

of which depends on the value of

another asset. The asset in which

its value depends is called the

underlying asset.
http://moneyterms.co.uk/underlying-asset/http://moneyterms.co.uk/underlying-asset/


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underlyin g asse tnderlyin g asse t An underlyi ng asset is the asset

on which the price of a derivative

depends. Most traded derivatives

(i.e. those traded on exchanges) aresettled for cash FOR EXAMPLE- . equity, FOREX

commodity, or any other asset

Ex- say an agreement with your

neighbor for 2 bags of sugar next

week
http://moneyterms.co.uk/derivatives/http://moneyterms.co.uk/derivatives/


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FEATURES OFFEATURES OF

DERIVATIVEDERIVATIVE

A SECURITY

CONTRACTUAL AGREEMENT

LOCK THE PRICE OF UNDERLYING

ASSETS


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TYPE OF DERIVATIVETYPE OF DERIVATIVE

MARKETMARKET

OTC DERIVATIVE MARKET

EXCHANGE TRADED DERIVATIVE

MARKET


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OTCOTC

OVER THE COUNTER MARKET

PRIVETLY NEGOTIATED

DERIVATIVE CONTRACT.

Self Regulatory Organization


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Types of deriv ativ eypes of deriv ativ econt ractsont racts

FORWARDS

FUTURES

OPTION

SWAPS


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Forward contracts..Forward contracts..

Agreement to buy and sell an assets onspecified date on specified price

LONG P OSITIO N- The party agreeing tobuy the underlying asset in the futureassumes a long position

SHOR T PO SIT ION - the party agreeingto sell the asset in the future assumes ashort position.

DELIVERY P RICE- The price agreedupon is called the delivery price OR

forward price.
http://en.wikipedia.org/wiki/Long_positionhttp://en.wikipedia.org/wiki/Short_positionhttp://en.wikipedia.org/w/index.php?title=Delivery_price&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Delivery_price&action=edit&redlink=1http://en.wikipedia.org/wiki/Short_positionhttp://en.wikipedia.org/wiki/Long_position


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FeatureFeature

Bilateral contract Customization not standardize

Private agreement

Settlement by delivery of theproduct

if party wish to reverse the contract

then he has to contract with thesame counter party which resulthigh price

Weakness- centralization,Illiquidity, counter-party risk


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Futures contracts..Futures contracts..

Futures contracts areFutures contracts are organised/ standar dis edrganised/ standar dis edcont ract s (ont ract s ( quantity, quality, time, unit of pricequantity, quality, time, unit of pricequotation & minimum price change, location)quotation & minimum price change, location)

These contracts, being standardised andThese contracts, being standardised and traded onraded onthe ex change she ex change s are veryare very liquidiquid in nature.in nature.

In futures market,In futures market, clearing cor porati on/ hous elearing cor porati on/ hous eprov ides th e s ettlement guar anteerov id es th e s ettlement guar antee ..

Every futures contract is a forward contract.Every futures contract is a forward contract.

As with options, almost all futures traded onAs with options, almost all futures traded onexchanges areexchanges are settled by paymentettled by payment of their valueof their valueon the day they expire rather than by delivery of theon the day they expire rather than by delivery of the

underlying assetunderlying asset..

Require margin payment
http://moneyterms.co.uk/underlying-asset/http://moneyterms.co.uk/underlying-asset/http://moneyterms.co.uk/underlying-asset/


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Forward / FuturesForward / Futures

ContractsContractsFeatures Forward Contract Futures ContractOperationalMechanism

Not traded onexchange

Traded on exchange

Contract

Specifications

Differ from trade to

trade.

Contracts are standardised

contracts.

Counterparty Risk Exists Exists, but assumed by

Clearing Corporation/house.

Liquidation Profile Poor Liquidity as

contracts are tailor

maid contracts.

Very high Liquidity as

contracts are standardised

contracts.

Price Discovery Poor; as markets arefragmented.

Better; as fragmentedmarkets are brought to the

common platform.

INTEREST RATE


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INTEREST RATEINTEREST RATE

FUTUREFUTURE

WHAT AR E INTER EST RATE FU TUR ES? Buying an interest rate futur es contract

allows the buyer of the contract to lock in afuture investment rate; not a borrowing rate asmany believe. Interest rate futures are based off

an underlying securitywhich is a debt obligationand moves in value as interest rates change.

When interest rates move higher, the buyer ofthe futures contract will pay the seller in anamount equal to that of the benefit received by

investing at a higher rate versus that of the ratespecified in the futures contract. Conversely,when interest rates move lower, the seller of thefutures contract will compensate the buyer forthe lower interest rate at the time ofexpiration.
http://www.mysmp.com/options/underlying-security.htmlhttp://www.mysmp.com/futures/futures-contract.htmlhttp://www.mysmp.com/options/options-expiration-week.htmlhttp://www.mysmp.com/options/options-expiration-week.htmlhttp://www.mysmp.com/futures/futures-contract.htmlhttp://www.mysmp.com/options/underlying-security.htmlhttp://www.mysmp.com/options/underlying-security.html


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Option..Option..

Option is a right given by optionOption is a right given by option

seller to the option buyer to buy orseller to the option buyer to buy or

sell a specific asset at a specificsell a specific asset at a specificprice on or before a specific date.price on or before a specific date.


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Option..Option..

Call Option - Option to buy.Call Option - Option to buy.

Put Option - Option to sell.Put Option - Option to sell.

American Option - An optionAmerican Option - An optionwhich can be exercised anytimewhich can be exercised anytime

on or before the expiry date.on or before the expiry date.

European Option - An optionEuropean Option - An option

which can be exercised only onwhich can be exercised only on

expiry date.expiry date.


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Future & Option MarketInstruments

The F&O segment of NSE provides trading

facilities for the following derivative

instruments:2. Index based futures

3. Index based options

4. Individual stock options

5. Individual stock futures


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Hedgers - Operators, who want to transfer a

risk component of their portfolio.

Speculators - Operators, who intentionally

take the risk from hedgers in pursuit of profit.

Arbitrageurs - Operators who operate in the

different markets simultaneously, in pursuit ofprofit and eliminate mis-pricing.

Operators in the derivatives market


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SwapSwap

A Swap may be defined as"cash settledover the counte r d erivative ". TheSwaps are considered as the sim plest form of over-the-counter derivative or

OTC. Swap is considered as an

agreement, which takes place between

two contracting members whereby there

is exchange of"tw o streams o f cashflo w". The main factor, which is takeninto consideration, is that the values of

the exchanging assets should be equal.


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If an investor is entitled to get

returns from equities, instead of

liquidating the returns, the

investor may swap the returnsinto any financial instrument,

which involves less risk and that,

which yields flow of cash incomeon a fixed basis.

INVESTER

RETURN ON EQUITY

LIQUIDATE

SWAP

LESS RISKY

ASSETS

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