ITM-SIA (Mumbai) - Derivatives (final)

DERIVATIVESGROUP MEMBERS

•Chirag Purohit•Diwanshu Sharma•Kalian Srinivasan•Kuber Mahajan•Navnath Pawar

Group D, Finance 12-14, ITM SIA Business School

DERIVATIVE DEFINITION :-

A Derivatives are agreements that derive their values on the basis of some asset called underlying asset.

BASICS:-

Derivative is a contract between two parties that specify conditions (especially the dates, resulting values & definitions of the underlying variables, the parties contractual obligations & the notional amt.) under which payments are to be made between the parties.


USES OF DERIVATIVESHedging:- Hedger are those who enter into derivative contract with objective of converting risk. Hedging is the practice of taking a position in one market to offset and balance against the risk adopted by assuming a position in a contrary or opposing market or investment.Speculation:- Speculators are those who enter into a derivative contract to make profit by assuming risk. Speculation is the practice of engaging in risky financial transactions in an attempt to profit from short or medium term fluctuations in the market value of a tradable good such as a financial instrument, rather than attempting to profit from the underlying financial attributes embodied in the instrument such as capital gains, interest, or dividends.

Arbitrage:- Arbitrageurs perform the function of making the prices in different markets converge and be in tandem with each other. They are conservative in nature and take riskless position and yet earn profit


TYPES OF DERIVATIVES

OVER THE COUNTER DERIVATIVE (OTC)• Where the contract is directly entered between two mutually

consenting parties with a matching needs that are known to each other are called Over-The- Counter (OTC) products

• These contracts are customized to requirement of counterparties and are normally settled by delivery of underlying assets.

• Forward and Swaps are example of OTC derivatives.

• OTC products give rise to another risk called counterparty risk concerned with failure of one of the parties to the contract to honour the obligation undertaken.


EXCHANGE TRADED DERRIVATES (ETD)

• Exchange Traded Derivatives are those derivatives instruments that are traded via specialized derivatives exchanges or other exchanges

• A derivatives exchange acts as an intermediary to all related transactions, and takes initial margin from both sides of the trade to act as a guarantee.

• Exchange traded derivatives are free from counterparty risk.

• They are standard products whose specification and characteristic of underlying assets is designed by the exchange authorities.


TYPES OF DERIVATIVE CONTRACTS

FORWARD CONTRACT :-A tailored contract between two parties, where payment takes place at a specific time in the future at today's pre-determined price. It is a non-standardised contract not regulated by stock exchange.

FUTURES :-

Future contracts are contracts to buy or sell an asset on or before a future date at a price specified today. It is a standard contract regulated by stock exchange.

OPTIONS :-Options are contracts that give the owner the right, but not the obligation, to buy (in the case of a call option) or sell (in the case of a put option) an asset. The price at which the sale takes place is known as the strike price, and is specified at the time the parties enter into the option.


WARRANTS :-

Apart from the commonly used short-dated options which have a maximum maturity period of 1 year, there exists certain long-dated options as well, known as Warrant (finance). These are generally traded over-the-counter.

SWAPS :-

Swaps are contracts to exchange cash (flows) on or before a specified future date based on the underlying value of currencies exchange rates, bonds/interest rates, commodities exchange, stocks or other assets.


FUTURE CONTRACTS :-FUTURE CONTRACT (more colloquially, futures) is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed upon today (the or strike price) with delivery and payment occurring at a specified future date.

While the futures contract specifies a trade taking place in the future, the purpose of the futures exchange institution is to act as intermediary and minimize the risk of default by either party. Thus the exchange requires both parties to put up an initial amount of cash, the margin. Additionally, since the futures price will generally change daily, the difference in the prior agreed-upon price and the daily futures price is settled daily also (variation margin). The exchange will draw money out of one party's margin account and put it into the other's so that each party has the appropriate daily loss or profit.


TYPES OF FUTURE CONTRACTSLONG POSITION (BULLISH VIEW) :-The long futures position is an unlimited profit, unlimited risk position that can be entered by the futures speculator to profit from a rise in the price of the underlying

SHORT POSITION (BEARISH VIEW) :-

The short futures position is an unlimited profit, unlimited risk position that can be entered by the futures speculator to profit from a fall in the price of the underlying


FUTURE CONTRACTSFuture contract is a standardized contract between 2 parties where the seller agrees to sell the asset to the buyer at a specified future for a price which is agreed upon today

Future contracts are available for fixed tenure of 1 2 or 3 months.

The Future contracts expire on the last Thursday of every month

The underlying asset or instrument, this could be anything from a barrel of crude oil to a short term interest rate.

A initial margin of 15% is required to be deposited with broker to enter into a future contract


SETTLEMENTS OF FUTURE CONTRACTSPHYSICAL DELIVERY :- The amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. They can pay, either by:- Cash for long position or Deliver shares for short position

CASH SETTLEMENT :- A cash payment is made based on the underlying reference rate or the closing value of a stock market index. The parties settle by paying/receiving the loss/gain related to the contract in cash when the contract expires.

OFFSET :- The investor can take short position to close the long position and vice-versa. For ex., He took long position but sold it in the middle i.e. taking short position



Merci...

ITM-SIA (Mumbai) - Derivatives (final)

Economy & Finance

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