7/27/2019 03. Derivatives

1/16

Financial risk management is not just atheoretical nicety; it is practical necessity.

Derivatives instruments dont createsurprise. They help minimize them(Risk)

7/27/2019 03. Derivatives

2/16

Discussion Points What are Derivatives: An IntroductionGlobal growth of DerivativesDomestic Derivatives MarketOverview of different types of derivatives Forwards( It is an agreement to buy or sell an asset at

a certain future time for certain price) Futures

Options Swaps

7/27/2019 03. Derivatives

3/16

A derivative is a financial /non financialinstrument whose value is derived fromunderlying asset.Is has no independent value. It has to bederived from underlying asset.The underlying assets could be financialinstruments, share price index, metals,agricultural products, oil price, interest rateetc.

7/27/2019 03. Derivatives

4/16

Primarily of 2 kinds

Traded on Exchange (organized derivatives trading)

Traded on OTC (unorganized trading)

OTC is a generic term used for the market outside the exchange

7/27/2019 03. Derivatives

5/16

Futures trading in commodities is said to have originated in

Japan in 17th century for silk and rice.

The Dojima Rice Exchange in Osaka, Japan is said to be theworlds first organized futures exchange, where trading

started in 1710.

Chicago becomes a commercial hub in the 1840s. In 1848,the Chicago Board of Trade (CBOT) was established.

Chicago Mercantile Exchange was started in 1919.

7/27/2019 03. Derivatives

6/16

It is believed that commodity futures have existed in India for thousands of years. Kautilyas Arthashastra alludes to market operations similar tomodern futures markets.

1875 Bombay Cotton Trade Association.

1947 Bombay Forward Contracts control Act was enacted by BombayState.

1952 Forward contracts (Regulation) Act formed by Central Government.

1969 Forward Trading was Prohibited.

1994 Prof. K.N.Kabra Committee recommended the opening up of FuturesTrading in 17commodities .

7/27/2019 03. Derivatives

7/16

1996 UNCTAD and World Bank joint Mission Report India : ManagingPrice Risk in Indias Liberalised Agriculture: Can Futures Market Help?Highlighted the role of Futures Markets as market based instruments for managing risks and suggested the strengthening of institutional capacity of the Regulator and the exchanges for efficient performance of thesemarkets.

2000 National Agricultural Policy expressed support for commodityfutures.

2001 The Expert Committee on Strengthening and DevelopingAgricultural Marketing emphasized the need for and role of futures trading

in price risk management and in marketing of agricultural produce

7/27/2019 03. Derivatives

8/16

Commodity Derivatives are contracts where theunderlying asset is a commodity like oil, gold, metalsetc.

FCRA Forward Contract Regulation Act governsCommodity Derivatives in India (FMC)

Commodity exchangesNCDEX National Commodity and Derivativesexchange (mostly agri products are traded)MCX Multi Commodity Exchange (trading mostlybullion, metals and energy products)NMCE - agricultural products, Oils and metalsICEX - Metals and spices

7/27/2019 03. Derivatives

9/16

The National Stock Exchange of India Limited (NSE)commenced trading in derivatives with the launch of indexfutures on June 12, 2000. The futures contracts are based onthe popular benchmark S&P CNX Nifty Index.The Exchange introduced trading in Index Options (also

based on Nifty) on June 4, 2001. NSE also became the firstexchange to launch trading in options on individual securitiesfrom July 2, 2001. Futures on individual securities wereintroduced on November 9, 2001. Futures and Options onindividual securities are available on 208 securities stipulated

by SEBI.

7/27/2019 03. Derivatives

10/16

The Exchange has also introduced trading inFutures and Options contracts based on CNX-IT,BANK NIFTY, and NIFTY MIDCAP 50 indices.

Since the launch of the Index Derivatives on thepopular benchmark S&P CNX Nifty Index in 2000,the National Stock Exchange of India Limited(NSE) today have moved ahead with a variedproduct offering in equity derivatives. TheExchange currently provides trading in Futuresand Options contracts on 9 major indices and 226securities. The Exchange also introduced tradingin Mini Derivatives contracts to provide easieraccess for small investors to invest in Niftyfutures and options.

7/27/2019 03. Derivatives

11/16

A currency future , also known as FX future , is a futures contract toexchange one currency for another at a specified date in thefuture at a price (exchange rate) that is fixed on the purchasedate. On NSE the price of a future contract is in terms of INR perunit of other currency e.g. US Dollars. Currency future contractsallow investors to hedge against foreign exchange risk. CurrencyDerivatives are available on four currency pairs viz. US Dollars(USD), Euro (EUR), Great Britain Pound (GBP) and Japanese Yen(JPY). Currency options are currently available on US Dollars.NSE was the first exchange to have received an in-principleapproval from SEBI for setting up currency derivative segment. Theexchange launched its currency futures trading platform on 29thAugust, 2008. Currency futures on USD-INR were introduced for

trading and subsequently the Indian rupee was allowed to tradeagainst other currencies such as euro, pound sterling and the Japanese yen. Currency Options was introduced on October 29,2010.

7/27/2019 03. Derivatives

12/16

Value is derived from future interest rates

Underlying instrument is Interest Rate

Interest Rate derivatives (IRD) introduced on NSEfrom 2009, offers futures contracts on 10 YearNotional Coupon-bearing Government of India(GOI) security (10YGS7) and the recently introduced(2011) 91-day Government of India (GOI) TreasuryBill.

7/27/2019 03. Derivatives

13/16

Hedgers Framers, traders(Hedger is a personwhose objective is to reduce risk)Speculators- investors, fund managers(Risktakers)Arbitragers-(simultaneously trading in two orthree markets) investors, fund managers

7/27/2019 03. Derivatives

14/16

Risk ManagementPrice DiscoveryMarket efficiency

7/27/2019 03. Derivatives

15/16

Increase in Macroeconomic instability during the crisis of 1970s

Oil crisis of 1970s exposed the financial systems to the riskinherent in commodities

Collapse of Bretton Woods system that led to most currenciesadopting free-float exchange rate

Increased currency risk

Increased Globalization of Business Activities resulting inhigher foreign trade and a need for managing FX exposure

7/27/2019 03. Derivatives

16/16

CBOTCMELIFFE

SIMEX