Derivatives market

PRESENTATION BY :

•SANDHANA AGHASTY C V•KARTHICK P• HARI KRISHNAN N•GANESH RAM J

•BALASUBRAMANIYAM S

• The term ‘Derivative’ stands for a contract whose price is derived from or is dependent upon an underlying asset.

• The underlying asset could be a financial asset such as currency, stock and market index, an interest bearing security or a physical commodity.

• The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset.

What is a “Derivative Market”?

The derivatives market performs a number of economic functions. They help in :

• Transferring risks

• Discovery of future as well as current prices

• Lower Transaction costs• Increasing saving and investments in long run.

Need for Derivatives

• Hedgers are those who buy or sell in derivatives market in order to reduce their risk of their portfolio.

• Speculators are those who enter into the market purely for making profit by buying or selling the derivatives, their only aim is to make profit based on their judgment about the stock or market.

• Arbitrage refers to obtaining risk free profits by simultaneously buying and selling similar instruments in different markets.

Participants in Derivative markets

• Over the Counter (OTC) derivatives are those which are privately traded between two parties and involves no exchange or intermediary.

• Non-standard products are traded in the so-called over-the-counter (OTC) derivatives markets.

• The Over the counter derivative market consists of the investment banks and include clients like hedge funds, commercial banks, government sponsored enterprises etc.

What is OTC (Over the counter)??

• A derivatives exchange is a market where individuals trade standardized contracts that have been defined by the exchange.

• 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 Market

• Spot Contract: An agreement to buy or sell an asset today.• Spot Price: The price at which the asset changes hands on

the spot date.

• Spot date: The normal settlement day for a transaction done today.

• Long position: The party agreeing to buy the underlying asset in the future assumes a long position.

• Short position: The party agreeing to sell the asset in the future assumes a short position

• Delivery Price: The price agreed upon at the time the contract is entered into.

Basic Terminologies

Classification of Derivatives

Future Contracts

Forward Contracts

Options

Swaps

• Forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today.

• For Example: If A has to buy a share 6 months from now. and B has to sell a share worth Rs.100. So they both agree to enter in a forward contract of Rs. 104. A is at “Long Position” and B is at “Short Position” Suppose after 6 months the price of share is Rs.110. so, A overall gained Rs. 4 but lost Rs. 6 while B made an overall profit of Rs. 6.

Forward Contract

The derivative in which counterparties exchange certain benefits of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of financial instruments involved. The types of Swaps are:

• Interest rate swaps

• Currency swaps

• Commodity swaps

• Equity Swap• Credit default swaps

• Futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today (the futures price or the strike price) with delivery occurring at a specified future date, the delivery date.

• Since such contract is traded through exchange, 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.

Futures Contract

• Contracts that give the holder the option to buy/sell specified quantity of the underlying assets at a particular price on or before a specified time period.

• The word “option” means that the holder has the right but not the obligation to buy/sell underlying assets.

Options

• Options are of two types – call and put

• Call option give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a particular date by paying a premium.

• Put option give the buyer the right, but not obligation to sell a given quantity of the underlying asset at a given price on or before a particular date by paying a premium.

Types of options

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