rkmoon
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DERIVATIVES
A derivative is a financial contract that derives its value from another financial product/commodity (say spot rate) called underlying (that may be a stock, stock index, a foreign currency, a commodity). Forward contract in foreign exchange transaction, is a simple form of a derivative.
Objectives and instruments of derivates: The major purpose that is served by derivatives is to hedge the risk. Futures, forwards, options, swaps etc. are the common instruments of derivatives. The derivatives do not have any independent existent and are based on the underlying assets that could be a stock index, a foreign currency, a commodity or an individual stocks.
Operators in the derivative market : There are various kinds of operators in the derivative market such as hedgers (which manage the risk), the speculators (who undertake risk for realization of profit) and the arbitrageurs (who make purchase and sales simultaneously but in different market to take benefit of price differentials). The players in option market include development finance institutions, mutual funds, institutional investors, brokers, retail investors.
Components: The derivatives have components such as Options, Futures-forwards and Swaps.
Option It is contract that provides a right but does not impose any obligation to buy or sell a financial instrument, say a share or security. It can be exercised by the owner. Options offer the buyers, profits from favourable movement of prices say of shares or foreign exchange.
Variants of option: There are two variants of options i.e. European (where the holder can exercise his right on the expiry date) and American (where the holder can exercise the right, anytime between purchase date and the expiry date). It is important to note that option can be exercised by the owner (the buyer, who has the right to buy or sell), who has limited liability but possibility of realization of profits from favourable movement in the rates. Option writers on the other hand have high risk and they cover their risk through counter buying.
Components of options: Options have two components i.e. call option and put option. The owner’s liability is restricted to the premium he is to pay.
Call option : The owner i.e. the buyer, has the right to purchase and the seller has to obligation to sell, a specified no. of instruments say shares at a specified price during the time prior to expiry date.
Put option : Owner or the buyer has the right to sell and the seller has the obligation to buy during a particular period.
Futures and forwards
The futures are the contracts between sellers and buyers under which the sellers (termed ‘short’) have to deliver, a pre-fixed quantity, at a pre-fixed time in future, at a pre-fixed price, to the buyers (known as ‘long’). It is a legally binding obligation between two parties to give/take delivery at a certain point of time in future. The main features of a futures contract are that these are traded in organised exchanges, regulated by institutions such as SEBI, they need only margin payment on a daily basis. The future positions can be closed easily. Futures contract are made primarily for hedging, speculation, price determination and allocation of resources.
The forward on the other hand is a contract that is traded off-the-stock exchange, is self regulatory and has certain flexibility unlike future which are traded at stock exchange only, do not have flexibility of quantity and quality of commodity to be delivered and these are regulated by SEBI, RBI or other agencies.
Futures and options
Futures can also be distinguished from options because in futures, both the parties have to perform the contract and no premium is required to be paid by either party, where as in case of option, only the writer has to perform while the buyers makes payment of the premium to the seller in consideration for his performance. In addition, in futures the contract is to be performed on the settlement date and not before that whereas in case of option the buyer can exercise the option any time prior to the expiry date.
Credit derivatives
Credit derivatives are over the counter financial contracts (i.e. off-balance sheet) through which the transferor can transfer the credit risk to another party without actually selling the asset. It can be defined as a contract on the basis of which one party has to make payment to another party on the basis of performance of a specified underlying credit assets. In a credit derivative there are two parties i.e. protection seller and protection buyer.
Protection seller assumes the credit risk in consideration of premium that the protection buyer pays. Protection buyer on the other hand transfer the risk to the protection seller for a premium. Under the arrangement, the protection seller makes the payment to the protection buyer on credit event (such as failure to pay, insolvency, bankruptcy, repudiation, price decline etc. of the underlying asset) taking place
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A derivative is a financial contract that derives its value from another financial product/commodity (say spot rate) called underlying (that may be a stock, stock index, a foreign currency, a commodity). Forward contract in foreign exchange transaction, is a simple form of a derivative.
Objectives and instruments of derivates: The major purpose that is served by derivatives is to hedge the risk. Futures, forwards, options, swaps etc. are the common instruments of derivatives. The derivatives do not have any independent existent and are based on the underlying assets that could be a stock index, a foreign currency, a commodity or an individual stocks.
Operators in the derivative market : There are various kinds of operators in the derivative market such as hedgers (which manage the risk), the speculators (who undertake risk for realization of profit) and the arbitrageurs (who make purchase and sales simultaneously but in different market to take benefit of price differentials). The players in option market include development finance institutions, mutual funds, institutional investors, brokers, retail investors.
Components: The derivatives have components such as Options, Futures-forwards and Swaps.
Option It is contract that provides a right but does not impose any obligation to buy or sell a financial instrument, say a share or security. It can be exercised by the owner. Options offer the buyers, profits from favourable movement of prices say of shares or foreign exchange.
Variants of option: There are two variants of options i.e. European (where the holder can exercise his right on the expiry date) and American (where the holder can exercise the right, anytime between purchase date and the expiry date). It is important to note that option can be exercised by the owner (the buyer, who has the right to buy or sell), who has limited liability but possibility of realization of profits from favourable movement in the rates. Option writers on the other hand have high risk and they cover their risk through counter buying.
Components of options: Options have two components i.e. call option and put option. The owner’s liability is restricted to the premium he is to pay.
Call option : The owner i.e. the buyer, has the right to purchase and the seller has to obligation to sell, a specified no. of instruments say shares at a specified price during the time prior to expiry date.
Put option : Owner or the buyer has the right to sell and the seller has the obligation to buy during a particular period.
Futures and forwards
The futures are the contracts between sellers and buyers under which the sellers (termed ‘short’) have to deliver, a pre-fixed quantity, at a pre-fixed time in future, at a pre-fixed price, to the buyers (known as ‘long’). It is a legally binding obligation between two parties to give/take delivery at a certain point of time in future. The main features of a futures contract are that these are traded in organised exchanges, regulated by institutions such as SEBI, they need only margin payment on a daily basis. The future positions can be closed easily. Futures contract are made primarily for hedging, speculation, price determination and allocation of resources.
The forward on the other hand is a contract that is traded off-the-stock exchange, is self regulatory and has certain flexibility unlike future which are traded at stock exchange only, do not have flexibility of quantity and quality of commodity to be delivered and these are regulated by SEBI, RBI or other agencies.
Futures and options
Futures can also be distinguished from options because in futures, both the parties have to perform the contract and no premium is required to be paid by either party, where as in case of option, only the writer has to perform while the buyers makes payment of the premium to the seller in consideration for his performance. In addition, in futures the contract is to be performed on the settlement date and not before that whereas in case of option the buyer can exercise the option any time prior to the expiry date.
Credit derivatives
Credit derivatives are over the counter financial contracts (i.e. off-balance sheet) through which the transferor can transfer the credit risk to another party without actually selling the asset. It can be defined as a contract on the basis of which one party has to make payment to another party on the basis of performance of a specified underlying credit assets. In a credit derivative there are two parties i.e. protection seller and protection buyer.
Protection seller assumes the credit risk in consideration of premium that the protection buyer pays. Protection buyer on the other hand transfer the risk to the protection seller for a premium. Under the arrangement, the protection seller makes the payment to the protection buyer on credit event (such as failure to pay, insolvency, bankruptcy, repudiation, price decline etc. of the underlying asset) taking place
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