SCOPE OF FUTURES AND FORWARDS

Presented by :Sapna KumawatPoonam Pareek (R.I.E.T. , Bhankrota, Jaipur)

INDIAN FINANCIAL SYSTEM

The financial system is a broader term which brings under its fold the financial markets and financial institutions which supports the system.

INDIAN FINANCIAL SYSTEM

FINANCIAL INSTITUTIONS FINANCIAL

SERVICESFINANCIAL MARKETS

FINANCIAL INSTRUMENT

S

FINANCIAL MARKETS

•A Market is a place where buyers and sellers come together to exchange something

•Financial Markets are where financial Instruments/products are exchanged.

•A Financial Market is known by type of product traded in it

DIFFERENT FINANCIAL MARKETSFINANCIAL MARKET

CAPITAL MARKET

EQUITY MARKET

PRIMARY MARKET

SECONDARY MARKET

DERIVATIVES MARKET

DEBT MARKET

MONEY MARKET

DERIVATIVESIn the financial marketplace some instruments are regarded as

fundamentals, while others are regarded as derivatives.

Financial Marketplace

Derivatives Fundamentals

• Futures• Forwards• Options• Swaps

• Stocks • Bonds

PRODUCTS OF DERIVATIVES…….

Forwards•It is an agreement between two parties that call for the delivery of an asset on a specified future date at a price i.e. negotiated at the time of entering into contract.

Futures•It is a contract that call for the delivery of an asset on a specified future date at a price i.e. fixed at the outside.

Options• It is a contract which gives the

right to the buyer to transact on/before a future date at a price i.e. fixed at the outset. It imposes an obligation on the seller.

Swaps •It is a contractual agreement between two parties to exchange specified cash flows at predetermined points in time.

FORWARD CONTRACTSA Forward Contract is an agreement to buy or sell an asset on a specified date for a specified price.

Salient Features :1. They are bilateral Contracts and hence exposed to counter party

risk. 2. Each contract is custom designed, and hence is unique in terms of

contract size, expiration date and the asset type and quality.

3. The contract price is generally not available in public domain

4. On the expiration date, the contract has to be settled by delivery of the asset.

5. If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party, which often results in high prices being charged.

Currency forwards-Currency forward contracts are widely used by companies to manage foreign exchange risks.

Equity forward contracts-Through equity forward, the value of transactions that will occur in the future was set at this time, so as to overcome the risk

Commodity forwards-Commodity forward is a contract with the underlying asset in the form of commodities such as oil, metal, corn, and others.

Bond forwards-Bond forward almost similar to the equity forward, except that the bonds have a maturity date, so that forward contracts must expiration before the due date.

TYPES

LIMITATIONS

COUNTER PARTY RISK

ILLIQUIDITY

LACK OF CENTRALISATION OF TRADING

FUTURE CONTRACTS

Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded.

Salient FeaturesObligation to buy or sellStated quantityAt a specific priceStated date (Expiration Date)Marked to Market on a daily basis

TYPES OF FUTURES

COMMODITY FUTURES

FINANCIAL FUTURES

STOCK INDEX FURTURES

INTEREST RATE FUTURES

CU

RRENCY FUTURES

STOCK FUTURES

LIMITATIONS

It is subjected to margin calls.

Quantity and initial exposures in future contracts are very high.

When volatility is high, required more margin money to secure future contracts.

TRADING OF FUTURES

SPECULATORS - willing to take on risk in pursuit of

profit.

HEDGERS - transfer risk by taking a position in the

Derivatives Market.

ARBITRAGEUS- simultaneously purchase of securities in one market at a lower price and sale thereof in other market at a higher

price.

PARTICIPANTS

Forwards Contract Futures Contract

Structure

Customized to customers need.

Usually no initial payment

required.

Standardized initial margin

payment required.

Method of pre-

termination

Opposite contract with same or

different counterparty.

Counterparty risk remains while

terminating with different

counterparty.

Opposite contract on the

exchange.

Risk High counterparty risk Low counterparty risk

Market regulation Not regulated Government regulated market

Contract size

Depending on the transaction

and the requirements of the

contracting parties.

Standardized

Expiry date: Depending on the transaction Standardized

Transaction method:Negotiated directly by the buyer

and seller

Quoted and traded on the

Exchange

Guarantees:

None. It is very difficult to undo

the operation; profits and losses

are cash settled at expiry.

Both parties must deposit an

initial guarantee (margin). The

value of the operation is

marked to market rates with

daily settlement of profits and

losses.

Institutional

guaranteeThe contracting parties Clearing House

NEED OF FUTURES & FORWARDS

The derivatives market performs a number of economic functions:

1. Help in transferring risk.

2. Help in the discovery of future prices.

3. Catalyze entrepreneurial activity.

4. Increase the volume traded in market.

5. Increase savings and investment.

SCOPE OF FUTURE & FORWARDSSCOPE

FOREX MARKET

AS A RISK MANAGEMENT

PORTFOLIO MANAGEMENT

HEDGING

SPECULATION

COMMODITY MARKET

FOREX MARKET• In the forex market, there are brighter chances of introducing derivatives on a large scale.

• The necessary groundwork for the introduction of derivatives in forex market was prepared by a high-level expert committee appointed by the RBI.

• Few derivative products such as interest rate swaps, coupon swaps, currency swaps and fixed rate agreements are available on a limited scale.

• It is easier to introduce derivatives in forex market because most of these products are OTC products (Over-the-counter) and they arehighly flexible.

RISK MANAGEMENT TOOL

These provide a powerful tool for limiting risk that individuals & organisations face in the ordinary conduct of their businesses.

It can save costs & increase returns.

Index futures are basically derivate tools based on stock index. They are really the risk management tools.

PORTFOLIO MANAGEMENT

• Every investor in the financial area is affected by index fluctuations. Hence, risk management using index derivatives is of far more importance than risk management using individual security options.

• Moreover, Portfolio risk is dominated by the market risk, regardless of the composition of the portfolio. •Investors are more interested in using index-based derivative products rather than security based derivative products.

HEDGING TOOL

Derivatives are used to hedge risk against price movement in the market.

Hedgers seek to protect against price movement in the underlying asset in which they have an intrest.

It is technique to shift unwanted price-risk to others.

SPECULATION

Derivatives are traded with a view & objective of making profit.

Investors take position (either long or short) & assume risks to profit from fluctuations in prices.

Speculators may be either intraday traders or position traders. The former speculate on the price movements during one trading day, while the later attempt to gain keep their position for longer time period to gain from price fluctuations.

COMMODITY MARKETThe commodity derivatives deal with trading in all type of commodity available particularly commodity market.

The value of commodity futures generally depends upon the price movements of market.

Commodity futures are traded in agriculture as well as metals.

In India futures on Soyabean, Black pepper & Spices have been trading for long.

IMPACT OF FUTURES & FORWARDS ON FINANCIAL MARKETS

• Derivatives allow a more efficient distribution of individual risks and a related reduction of aggregate risk within an economy.

• Poor market transparency makes it difficult at present to give an adequate assessment of risk distribution.

• A high market concentration currently hinders the economically optimal allocation of risks, although it does not directly endanger the stability of the financial markets.

• The use of derivatives may change traditional incentive structures. This is mainly a theoretical phenomenon. In practice, various mechanisms help to deal with the incentive problems which could potentially increase risk.

GROWTH FACTORS OF FUTURES & FORWARDS

A. PRICE VOLATILITY

B. GLOBALISATION OF MARKETS

C. TECHNOLOGICAL ADVANCES

D. ADVANCES IN FINANCIAL THEORIES

CONCLUSIONIn the current scenario, investing in stock markets is a major challenge ever for professionals. Derivatives acts as a major tool for reducing the risk involved in investing in stock markets for getting the best results out of it.

Awareness about the various uses of derivatives can help investors to reduce risk and increase profits. Though the stock market is subjected to high risk, by using derivatives the loss can be minimized to an extent.

During 1995-2001, when derivatives were not introduced, turnover of cash market was 7853439.4 (Rs. In crores).

After introduced Derivatives, total turnover of cash market is 7071414.5 (Rs. In crores) till 2005-06, which is lesser than before introduction of derivatives.

In comparison of cash market (15778844 Rs. In crores), derivatives (48452670 Rs. In crores.) have 3 times more turnover.

There is a constant growth in derivatives started from Index futures to interest rate futures which was introduced recently.

QUERIES…???