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DERIVATIVES
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What are deri vati ves ?hat are deri vati ves ? Deri vat ive- is a product whosevalue is derived from the MORE
BASIC VARIABLE
These basic variable are called
UNDERLYING
Derivative is a security, the value
of which depends on the value of
another asset. The asset in which
its value depends is called the
underlying asset.
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underlyin g asse tnderlyin g asse t An underlyi ng asset is the asset
on which the price of a derivative
depends. Most traded derivatives
(i.e. those traded on exchanges) aresettled for cash FOR EXAMPLE- . equity, FOREX
commodity, or any other asset
Ex- say an agreement with your
neighbor for 2 bags of sugar next
week
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FEATURES OFFEATURES OF
DERIVATIVEDERIVATIVE
A SECURITY
CONTRACTUAL AGREEMENT
LOCK THE PRICE OF UNDERLYING
ASSETS
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TYPE OF DERIVATIVETYPE OF DERIVATIVE
MARKETMARKET
OTC DERIVATIVE MARKET
EXCHANGE TRADED DERIVATIVE
MARKET
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OTCOTC
OVER THE COUNTER MARKET
PRIVETLY NEGOTIATED
DERIVATIVE CONTRACT.
Self Regulatory Organization
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Types of deriv ativ eypes of deriv ativ econt ractsont racts
FORWARDS
FUTURES
OPTION
SWAPS
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Forward contracts..Forward contracts..
Agreement to buy and sell an assets onspecified date on specified price
LONG P OSITIO N- The party agreeing tobuy the underlying asset in the futureassumes a long position
SHOR T PO SIT ION - the party agreeingto sell the asset in the future assumes ashort position.
DELIVERY P RICE- The price agreedupon is called the delivery price OR
forward price.
http://en.wikipedia.org/wiki/Long_positionhttp://en.wikipedia.org/wiki/Short_positionhttp://en.wikipedia.org/w/index.php?title=Delivery_price&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Delivery_price&action=edit&redlink=1http://en.wikipedia.org/wiki/Short_positionhttp://en.wikipedia.org/wiki/Long_position8/14/2019 Derivatives Anu
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FeatureFeature
Bilateral contract Customization not standardize
Private agreement
Settlement by delivery of theproduct
if party wish to reverse the contract
then he has to contract with thesame counter party which resulthigh price
Weakness- centralization,Illiquidity, counter-party risk
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Futures contracts..Futures contracts..
Futures contracts areFutures contracts are organised/ standar dis edrganised/ standar dis edcont ract s (ont ract s ( quantity, quality, time, unit of pricequantity, quality, time, unit of pricequotation & minimum price change, location)quotation & minimum price change, location)
These contracts, being standardised andThese contracts, being standardised and traded onraded onthe ex change she ex change s are veryare very liquidiquid in nature.in nature.
In futures market,In futures market, clearing cor porati on/ hous elearing cor porati on/ hous eprov ides th e s ettlement guar anteerov id es th e s ettlement guar antee ..
Every futures contract is a forward contract.Every futures contract is a forward contract.
As with options, almost all futures traded onAs with options, almost all futures traded onexchanges areexchanges are settled by paymentettled by payment of their valueof their valueon the day they expire rather than by delivery of theon the day they expire rather than by delivery of the
underlying assetunderlying asset..
Require margin payment
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Forward / FuturesForward / Futures
ContractsContractsFeatures Forward Contract Futures ContractOperationalMechanism
Not traded onexchange
Traded on exchange
Contract
Specifications
Differ from trade to
trade.
Contracts are standardised
contracts.
Counterparty Risk Exists Exists, but assumed by
Clearing Corporation/house.
Liquidation Profile Poor Liquidity as
contracts are tailor
maid contracts.
Very high Liquidity as
contracts are standardised
contracts.
Price Discovery Poor; as markets arefragmented.
Better; as fragmentedmarkets are brought to the
common platform.
INTEREST RATE
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INTEREST RATEINTEREST RATE
FUTUREFUTURE
WHAT AR E INTER EST RATE FU TUR ES? Buying an interest rate futur es contract
allows the buyer of the contract to lock in afuture investment rate; not a borrowing rate asmany believe. Interest rate futures are based off
an underlying securitywhich is a debt obligationand moves in value as interest rates change.
When interest rates move higher, the buyer ofthe futures contract will pay the seller in anamount equal to that of the benefit received by
investing at a higher rate versus that of the ratespecified in the futures contract. Conversely,when interest rates move lower, the seller of thefutures contract will compensate the buyer forthe lower interest rate at the time ofexpiration.
http://www.mysmp.com/options/underlying-security.htmlhttp://www.mysmp.com/futures/futures-contract.htmlhttp://www.mysmp.com/options/options-expiration-week.htmlhttp://www.mysmp.com/options/options-expiration-week.htmlhttp://www.mysmp.com/futures/futures-contract.htmlhttp://www.mysmp.com/options/underlying-security.htmlhttp://www.mysmp.com/options/underlying-security.html8/14/2019 Derivatives Anu
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Option..Option..
Option is a right given by optionOption is a right given by option
seller to the option buyer to buy orseller to the option buyer to buy or
sell a specific asset at a specificsell a specific asset at a specificprice on or before a specific date.price on or before a specific date.
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Option..Option..
Call Option - Option to buy.Call Option - Option to buy.
Put Option - Option to sell.Put Option - Option to sell.
American Option - An optionAmerican Option - An optionwhich can be exercised anytimewhich can be exercised anytime
on or before the expiry date.on or before the expiry date.
European Option - An optionEuropean Option - An option
which can be exercised only onwhich can be exercised only on
expiry date.expiry date.
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Future & Option MarketInstruments
The F&O segment of NSE provides trading
facilities for the following derivative
instruments:2. Index based futures
3. Index based options
4. Individual stock options
5. Individual stock futures
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Hedgers - Operators, who want to transfer a
risk component of their portfolio.
Speculators - Operators, who intentionally
take the risk from hedgers in pursuit of profit.
Arbitrageurs - Operators who operate in the
different markets simultaneously, in pursuit ofprofit and eliminate mis-pricing.
Operators in the derivatives market
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SwapSwap
A Swap may be defined as"cash settledover the counte r d erivative ". TheSwaps are considered as the sim plest form of over-the-counter derivative or
OTC. Swap is considered as an
agreement, which takes place between
two contracting members whereby there
is exchange of"tw o streams o f cashflo w". The main factor, which is takeninto consideration, is that the values of
the exchanging assets should be equal.
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If an investor is entitled to get
returns from equities, instead of
liquidating the returns, the
investor may swap the returnsinto any financial instrument,
which involves less risk and that,
which yields flow of cash incomeon a fixed basis.
INVESTER
RETURN ON EQUITY
LIQUIDATE
SWAP
LESS RISKY
ASSETS