DERIVATIVES

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12/18/12

Derivatives are financial contracts whose value is determined from the underlying assets.i.e.an asset which has no independent value but derives the value from the underlying asset. They allow the investors ,corporate and government to manage financial risk. The Derivatives are off balance sheet transactions as they are not 12/18/12

Importance of Derivatives

Acts as major risk management tool and they are used to minimise risk They separate risks and transfer them to parties who can bear them i.e. they manipulate risks* They provide hedging which is cheaper and more convenient in comparison to cash instrument* They are simple to operate as they 12/18/12 do not operate on daily basis

Forwards

Forwards are the oldest derivatives .It is an agreement between two parties where one promises to buy and the other agrees to sell at the price,date,quality and location agreed upon at the time of entering into the contract. The party that is buying is in the long position and the party that is selling in the short position 12/18/12

Features Of Forward Contract

1.Customized Contractsthey are private arrangement and are not standardised so they are flexible and can be modified 2 .It is private contract so no secondary market exists as they are not traded on stock exchange 3.No down Payment----since no money is paid at the time of 12/18/12 commencement of contract so

Futures

Futures are an important forward contracts They are standardized contracts and are legally enforceable and are always traded on organised exchange They are not required to pay any down payment but a certain % so as guarantee that the contract will be 12/18/12 honoured.It is called initial margin

Options

An option is a contract which gives the buyer or the holder the right to buy or sell underlying asset at a specified price on or before a specified time TERMS USED IN OPTION CONTRACT:Underlying: It refers to the asset for which option contract is undertaken Option Buyer/Holder: He is the 12/18/12 person who buys the option and pays

Swaps

A swap is a contract between two parties to deliver one sum of money against another sum of money at periodic interwals.For example :-A person borrows from a money lender against an asset and he receives the required money .Then he regularly pays interest and at maturity he pays the principal and gets backs the 12/18/12 assets. This is a swap contract. They

Features Of swap

Basically a forward contract so has all the features of it Two parties are required with equal and opposite wants .This has required the existence of intermediaries They are long term agreements as fixed interest are exchange for floating rates
12/18/12