Derivativves & risk management

YOGESH NAMDEO INGLE.MBA (FINANCE), NET (MANAGEMENT), Ph.D (WIP), G.D.C &A, NCMP.

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DERIVATIVES & RISK MANAGEMENT

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Contract Price is derived from or is dependent

upon an underlying asset.

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Underlying asset could be a financial asset such as

1. Currency 2. Stock and market index 3. An interest bearing security 4. Physical commodity

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Derivative contracts are also traded on –

1. Electricity2. Weather3. Temperature 4. Volatility

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According to the Securities Contract Regulation Act, (1956) the term “derivative” includes:

A security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security.

A contract which derives its value from the prices or index of prices of underlying securities. derivatives


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Types of Derivative Contracts

Forward Contracts Futures Contracts Options Contracts Swaps

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Forward Contracts

An agreement to buy or sell an asset on a specified date for a specified price.

Long position Short position Negotiated bilaterally by the parties to

the contract.

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Features of forward contracts Bilateral contracts Unique Not available in public domain Has to be settled

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Limitations of forward contracts

Lack of centralization of trading, Illiquidity Counterparty risk

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Introduction to Futures

Standardized and exchange traded Quantity of the underlying Quality of the underlying The date and the month of delivery The units of price quotation and

minimum price change Location of settlement

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Options Contracts

An option gives the holder of the option the right to do something in future. The holder does not have to exercise this right.

Purchase of an option requires an up-front payment.

Non linear or asymmetrical profit profiles

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Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/ writer.

Writer of an option: The writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.

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Two basic types of options

Call option It gives the holder the right but not the

obligation to buy an asset by a certain date for a certain price.

Put option A It gives the holder the right but not the

obligation to sell an asset by a certain date for a certain price.

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Swaps

Swaps are private agreements between two parties to exchange cash flows in the future.

The two commonly used swaps Interest rate swaps: These entail swapping only

the interest related cash flows between the parties in the same currency.

Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.

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Participants in a Derivative Market

Hedgers Speculators Arbitrageurs

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Distinction between Futures and Forwards

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Basic purpose of derivatives

The main purpose of derivatives is to transfer risk from one person or firm to another, that is, to provide insurance.

For example- If a farmer before planting can guarantee a

certain price he will receive, he is more likely to plant.

Derivatives improve overall performance of the economy

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Help yourself

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Business

Derivativves & risk management