Presentation by,

Ragumoorthy Nehrumoorthy

Indian History of Derivatives

The Bombay Cotton trade association started future
Trading in 1875
In 1952 the government banned cash settlement and
Option Trading
In 1995 a Prohibition of trading options was lifted
In 1999, the Securities Contract (Regulation) Act
of 1956 was amended and derivatives could be
Declared securities
NSE Started trade in future and option by 2005

Derivative is . . . .
A Derivative is a Financial Instrument whose
value depends on is derived from the value
of some other financial instrument, called the
underlying asset.
The value of derivative is linked to risk or volatility in
Either financial asset, transaction, market rate, or
contingency, and creates a product

Foreign Exchange
Rate
Interest Rates

Stocks

Underlying Assets

T-Bill

Agricultural
Commodities

Bonds

Crude Oil
Precious Metals

Features of Derivatives
Traded on Exchange
All Transaction in derivatives take place in future
specific date
Hedging Device-Reduces Risk
Derivatives are often leveraged, such that a small
movement in the underlying value can cause a
Large difference in the value of the derivative

Basic Purpose of Derivatives

In Derivative Transactions, one partys loss is always
another partys gain
The main purpose of derivatives is to transfer risk
from one person or firm to another, that is, to provide
insurance
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

Types of Derivatives Contract

Futures

Forwards

Swaps

Options

Futures
A Financial contract obligating the buyer to purchase an
asset, (or the seller to sell an Asset), such as a physical
commodity or a financial instrument, at a predetermined
Future date and price.
Some of the most popular assets on which futures
Contracts are available are equity stocks, indices,
Commodities and Currency

Margin accounts and

marking to market
Clearing Corporation requires initial deposits in a
margin account
Tracks daily gains and losses and posts these to margin
accounts
The contract is settled daily basis which is known as
Marking to Market

Practical View on Futures &

Clearing Corporation

Forwards
A forward contract is a customized contract between
two entities, where settlement takes place as a specific
date in the future at Predetermined price

Forwards are also known as Private Contracts

Normally traded outside exchange

Options
The owner of the option has option to sell or buy assets
at a given price on or before given date

American Option
An option that may be
exercised on any trading
Day on or before expiry

European Option
An option that may only be
exercised on expiry date

Important Concepts of Option

Options
Call Option a right to buy an asset at a predetermined
price (strike price) on or Before a specific date
If asset price is higher than the strike price
- Option is in the money
If asset price is exactly at the strike price
- Option is at the money
If asset price is below the strike price
- Option is out of the money
Obviously would not exercise an option that is out of
the money

Options
Put Option a right to sell and asset at a predetermined
Price on or before a specific date
If asset price is lower than the strike price
- Option is in the money
If asset price is exactly at the strike price
- Option is at the money
If asset price is higher than the strike price
- Option is out of the money

Swaps
Swaps are private agreement between two parties to
exchange cash flows in the future according to a
pre-arranged formula
They can be regarded as portfolio of forward contracts
The two commonly used Swaps are:
(i)Interest Rate Swaps : A interest rate swap entails swapping
only the interest related cash flows between the parties in the
same currency.
(ii) Currency Swaps : A currency swap is a foreign exchange
Agreement between two parties to exchange a given amount of
one currency for Another and after a specified period of time,
to give back the original Amount swapped.

Practical View on SWAPS

Types of Derivatives Markets

Over-the-Counter derivatives :
Contracts that are traded between two parties directly
without going through an exchange
Forward and Swap Contracts are OTC derivatives

Exchange-traded derivatives :
Contracts that are traded in derivatives exchanges

Market Players
Hedgers Transfer of Risk component of their portfolio
Speculators Intentionally taking the risk from the
Hedgers in pursuit of profit
Arbitrageurs Operating in different markets
Simultaneously, in pursuit of profit and eliminate
mis-pricing

Any Questions ?