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Introduction To Derivatives

Derivatives are financial products whose value is derived from an underlying asset such as equity, forex or commodities. The growth of derivatives is driven by increased market volatility, integrated financial markets, improved communication, and more sophisticated risk management tools. Common derivative products include forwards, futures, options, warrants, baskets, swaps, and swaptions. Participants in the derivatives market include hedgers who manage risk, speculators who take on risk, and arbitrageurs who exploit pricing inefficiencies.

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0% found this document useful (0 votes)
393 views7 pages

Introduction To Derivatives

Derivatives are financial products whose value is derived from an underlying asset such as equity, forex or commodities. The growth of derivatives is driven by increased market volatility, integrated financial markets, improved communication, and more sophisticated risk management tools. Common derivative products include forwards, futures, options, warrants, baskets, swaps, and swaptions. Participants in the derivatives market include hedgers who manage risk, speculators who take on risk, and arbitrageurs who exploit pricing inefficiencies.

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Rashwanth Tc
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INTRODUCTION TO

DERIVATIVES
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Derivatives defined

 Derivatives is a product whose


value is defined from the value of one or
more basic variables, called bases, in a
contractual manner. The underlying asset can
be equity, forex, commodity or any other
asset.

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Factors driving the growth of
derivatives
• Increased volatility in asset prices in
financial markets.
• Increased integration of national financial
markets with the international markets.
• Marked improvement in communication facilities
and sharp decline in their costs.
• Development of more sophisticated risk
management tools, providing economic agents
a wider choice of risk management
strategies.
• Innovations in the derivatives markets, which
optimally combine the risks and returns over
a large number of financial assets.
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Derivative products

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Forwards A forward contract is a customized contract between the
two entities, where settlement takes place on a specific
date in the future at today’s pre-agreed price.

Futures A futures contract is an agreement between two parties


to buy or sell an asset at a certain time in the future
at certain price.

Options Options are of two types. Call option and Put option.
Call option : Right to buy but not obligation to buy a
given quantity of the underlying asset, at a given price
on or before a given future date.
Put option : Right to sell but not obligation to sell a
given quantity of the underlying asset, at a given price
on or before a given future date.

Warrants Longer dated options are called warrants.

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LEAPS L ong-term E quity A nticipation S ecurities. These
options have a maturity of upto three years.
Baskets Basket options are options on portfolio of
underlying assets. The underlying asset is usually
a moving average of a basket of assets. Equity
index options are a form of basket options.

Swaps Swaps are the private agreements between the two


parties to exchange cash flows in the future
according to the pre arranged formula.
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 the
principal and interest between the parties, with
the cash flows in one directions being in a
different currency than those in the opposite
direction.

Swaptions Swaptions are options to buy or sell a swap that


will become operative at the expiry of options.
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Participants in the derivatives
market
The following three are the broad categories of

participants
• Hedgers.
• Speculators
• Arbitrageurs.

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