JUN 3, 2020 By : ATHUL RAJEEV, VENTESKRAFT
In this blog we will go through about Derivatives. They are goods whose value derives from one or more fundamental variables known as underlying assets or foundation. We are, in a simplified way, financial security like an option or a future costs. Whose worth is in part derived from another an underlying asset’s value and characteristics.Derivatives are widely used for hedging. Some people use it to speculate as well, of course even though such speculation is prohibited in India.
In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the “underlying“. Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation or getting access to otherwise hard-to-trade assets or markets. Some of the more common derivatives include forwards, futures, options, swaps, and variations of these such as synthetic collateralized debt obligations and credit default swaps. Most derivatives are traded over-the-counter (off-exchange) or on an exchange such as the Chicago Mercantile Exchange, while most insurance contracts have developed into a separate industry. In the United States, after the financial crisis of 2007–2009, there has been increased pressure to move derivatives to trade on exchanges.
TYPES OF DERIVATIVE INSTRUMENTS:
Derivative contracts are of several types. The most common types are forwards, futures, options and swap.
A forward contract is a deal between two parties, a buyer and a seller to buy or sell something at a later date at a price negotiated today. Contracts forward, also called commitments forward, are very normal in any life.
A futures contract is a two-party deal-a buyer and a seller-to purchase or sell something at a future date. The touch is traded on a futures exchange and is subject to regular settlement. Future contracts have evolved from forward contracts, and they have many of the same features. Futures contracts deal in regulated exchanges, called future markets, as opposed to forward contracts. Future communications are often distinct from forward communications. Because they are subject to regular settlement. In the daily settlement, investors who suffer losses pay it to investors who make money every day.
Options are of two types – calls and puts.Calls deliver the buyer the proper but not the commitment to purchase a given amount of the basic resource, at a given cost on or some time recently a given future date. Puts deliver the buyer the correct, but not the commitment to offer a given amount of the fundamental resource at a given cost on or some time recently a given date.
Swaps are private arrangements between two parties to swap cash flows according to a pre-arranged arrangement in the future. They can be looked at as forward contract portfolios. The two derivatives which are widely used are interest rate derivatives and currency swaps.
1. Interest rate swaps: These involve swapping only the interest related cash flows between the parties in the same currency.
2. 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.
TYPES OF DERIVATIVES
It can be differentiated into several types. All the contracts are created and traded in two distinct financial markets, and hence are categorized as following based on the markets:
- EXCHANGE TRADED CONTRACT
- OVER THE COUNTER CONTRACT
Derivatives play an important role by enabling investors to pass it to others who do not want the risks associated with owning an asset. Because they are risk markets as opposed to physical assets, however, derivatives markets can be very risky places for unsophisticated investors. People who reduce their risk by entering a derivative market are called hedgers and speculators are called those who increase their risk.