KONGU ENGINEERING COLLEGE

[An Autonomous Institution | Affiliated to Anna University, Chennai]

PERUNDURAI ERODE !"# $%&

EMERGING TRENDS IN FINANCIAL
DERIVATIVES
A Report Submitted by
ARULKUMAR. S
ARUN.V
ASHOKKING.R
[DEPARTMENT OF MANAGEMENT STUDIES]
EMERGING TRENDS IN FINANCIAL DERIVATIVES(Arulkumar,Arun,Ashokking) Pag
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CONCEPT OF FINANCIAL DERIVATIVES
At 'resent the Indian sto() mar)ets are not havin* any ris) hed*ed instruments that
+ould allo+ the investors to mana*e and minimi,e the ris)- In industriali,ed (ountries a'art
from money mar)et and (a'ital mar)et se(urities, a variety of other se(urities )no+n as
.derivatives/ have no+ 0e(ome availa0le for investment and tradin*-
1he derivatives ori*inate in mathemati(s and refer to a varia0le +hi(h has 0een derived
from another varia0le- A derivative is a finan(ial 'rodu(t +hi(h has 0een derived from another
finan(ial 'rodu(t or (ommodity- 1he derivatives do not have inde'endent e2isten(e +ithout
underlyin* 'rodu(t and mar)et- Derivatives are (ontra(ts +hi(h are +ritten 0et+een t+o 'arties
for a easily mar)eta0le assets-
Derivatives are also )no+n as deferred delivery or deferred 'ayment instruments- 3in(e
finan(ial derivatives (an 0e (reated 0y means of a mutual a*reement, the ty'es of derivative
'rodu(ts are limited only 0y ima*ination and so there is no definitive list of derivative 'rodu(ts-
UNDERLYING ASSET IN A DERIVATIVES CONTRACT
As defined a0ove, its value is entirely derived from the value of the underlyin* asset- 1he
underlyin* asset (an 0e se(urities, (ommodities, 0ullion, (urren(y, livesto() or anythin* else- In
other +ay the underlyin* asset may assume many forms4
Commodities in(ludin* *rain, (offee 0eans, oran*e 5ui(e-
Pre(ious metals li)e *old 6 silver-
7orei*n e2(han*e rates or (urren(ies-
8onds of different ty'es, in(ludin* medium to lon* term ne*otia0le de0t, se(urities
issued 0y *overnments, (om'anies et(-
3hares and share +arrants of (om'anies traded on re(o*ni,ed sto() e2(han*es and sto()
inde2-
3hort term se(urities su(h as 140ills-
Over the (ounter 9O1C: money mar)et 'rodu(ts su(h as loans or de'osits-
EMERGING TRENDS IN FINANCIAL DERIVATIVES(Arulkumar,Arun,Ashokking) Pag
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THE MAJOR PLAYERS OF DERIVATIVES MARKET
1here are three ma5or 'layers in the finan(ial derivatives tradin*;
1.Hedgers, 2.Speculators, 3.Ar!trageurs
FINANCIAL DERIVATIVES
1hose derivatives +hi(h are of finan(ial nature are (alled finan(ial derivatives- 1hey are
follo+in*;
7OR<ARD3
7U1URE3
OP1ION3
3<AP3
I" FORWARD CONTRACT
A for+ard (ontra(t is a (ustomi,ed (ontra(t 0et+een the 0uyer and the seller +here
settlement ta)es 'la(e on a s'e(ifi( date in future at a 'ri(e a*reed today- In (ase of a for+ard
(ontra(t the 'ri(e +hi(h is 'aid=re(eived 0y the 'arties is de(ided at the time of enterin* into
(ontra(t- It is sim'lest form of derivative (ontra(t mostly entered 0y individual in day to day life-
It is (ontra(t for deliverin* the *oods- It is also )no+n as >s'e(ifi( delivery (ontra(t?-
7or+ard (ontra(t is a (ash mar)et transa(tion in +hi(h delivery of the instrument is
differed until the (ontra(t has 0een made- Althou*h the delivery is made in the future, the 'ri(e is
determined on the initial trade date- One of the 'arties to a for+ard (ontra(t assumes a lon*
'osition 90uyer: and a*rees to 0uy the underlyin* asset at a (ertain future date for a (ertain 'ri(e-
1he other 'arty to the (ontra(t )no+n as seller assumes a short 'osition and a*rees to sell
the asset on the same date for the same 'ri(e- 1he (ontra(t terms li)e delivery 'ri(e and the
@uantity are mutually a*reed u'on 0y the 'arties to the (ontra(t- 7or+ard (ontra(ts are traded at
over4the4(ounter and are not dealt +ith on an e2(han*e- Usually traded 0et+een t+o finan(ial
institutions or 0et+een a finan(ial institution and one of its (lient- 1he 0asi( features of a (ontra(t
are *iven in 0rief here as under;
7or+ard (ontra(ts are 0ilateral (ontra(ts, and hen(e, they are e2'osed to the
(ounter 'arty ris)-
Ea(h (ontra(t is (ustom desi*ned, and hen(e, is uni@ue in terms of (ontra(t si,e,
e2'iration date, the asset ty'e, @uality et(-
EMERGING TRENDS IN FINANCIAL DERIVATIVES(Arulkumar,Arun,Ashokking) Pag
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1he s'e(ified 'ri(e in a for+ard (ontra(t is referred to as the delivery 'ri(e- 1he
for+ard 'ri(e for a 'arti(ular for+ard (ontra(t at a 'arti(ular time is the delivery 'ri(e
that +ould a''ly if the (ontra(t +ere entered into at that time- It is im'ortant to
differentiate 0et+een the for+ard 'ri(e and the delivery 'ri(e- 8oth are e@ual at the time
the (onta(t is entered into- Ao+ever, as time 'asses, the for+ard 'ri(e is li)ely to (han*e
+hereas the delivery 'ri(e remains the same-
In the for+ard (ontra(t, derivative asset (an often 0e (ontra(ted from the
(om0ination of underlyin* assetsB su(h assets are often )no+n as syntheti( assets in the
for+ard mar)et-
In the for+ard mar)et, the (ontra(t has to 0e settled 0y delivery of the asset on
e2'iration date-
In a for+ard (ontra(t, (overed 'arty or (ost of (arry relations are relation 0et+een
the 'ri(es of for+ard and underlyin* assets-
7or+ard (ontra(t are very 'o'ular in forei*n e2(han*e mar)et as +ell as interest
rate 0earin* instruments-
II FUTURES CONTRACTS
7uture (ontra(ts are normally traded on an e2(han*e +hi(h sets the (ertain standardi,ed
norms for tradin* in futures (ontra(ts- 1he features of a futures (ontra(t may 0e s'e(ified as
follo+s;
7utures are traded only in or*ani,ed e2(han*es-
7utures (ontra(t re@uired to have standard (ontra(t terms-
7utures e2(han*e has asso(iated +ith (learin* house-
7utures tradin* re@uired mar*in 'ayment and daily settlement-
7utures 'ositions (an 0e (losed easily-
7utures mar)ets are re*ulated 0y re*ulatory authorities li)e 3E8I-
1he futures (ontra(ts are e2e(uted on e2'iry date-
1he futures 'ri(es are e2'ressed in (urren(y units, +ith a minimum 'ri(e
movement (alled a ti() si,e-
1here are different ty'es of (ontra(ts in finan(ial futures +hi(h are traded in the various
futures mar)et of the +orld- 1he follo+in*s are the im'ortant ty'es of finan(ial futures (ontra(t;
3to() future or e@uity futures
EMERGING TRENDS IN FINANCIAL DERIVATIVES(Arulkumar,Arun,Ashokking) Pag
$
3to() inde2 futures
Curren(y futures
Interest rate futures
III OPTIONS CONTRACT
O'tions are derivative (ontra(t that *ive the ri*ht, 0ut not the o0li*ation to either 0uy or
sell a s'e(ifi( underlyin* se(urity for a s'e(ified 'ri(e on or 0efore a s'e(ifi( date- In theory,
o'tion (an 0e +ritten on almost any ty'e of underlyin* se(urity- E@uity 9sto(): is the most
(ommon, 0ut there are also several ty'es of non4e@uity o'tions, 0ased on se(urities su(h as
0onds, forei*n (urren(y, indi(es or (ommodities su(h as *old or oil-
1he 'erson +ho 0uys an o'tion is normally (alled the 0uyer or holder- Conversely, the
seller is )no+n as the seller or +riter- A*ain +e (an say >An o'tion is a 'arti(ular ty'e of a
(ontra(t 0et+een t+o 'arties +here one 'erson *ives the other 'erson the ri*ht to 0uy or sell a
s'e(ifi( asset at a s'e(ified 'ri(e +ithin a s'e(ified time 'eriod-? 1oday, o'tions are traded on a
variety of instruments li)e (ommodities, finan(ial assets as diverse as forei*n e2(han*e, 0an)
times de'osits, treasury se(urities, sto(), sto() inde2es, 'etroleum 'rodu(ts, food *rains, metals
et(-
1he main (hara(teristi(s of o'tions are follo+in*;
O'tions holders do not re(eive any dividend or interest-
O'tion yield only (a'ital *ains-
O'tions holder (an en5oy a ta2 advanta*es-
O'tions are traded on O1C and in all re(o*ni,ed sto() e2(han*es-
O'tions holders (an (ontrol their ri*hts on the underlyin* assets-
O'tions (reate the 'ossi0ility of *ainin* a +indfall 'rofit-
O'tions holder (an en5oy a mu(h +ider ris)4return (om0inations-
O'tions (an redu(e the total 'ortfolio transa(tion (osts-
O'tions ena0le +ith the investors to *ain a 0etter returns +ith a limited amount of
investment-
A (all +hi(h is the ri*ht to 0uy shares under a ne*otia0le (ontra(t and +hi(h do not (arry
any o0li*ation- 1he 0uyers have the ri*ht to re(eive the delivery of assets are )no+n as .(all
o'tion-/
EMERGING TRENDS IN FINANCIAL DERIVATIVES(Arulkumar,Arun,Ashokking) Pag
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In this o'tion the o+ner has the ri*ht to sell the underlyin* asset under the ne*otia0le
(ontra(t- Put o'tion holder has the ri*ht to re(eive the 'ayment 0y surrenderin* the asset-
1he +riter of an o'tion is a sto() 0ro)er, mem0er or a se(urity dealer- 1he 0uyer of an
o'tion 'ays a 'ri(e de'endin* on the ris) of underlyin* se(urity and he as an investor or a dealer
or trader-
1he 0asi( features of o'tions or follo+in*s;
1he o'tion is e2er(isa0le only 0y the o+ner namely the 0uyer of the o'tion-
1he o+ner has limited lia0ility-
O+ners of o'tions have no votin* ri*hts and dividend ri*ht-
O'tions have hi*h de*ree of ris) to the o'tion +riters-
O'tions involvin* 0uyin* (ounter 'ositions 0y the o'tion sellers-
7le2i0ility in investors needs-
No (ertifi(ates are issued 0y the (om'any-
O'tions are 'o'ular 0e(ause they allo+ the 0uyer 'rofits from favora0le
movement in e2(han*e rate-
O'tions (an 0e (lassified into different (ate*ories li)e;
Call o'tions
Put o'tions
E2(han*e traded o'tions
O1C traded o'tions
Ameri(an o'tions
Euro'ean o'tions
Commodity o'tions
Curren(y o'tions
3to() o'tions
3to() Inde2 o'tions
EMERGING TRENDS IN FINANCIAL DERIVATIVES(Arulkumar,Arun,Ashokking) Pag
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I# SWAPS CONTRACT
A s+a' is an a*reement 0et+een t+o or more 'eo'le or 'arties to e2(han*e sets of (ash
flo+s over a 'eriod in future-
3+a's are a*reements 0et+een t+o 'arties to e2(han*e assets at 'redetermined intervals-
3+a's are *enerally (ustomerised transa(tions- 1he s+a's are innovative finan(in* +hi(h
redu(es 0orro+in* (osts, and to in(rease (ontrol over interest rate ris) and fore2 e2'osure- 1he
s+a' in(ludes 0oth s'ot and for+ard transa(tions in a sin*le a*reement-
3+a's are at the (entre of the *lo0al finan(ial revolution- 3+a's are useful in avoidin*
the 'ro0lems of unfavora0le flu(tuation in fore2 mar)et- 1he 'arties that a*ree to the s+a' are
)no+n as (ounter 'arties- 1he t+o (ommonly used s+a's are interest rate s+a's and (urren(y
s+a's-
Interest rate s+a's +hi(h entail s+a''in* only the interest related (ash flo+s 0et+een the
'arties in the same (urren(y-
Curren(y s+a's entail s+a''in* 0oth 'rin(i'al and interest 0et+een the 'arties, +ith the
(ash flo+s in one dire(tion 0ein* in a different (urren(y than the (ash flo+s in the o''osite
dire(tion-
CONCLUSION
7inan(ial derivatives have earned a +ell deserved and e2tremely si*nifi(ant 'la(e amon*
all the finan(ial instruments 9'rodu(ts:, due to innovation and revolutioni,ed the lands(a'e-
Derivatives are tool for mana*in* ris)- Derivatives 'rovide an o''ortunity to transfer ris) from
one to another- Caun(h of e@uity derivatives in Indian mar)et has 0een e2tremely en(oura*in*
and su((essful- 1he *ro+th of derivatives in the re(ent years has sur'assed the *ro+th of its
(ounter'art *lo0ally-
EMERGING TRENDS IN FINANCIAL DERIVATIVES(Arulkumar,Arun,Ashokking) Pag
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