DERIVATIVE

A derivative is a contract between two parties which derives its value/price from an underlying asset.

Definition: A derivative is a contract between two parties which derives its value/price from an underlying
asset. The most common types of derivatives are futures, options, forwards and swaps.

Description: It is a financial instrument which derives its value/price from the underlying assets. Originally,
underlying corpus is first created which can consist of one security or a combination of different securities. The
value of the underlying asset is bound to change as the value of the underlying assets keep changing
continuously.

OPTIONS
The right, but not the obligation, to buy (for a call option) or sell (for a put option) a
specific amount of a given stock, commodity, currency, index, or debt, at a specified price (the strike
price) during a specified period of time. For stock options, the amount is usually 100 shares. Each
option has a buyer, called the holder, and a seller, known as the writer. If the option contract is
exercised, the writer is responsible for fulfilling the terms of the contract by delivering the shares to
the appropriate party. In the case of a security that cannot be delivered such as an index, the contract
is settled in cash.

Definition of forward contract.

An agreement to sell a currency, commodity or other asset at a specified future date and at a
predetermined price. This may be the current price or exchange rate, or an agreed forward price/rate,
which would be at a discount or premium to the spot rate.

The butterfly spread is a neutral strategy that is a combination of a bull spread and a bearspread. It is a
limited profit, limited risk options strategy. There are 3 striking prices involved in a butterfly spread and
it can be constructed using calls or puts.

Candor spread
a condor is an options strategy that also has a bear and a bull spread, except that the strike
prices on the short call and short put are different.

The purpose of this option strategy is to earn limited profits, regardless of market
movements, with a small amount of risk.

Mark to market (MTM) is a measure of the fair value of accounts that can change over time, such as
assets and liabilities. Mark to marketaims to provide a realistic appraisal of an institution's or company's
current financial situation.

ARBITRAGE

Arbitrage is the market activity of buying and selling of same security on exchanges or between spot prices of
a security and its future contract.

Definition: Arbitrage is the profit making market activity of buying and selling of same security on different
exchanges or between spot prices of a security and its future contract. Here exchange refers to the stock market
where shares are traded, like the NSE and BSE.

Description: A stock is traded in multiple stock exchanges and on each stock exchange the quoting price may
be a bit different. Hence arbitrage as a practice is followed to take advantage of the price disparity. Originally
arbitrage occurred in the currency market, but now it applies equally in the commodity, futures and the stock
market as well.

For example: Infosys is quoting at Rs 2750 on the BSE and Rs 2760 on the NSE. Hence one can sell the stock
on the NSE and buy from the BSE at the same time. This trade will lead to a profit without any risk. This
process is arbitrage.

PUT CALL PARITY

Put-call parity is a principle that defines the relationship between the price
of European put options and European call options of the same class, that is, with the
same underlying asset, strike price and expiration date. Put-call parity states that
simultaneously holding a short European put and long European call of the same class
will deliver the same return as holding one forward contract on the same underlying
asset, with the same expiration and a forward price equal to the option's strike price. If the
prices of the put and call options diverge so that this relationship does not hold,
an arbitrage opportunity exists, meaning that sophisticated traders can earn a theoretically
risk-free profit. Such opportunities are uncommon and short-lived in liquid markets.
The equation expressing put-call parity is:

C + PV(x) = P + S

where:

C = price of the European call option

PV(x) = the present value of the strike price (x), discounted from the value on the
expiration date at the risk-free rate

P = price of the European put

S = spot price, the current market value of the underlying asset

INTREST RATE SWAP

An interest rate swap (IRS) is a liquid financial derivative instrument in which two parties agree to
exchange interest rate cash flows, based on a specified notional amount from a fixed rate to a
floating rate (or vice versa) or from one floating rate to another.

VOLATILITY SKEW DEFINITION:

Using the Black Scholes option pricing model, we can compute the volatility of the underlying by
plugging in the market prices for the options. Theoretically, for options with the same expiration date, we
expect the implied volatility to be the same regardless of which strike price we use

CURRENCY SWAP

A currency swap (or a cross currency swap) is a foreign exchange derivative between two institutions to
exchange the principal and/or interest payments of a loan in one currency for equivalent amounts, in net
present value terms, in another currency. Currency swaps are motivated by comparative advantage

SWAP
A swap is a derivative contract through which two parties exchange financial instruments.
These instruments can be almost anything, but most swaps involve cash flows based on
a notional principal amount that both parties agree to. Usually, the principal does not
change hands. Each cash flow comprises one leg of the swap. One cash flow is generally
fixed, while the other is variable, that is, based on a a benchmark interest rate, floating
currency exchange rate or index price.

The most common kind of swap is an interest rate swap. Swaps do not trade
on exchanges, and retail investors do not generally engage in swaps. Rather, swaps
are over-the-counter contracts between businesses or financial institutions.