Defining Derivatives

A derivative is a financial instrument whose

value depends on is derived from the value of some other financial instrument, called the underlying asset.
Common examples of underlying assets are

stocks, bonds, corn, pork, wheat, rainfall, etc.

Basic purpose of derivatives

The main purpose of derivatives is to transfer risk from

one person or firm to another, that is, to provide insurance.

Derivatives improve overall performance of the economy.

Major categories of derivatives

1. Forwards and futures
2. Options 3. Swaps

Forwards
A forward contract is customized contract between two

entities, where settlement takes place on a specific date in the future at todays pre-agreed price.
Forwards are highly customized, and are

much less common than the futures.

Futures
Futures contacts are special types of forward contracts in

the contracts in the sense that the former are standardized exchange-traded contracts.
An agreement between two parties to buy or sell an asset

at a certain time in the

future at a certain price.

Operators in the derivatives market

Hedgers - Operators, who want to transfer a

risk component of their portfolio.

Speculators - Operators, who intentionally take the risk

from hedgers in pursuit of profit.

Arbitragers - Operators who operate in the different

markets simultaneously, in pursuit of profit and eliminate mis-pricing.

Option

Call Option

Put Option

Defining of Options
Options are instruments whereby the right is given by the

option seller to the option buyer to buy or sell a specific asset at a specific price on or before a specific date.
Call Option - The right to buy a specified amount of

currency at a specified rate

Put Option -The right to sell a specified amount of

currency at a specified rate

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

Put Option
A right to sell an 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

Conculsion