Derivativves & risk management

DERIVATIVES & RISK
MANAGEMENT
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YOGESH NAMDEO INGLE.MBA (FINANCE), NET (MANAGEMENT),
Ph.D (WIP), G.D.C &A, NCMP.

 Contract
 Price is derived from or is dependent upon an
underlying asset.
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YOGESH NAMDEO INGLE.MBA (FINANCE), NET
(MANAGEMENT), Ph.D (WIP), G.D.C &A, NCMP.

 Underlying asset could be a financial asset
such as
1. Currency
2. Stock and market index
3. An interest bearing security
4. Physical commodity
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 Derivative contracts are also traded on –
1. Electricity
2. Weather
3. Temperature
4. Volatility
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 According to the Securities Contract
Regulation Act, (1956) the term “derivative”
includes:
 A security derived from a debt instrument,
share, loan, whether secured or unsecured,
risk instrument or contract for differences or
any other form of security.
 A contract which derives its value from the
prices or index of prices of underlying
securities.
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Types of Derivative Contracts
 Forward Contracts
 Futures Contracts
 Options Contracts
 Swaps
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Forward Contracts
 An agreement to buy or sell an asset on a
specified date for a specified price.
 Long position
 Short position
 Negotiated bilaterally by the parties to the
contract.
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Features of forward contracts
 Bilateral contracts
 Unique
 Not available in public domain
 Has to be settled
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Limitations of forward contracts
 Lack of centralization of trading,
 Illiquidity
 Counterparty risk
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Introduction to Futures
 Standardized and exchange traded
 Quantity of the underlying
 Quality of the underlying
 The date and the month of delivery
 The units of price quotation and minimum
price change
 Location of settlement
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Options Contracts
 An option gives the holder of the option the
right to do something in future. The holder
does not have to exercise this right.
 Purchase of an option requires an up-front
payment.
 Non linear or asymmetrical profit profiles
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 Buyer of an option: The buyer of an option is
the one who by paying the option premium
buys the right but not the obligation to exercise
his option on the seller/ writer.
 Writer of an option: The writer of a call/put
option is the one who receives the option
premium and is thereby obliged to sell/buy the
asset if the buyer exercises on him.
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Two basic types of options
Call option
 It gives the holder the right but not the
obligation to buy an asset by a certain date for
a certain price.
Put option
 A It gives the holder the right but not the
obligation to sell an asset by a certain date for
a certain price.
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Swaps
 Swaps are private agreements between two
parties to exchange cash flows in the future.
The two commonly used swaps
 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
principal and interest between the parties, with
the cash flows in one direction being in a
different currency than those in the opposite
direction.
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Participants in a Derivative
Market
 Hedgers
 Speculators
 Arbitrageurs
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Distinction between Futures and
Forwards
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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.
For example-
 If a farmer before planting can guarantee a certain
price he will receive, he is more likely to plant.
 Derivatives improve overall performance of the
economy
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Help yourself
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Derivativves & risk management

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