Derivatives

• It is a type of security and financial

instrument, whose value is derived from
underlying assets.
• The general practice is to use derivatives as a
risk management tool that allows an investor
to transfer the risks attached with the
underlying asset to the party who is willing to
take it.
• There can be a number of risks such as market
risks, credit risk and liquidity risk.
• Types: Forwards, Futures, Options, etc.
• Forward: it is a customized contract between two entities, where
settlement takes place on a specified date in the future at todays
agreed price. It is OTC traded instruments. Example, Rice farmers
wish to sell their rice at a safe price in future. They enter into a
forward contract and any loss caused by the fall in the price will
then be offset by profits on the forward contract. Hedging by
derivatives is equivalent of insurance facility against risks. Here
agreed future price is strike price. Market price on the future date is
spot price
• Futures: It is an agreement between two parties for the purchase
and delivery of an asset at an agreed upon price at a future date.
Futures are exchange traded, and the contracts are standardized.
Traders will use a futures contract to hedge their risk or speculate
on the price of an underlying asset.
• Swap: An OTC derivative. A barter or exchange. Currency Swaps
result in exchange of one currency with another, where interest rate
swap help exchange a fixed rate interest with a variable rate.
• Options: are another common form of derivative. An option is
similar to a futures contract in that it is an agreement between two
parties to buy or sell an asset at a predetermined future date for a
specific price. The key difference between options and futures is
that, with an option, the buyer is not obligated to "exercise" the
option, while the option seller is obligated to either buy or sell the
underlying asset if the buyer chooses to exercise the contract. As
with futures, options may be used to hedge or speculate on the
price of the underlying asset.
– Put option: Investor owns 100 shares of a stock worth 50. investor
could buy a put option that gives him the right to sell 100 shares of
stock for Rs.50 per share (strike price) until a specific day in the future
(expiration date). (SELL)
– Call option - Investor does not own the stock that is currently worth 50
per share. This investor could buy a call option that gives him the right
to buy the stock for Rs.50 before or at expiration. (BUY)
– In both examples, the put and call sellers are obligated to fulfill their
side of the contract if the call or put option buyer chooses to exercise
the contract.
– LEAPS: options having maturity upto 3 years. (Long term Equity
Anticipation Securities)
• 2(d) of SCRA, 1956 “option in securities”
means a contract for the purchase or sale of a
right to buy or sell, or a right to buy and sell,
securities in future, and includes a teji, a
mandi, a teji mandi, a galli, a put, a call or a
put and call in securities.
• Derivative Markets:
• The derivatives market is the financial market
for derivatives, financial instruments like
futures contracts or options
• Trading in Futures and Options were
introduced in India – NSE (2000) – BSE (2001)
• Section 11AA of the SEBI Act, 1992 - Collective investment scheme.
• (1) Any scheme or arrangement which satisfies the conditions
referred to in sub-section (2) or sub-section (2A) shall be a
collective investment scheme:
• Provided that any pooling of funds under any scheme or
arrangement, which is not registered with the Board or is not
covered under sub - section (3), involving a corpus amount of one
hundred crore rupees or more shall be deemed to be a collective
investment scheme.
• (2) Any scheme or arrangement made or offered by any [person]
under which,—
– (i) the contributions, or payments made by the investors, by whatever
name called, are pooled and utilized for the purposes of the scheme
or arrangement;
– (ii) the contributions or payments are made to such scheme or
arrangement by the investors with a view to receive profits, income,
produce or property, whether movable or immovable, from such
scheme or arrangement;
– (iii) the property, contribution or investment forming part of scheme
or arrangement, whether identifiable or not, is managed on behalf of
the investors;
– (iv) the investors do not have day-to-day control over the
management and operation of the scheme or arrangement
• (2A) Any scheme or arrangement made or offered by any
person satisfying the conditions as may be specified in
accordance with the regulations made under this Act.
• (3) Notwithstanding anything contained in sub - section (2)
[or sub - section (2A)],any scheme or arrangement –
– (i) made or offered by a co-operative society registered under
the Co-operative Societies Act, 1912 (2 of 1912) or a society
being a society registered or deemed to be registered under any
law relating to co -operative societies for the time being in force
in any State;
– (ii) under which deposits are accepted by non-banking financial
companies as defined in clause (f) of section 45-I of the Reserve
Bank of India Act, 1934 (2 of 1934);
– (iii) being a contract of insurance to which the Insurance Act,
1938 (4 of 1938), applies;
– (iv) providing for any Scheme, Pension Scheme or the Insurance
Scheme framed under the Employees Provident Fund and
Miscellaneous Provisions Act, 1952 (19 of 1952)
 – (v) under which deposits are accepted under section
58A of the Companies Act, 1956 (1 of 1956);
– (vi)under which deposits are accepted by a company
declared as a Nidhi or a mutual benefit society under
section 620A of the Companies Act, 1956 (1 of 1956);
– (vii) falling within the meaning of Chit business as
defined in clause (d) of section 2 of the Chit Fund Act,
1982 (40 of 1982);
– (viii) under which contributions made are in the
nature of subscription to a mutual fund;
– [(ix) such other scheme or arrangement which the
Central Government may, in consultation with the
Board, notify,]
• shall not be a collective investment scheme.
• security receipt:
• defined in clause (zg) of section 2 of the Securitisation
and Reconstruction of Financial Assets and Enforcement
of Security Interest Act, 2002.
• (zg) "security receipt" means a receipt or other security,
issued by a securitisation company or reconstruction
company to any qualified institutional buyer pursuant to
a scheme, evidencing the purchase or acquisition by the
holder thereof, of an undivided right, title or interest in
the financial asset involved in securitisation;
• Section 2 (z) "securitisation" means acquisition of
financial assets by any securitisation company or
reconstruction company from any originator, whether by
raising of funds by such securitisation company or
reconstruction company from qualified institutional
buyers by issue of security receipts representing
undivided interest in such financial assets or otherwise;
 Financial Market
• Financial system is essentially concerned with borrowing
and lending.
• Lending occurs either directly to borrowers (e.g. equity held
by an individual) or indirectly via financial intermediaries.
• Financial Instruments – Debt Instruments, Deposit
Instrument (Variation of debt instrument) and Equity
Instruments.
• Financial Market: The institutional arrangement and
conventions that exist for the issue and trading dealing of
the financial instruments.
• It brings buyers and sellers together to trade financial
instruments.
• Primary – Market for issue of new securities
• Secondary – trading securities that are already issued.
• It includes money market (short term debt instruments
mainly OTC – directly between parties) and capital market
(Exchange driven markets).
• Capital market is the market in which prime
borrowers are able to access long term and or
permanent funding.
• Equity Market: It is a part of the capital market.
• The ‘Equity market is the mechanisms/conventions
that exist for the ‘issue of’, ‘investing in’, and the
‘trading of marketable equity instruments that
represent the permanent/semi-permanent capital
of the issuers companies.
• Equity represent part-ownership and not a debt of
a company.
• Equity include preference shares which is are
redeemable.
• Bond Market/debt market/ credit market :
• Debt instruments represent either marketable
debt (MD) or non-marketable debt, either
short term (upto 1 year) or long term in terms
of maturity.
• MD with long duration makes up the bond
market.
• Issuer: Government sector, corporate sector,
and foreign sector.
• Primary market and secondary market