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Introduction to Derivatives
Derivatives are the financial instruments which derive
their value from the value of the underlying asset. The price movements of derivative products are related to that of the underlying securities.
History of Derivatives
Chicago Board of Trade (CBOT) for derivatives trading,
became functional in 1848 and by 1865 futures contract in commodities started trading. In 1972 currency futures were introduced, followed by equity options in 1973. Year 1975 saw introduction to Interest Rate futures. Currency Swaps were introduced in 1981 and in 1982 Index futures, Interest Rate swaps and Currency Options were started. In 1983, Index Options and Options on futures were started.
Derivatives to be discussed
Futures
Forwards Options
In simple terms, a futures contract is a contract that allows the counterparties to exchange the underlying assets in future at a price agreed upon today. Following are the features of a futures contractContract through an exchange To exchange obligations on a future date At a price decided today Settlement guaranteed by the clearing corporation of the exchange
Forward Contracts
Forward Contract is an OTC derivative product.
buyer to lock a desired value of the underlying that will become applicable at some future date, now. There is no counterparty guarantee provided by any third party. Forward contracts unlike futures, are deliverable contracts (Though there are non-deliverable forward contracts also).
view to protect or cover an existing exposure in the spot market. Speculators These dealers based on their opinion about the market movements take an exposure in the forward market with a view to make profits from the expected movement in the underlying element. Arbitrageurs These players neither hedge nor speculate. They try to take advantage of the price differences in the spot and forward markets.
Options
Options or option contracts are instruments
Right, but not the obligation, is given To buy or sell a specific asset At a specific price On or before a specified date
Option Classifications
Call Option : an option which gives a right to buy the
Both the Call and Put option buyers are buying the
rights, that is they are transferring their risks to the sellers of the option. For this transfer of risk to the sellers, buyers have to compensate by paying Option Premium. Option premium is also known as Price of the option, Cost or Value of the option.
options.
Risk free Rate of Interest If interest rate goes up, calls
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