DERIVATIVES

DERIVATIVES
Derivatives

are instruments which derive their

value from an underlying asset.

Simply we can say that it is a contract.

Equities,

debts, forex instruments, insurance,

commodity based contracts etc...

Derivatives

are useful to reduce many risks and

considered as a risk reducing machinery

TYPES/KINDS OF FINANCIAL
DERIVATIVES
Forward
Future
Options
Swaps

FORWARD CONTRACT
Oldest

derivatives

It refers to an agreement between two parties to

exchange an agreed quantity of an asset for cash
at a certain date in future at a predetermined
price specified in the agreement

FUTURE CONTRACT

Similar to forward contract, it is an agreement

between two parties to exchange any asset at a
certain date at an agreed price.

It

takes place only in an organised financial

markets according to well established standards.

Future contracts are nothing but a standardized

forward market.

Types;
Financial future
Commodity future

DIFFEENCE BETWEEN FORWARD

AND FUTURE CONTRACT
Basis

Forward contract

Future contract

1. Nature

Not standardized

Highly standardized

2.Existence of
secondary market

No secondary market

Existence of
secondary market

3.Settlement

On the date of
maturity

On a daily basis

4.Modus operandi

Through Financial
intermediary

Through exchanges

5.Down payment

No down payment

Deposit a certain %of

the contract price
asmargin money

6.Delivery of the
asset

Contract will end On

the date of maturity

Does not end with

the delivery of the
asset

OPTIONS
Option

contract gives the buyer an option to buy or sell

an underlying asset at a predetermined price on or
before a specified date in future.

The

price so predetermined is called strike price or

exercise price

Types;
Call option (buy)
Put option (sell)
Double option (buy and sell)
In the money option(positive cash flow to holder)
At the money option (zero cash flow)
Out of the money option (negative cash flow)

DIFFEENCE BETWEEN FORWARD

AND OPTION CONTRACT
Basis

Forward contract

Option contract

1. Nature

Not standardised

Both standardised
and not standardised

2.Down payment

No down payment

Pay premium amount

3.Settlement

At the date of
maturity

At the time of
exercise or maturity
date

4.Linearity

Linearity

Non-linearity

AMERICAN OPTION AND

EUROPEAN OPTION

If the option can be exercised at any time

between the writing of the contract and its
expiration, it is American Option

If the option can be exercised only at the

time of maturity is European Option

SWAP

Combination of forwards by two counterparties.

Currency swaps
Interest rate swaps

FEATURES OF SWAP
1.
2.
3.
4.
5.

Basically a forward
Double coincidence of wants
Necessity of an intermediaries
Settlement
Long term agreement

OPTION RATING
Basis

Call (Buy)

Put (Sell)

Equation

S-K

K-S

In the money Option

S>K (+)

K>S

At the Money Option

S=K (0)

K=S

Out of the money

Option

S<K (-)

K<S

S = MARKET PRICE
K = EXCERCISE PRICE OR STRIKE PRICE