Derivative Markets

Derivatives 

Derivatives are financial contracts, which derive their value from the underlying assets. The underlying assets can be equity, commodity, foreign exchange, interest rates, real estates or any other asset.

Broadly, four types of derivatives are traded:

Forward

Futures

Option and

Swaps

FUTURES CONTRACT

A futures contract is an agreement between two parties to buy or sell a specified quantity and quality of an asset at a certain time in the future at a price agreed upon at the time of entering into the contract on the futures exchange.

FORWARD CONTRACT

A forward contract is an agreement between to parties to buy or sell an asset at a future date for price agreed upon while signing the agreement. Forward contract is not traded on an exchange. It is the oldest and simplest form of derivative contract.

Distinction between futures and forward contracts.

Forward contracts are often confused with futures contracts. The confusion is primarily because both serve the same economic functions of allocating risk in the presence of future price uncertainty. However futures are a significant improvement over the forward contracts as they eliminate counter party risk and offer more liquidity.     

                Futures                                                        Forwards

Traded on an organized exchange                        OTC in nature

Standardized contract terms                                Customized contract terms    

More liquidity                                                       Less liquidity 

Follows daily settlement                                       Settlement happens at end of Period                 

          

                                                        OPTION

An option gives the right but not the obligation to the option owner to buy or sell an underlying asset at a specific price at a specific period in the future.

There are two types of option:

1.Call option 

2.Put option

Call option    

A call option contract that gives the owner of the option, the right, but not the obligation to buy the underlying asset on or before a specific date and at a specific price.

Put option

A put option contract that gives the owner of the option, the right, but not the obligation to sell the underlying asset on or before a specific date and at a specific price.

SWAPS

Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. 

The two commonly used swaps are
1.Interest Rate Swaps
2.Currency Swaps

Interest Rate Swaps

Interest Rate swaps entail swapping only Interest related cash flows between the parties in the same currency.

Currency Swaps

Currency Swaps entail swapping both Principal and Interest between the Parties, with  Cash Flows in one direction being in a different currency than those in the Opposite direction.

Related Links:

• MCX live Rate
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• MCX Intraday Calculator
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• MCX Trading Holidays 2013