A PRESENTATION ON

DERIVATIVES FUNDAMENTAL

CONTENT OF PRESENTATION

• DEFINATION OF DERIVATIVES • TYPES OF DERIVATIVES

• A derivative is a financial contract /instrument whose value is derived from the other or economical value which is called underlying.

• In other word we can say one variable derived from the other variables.

• A substance that can be derived from the other substances .

Type of derivatives

Forward contract

• A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges.

Example

• On 1st October ,Mr. Hema enters into a forward contract with Mrs. laya and agrees to purchase 500 shares of TATA sons for a predetermined price of RS 130 three months forward. Here on the fixed future date ,Mr. hema will get 500 shares and will pay the price that is RS 65000 and Mrs. laya will deliver shares and will receive the money.as per the terms of the contracts the settlement will be strictly on maturity date. The holder of the short position delivers the assets to the holder of the long position in return for a case amount equivalent to delivering price.

Examples

Assume that an agricultural producer has 2 thousands ton of corn to sell six months from now, and is concerned about a potential decline in the price of corn. It therefore enters into a forward contract with its financial institution to sell 2 thousands ton of corn at a price of Rs 4.30 per in six months, with settlement on a cash basis.

Future contract

A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts.

Examples

• On 1st January ,Mr. hima enters into a future contracts to buy 500 share of IBM co at an agreed price of Rs 130 per share in march .if on maturity date (as determined by the stock exchange during the month of December ),the price of the equity share rises to Rs 160 per share ,Mr. hima will receive Rs 30 per share and otherwise if the price of the share falls to Rs 110, Mr. hima pay Rs 20per share.

EXAMPLES ABC Co does nothing and decides to pay the money by converting the INR to USD, if the spot rate after three months Is Rs 47,the ABC Co will have to pay INR 47,00,000 to buy USD 100000.Alternatively , if the spot price is Rs 4,30,000, ABC Co Will have to pay only 43,00,000 to buy USD 100000.the point is that ABC Co is not sure of its future liability and is subject to risk of exchange rate Fluctuations.

Forward vs future

Option contract

oA derivative instrument which gives holder the right, without obligation, to trade (buy/sell) according to the specified terms and conditions.

oOptions: Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given.

Examples

• An investors buys one European call option on Infosys at the strike price of Rs 3500 at a premium of Rs .100.if the market price of Infosys on the day of expiry is more than Rs 3500 ,the option will be exercised.

• An investor buys one European put option on reliance at the strike price of Rs 300/-,at a premium of Rs 25 /-.if the market price of reliance ,on the day of expiry is less than Rs 300,the option can be exercised.

Swap contract

• Swaps:-Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contract.

• Example:- 6 months USD LIBOR against 3 months USD LIBOR. 6 month MIFOR against 6 month USD LIBOR