Thursday, 9 January 2020

Unit 8: Derivatives


Unit 8: Derivatives

Derivatives are a new invention of the international financial markets, which are traded both in Over-the-Counter and Exchanges.

Derivatives are very much useful for the concerns whose potential profits are volatile due to changes in weather conditions like agricultural products processing, power generation, oil exploration, tourism, insurance, etc.

Credit derivatives have been invented to hedge the risk of banks, financial institutions.

Credit derivatives allow users to isolate price and trade firm-specific risk into its component parts and transfer each risk to those best suited or more interested in managing it.

Margin money is to be kept with the exchange for entering into futures contracts, as this aims to minimise the risk of default by the counter party.

The futures contracts overcome the problems faced by forward contracts, since futures contracts are entered into under the supervision and control of an organised exchange.

The futures contracts are entered into for a wide variety of instruments like agricultural commodities, minerals, industrial raw materials, financial instruments etc.

Security Analysis and Portfolio Management Notes Options contract gives the holder of the contract the option to buy or sell the asset at a specified price on or before a specific date in the future.

The option is sold by the seller (writer) to the purchaser (holder) in return for a payment (premium).

In a European option, the holder of the option can exercise his right (if he desires) only on the expiration date.

In a call option the buyer receives the right, but not the obligation to buy a given quantity of the underlying asset at an exercise price or strike price on or before a given future date called 'maturity date' or 'expiry date.' The put option gives 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 expiry date.

In determination of prices of the options, some of the important factors like future price, strike price, interest rates, time of the option, volatility of the market, etc., will exert their influence.

Arbitrageurs: Riskless profit making is the prime goal of arbitrageurs.

Buying in one market and selling in another, buying two products in the same market are common.

Credit Derivative: A financial instrument used to mitigate or to assume specific forms of credit risk by hedgers and speculators.

Hedgers: The objective of these kinds of traders is to reduce the risk.

They are not in the derivatives market to make profits.

They are in it to safeguard their existing positions.

Put Option: The reverse of the call option deal.

Here, there is a contract to sell a particular number of underlying assets on a particular date at a specific price.

Speculators: They are traders with a view and objective of making profits.

They are willing to take risks and they bet upon whether the markets would go up or come down.

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