Derivative market

The derivatives market is the financial market forderivatives. 

The Securities Contracts (Regulation) Act, 1956 (SC(R)A) defines “derivative” to include –

• A security derived from a debt instrument, share, loan whether secured or unsecured,risk instrument or contract for differences or any other form of security.

• A contract, which derives its value from the prices, or index of prices, of underlyingsecurities.

Types of derivatives are:

• Futures and forwards:  A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today’s pre-agreed price.

A futures contract is an agreement between two parties to buy or sell anasset at a certain time in the future at a certain price. Futures contracts are specialtypes of forward contracts in the sense that the former are standardized exchangetradedcontracts.

Futures are contracts that represent an agreement to buy or sell a set of assets at a specified time in the future for a specified amount. Forwards are futures, which are not standardized. They are not traded on a stock exchange.

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

• Swaps: Swaps are private agreements between two parties to exchange cash flowsin the future according to a prearranged formula. They can be regarded as portfoliosof forward contracts. The two commonly used swaps are:

a) Interest rate swaps: These entail swapping only the interest related cash flows betweenthe parties in the same currency and

b) Currency swaps:These entail swapping both principal and interest between the parties,with the cash flows in one direction being in a different currency than those in theopposite direction.

Source:: iasscore