INTRODUCTION OF DERIVATIVES
The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset Prices. As instruments of risk management, these generally do not influence the Fluctuations in the underlying asset prices. However, by locking-in asset prices, Derivative products minimize the impact of fluctuations in asset prices on the Profitability and cash flow situation of risk-averse investors.
Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, share, bonds, Currency, interest, etc., Banks, Securities firms, companies and investors to hedge risks, to gain access to cheaper money and to make profit, use derivatives. Derivatives are likely to grow even at a faster rate in future.
DERIVATIVE PRODUCTS (TYPES)
The following are the various types of derivatives. They are:
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.
Futures:
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.
Options:
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 date.
Warrants:
Options generally have lives of upto one year; the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded Over-the-counter.
Leaps:
The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of upto three years.
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