Presented By:

NAME

ROLL NO.

Smit Mestry

327

Pooja Manani

326

Vidhi Nisar

329

Jaimini Nisar

328

Sonali Padhiar

330

Disha Thanawala

353

Pinal Suthar

351

Achal Sureka

350

Harmeet Thandi

354

Mehul Soni

349

Tejal Limbadia

325

Aayushi Thaker

352

TOPICS

Introduction.
Structure of derivative market.
Characteristics.
Needs of Derivatives.
Ways derivatives are used.
Factors contributing to the growth of derivative.
Advantages of derivatives.
Disadvantages of derivatives.
Economic benefits of derivative market.
Uses of derivatives in portfolio management.
Types of derivative market.
Participants in derivative market.
Exchange traded v/s OTC derivative.
Forward terminology.
Advantages of forward contracts.

Disadvantages of forward contracts.

Forwards markets commission.
Futures terminology.
Advantages.
Disadvantages.
Futures v/s Forwards.
Options.
Types of options.
Options terminology.
Application of options.
Options v/s Future.
Swap.
Commonly used swaps.
Stock derivative.
Entities in trading system.
Corporate hierarchy.
Client broker relation in derivative segment..

INTRODUCTION.
A derivative is a security with a price that is
dependent upon or derived from one or more
underlying assets. The derivative itself is a contract
between two or more parties based upon the asset or
assets. Its value is determined by fluctuations in the
underlying assets include stocks, bonds, commodities,
currencies, interest rates & market indexes.

Structure of Derivatives Market

Regulatory Objectives
A) Investor Protection:
I.
II.
III.
IV.

Fairness & Transparency

Safeguard for Clients money
Competent & honest service
Market integrity

B) Quality of markets:
The concept of Quality of Markets goes well beyond market
integrity and aims at enhancing important market qualities,
such as cost-efficiency, price-continuity, and price-discovery.
This is a much broader objective than market integrity.
C) Innovation:
While curbing any undesireable tendencies, the regulatory
framework should not stifle innovation which is the source of all
economic progress, more so because financial derivatives
represent a new rapidly developing area, aided by
advancements in IT.

Characteristics of derivatives.
Derivative can be defined as a contract or an agreement for
exchange of payments, whose value is derived from the value of an
underlying asset. In simple words the price of derivative depends
on the price of other assets.
Here are some of the features of derivative markets
1) Derivative are of three kinds future or forward contract, options
and swaps and underlying assets can be foreign exchange, equity,
commodities markets or financial bearing assets.

2) As all transactions in derivatives takes place in future specific

dates it
is easier to short sell then doing the same in cash
markets because an individual can take of markets and take the
position accordingly because one has more time in derivatives.
3) Since derivatives have standardized terms due to which it has
low counterparty risk, also transactions costs are low in derivative
market and hence they tend to be more liquid and one can take
large positions in derivative markets quite easily.
4) When value of underlying assets change then value of
derivatives also changes and hence one can construct portfolio
which is needed by one and that too without having the underlying
asset. So for example if one want to buy some stock and short the
market then he can buy the future of a stock and at the same time
short sell the market without having to buy or sell the underlying
assets.

Needs of derivatives.
The market of derivative financial instruments plays an
important role in the global economy. Futures exchanges
where derivatives are traded function as the centres of
pricing for many assets and also as mechanisms that make
it possible to re-distribute various financial risks among the
participants in this market.
The terms derivative financial instruments and
derivatives are synonyms. The instruments are referred to
as derivative because their value depends on the value of
other assets that form their basis, which are referred to as
underlying assets. Distinctive features of derivatives are a
high level of leverage and fulfilling obligations in the future.

 Underlying assets may be comprised of both real

assets that are subject to civil law, which may be
transferred in the market and may be owned by a
party to a transaction (for example, securities,
foreign currency, commodity assets, etc.), and
virtual assets, not transferable owing to their nature,
which may not be owned by a party to a transaction
(for example, price indices, interest rates, exchange
rates, other indicators characterizing certain events
or phenomena, or opinions of the parties).

WAYS DERIVATIVES ARE USED:

To hedge risk.
To speculate.
To lock in an arbitrage profit.
To change the nature of the liability.

Factors contributingto the

growth of derivatives.
Price Volatility.

Globalization of the Markets.

Technological Advances.
Advances in Financial Theories.

Advantages Of Derivatives.

Minimization of riskDerivatives were introduced with the aim of minimising the risk. With the
proper application of contracts one can minimise risk of losses & take
advantage of fluctuations by maximising the profit.

Maximization of profitWith the use of Derivatives, by exercising the option at right time one can
hedge the risk. By right prediction one can maximise the profit by exercising
contract at a right price

 New Investment AvenueThere was a scope in stock market for a kind of insurance
product, a product which will provide returns with protection of
risk.
Increase in turnoverTurnover of F&O market is highest as compared to equity
trading. Turnover of index futures is Rs. 17214.58 crores as of 1 st
June,2010.
Attracting untapped populationWith the increase in awareness about derivatives contracts many
individual investors who were hesitating to invest in market just
because of their low risk appetite are now investing in market.

Disadvantages of Derivatives.
.Generation of Hot moneyWith money changing hands with exercising of option by
investors, more hot money is generated in market.
. Encouragement to speculationGeneration of hot money is giving encouragement to
speculation activities in market thus making market.

 Unstable marketSpeculation & Hot money goes hand in hand encouraging more
number of speculators & discouraging long term investors,
resulting in a unstable market all over.
No physical deliveryDerivatives are settled on cash basis. No physical delivery of
underlying assts take place.

Economic Benefits of
Derivatives Market.
Reduces risk.
Enhance liquidity of the underlying assets.
Lower transaction costs.
Enhances the price discovery process.
Portfolio management.
Provides signals of market movements.
Facilitates financial markets integration.

Uses of derivatives in Portfolio

Management.
To manage risk.
To enable greater flexibility and lower cost.
.To generate investment returns.

Types of Derivatives Market.

There are mainly 4 types of Derivatives Market:
Forwards
Futures
Options
Swaps

Forwards.

In finance, a forward contract or simply a forward is a non-standardized contract

between two parties to buy or to sell an asset at a specified future time at a price
agreed upon today, making it a type of derivative instrument.
Instead this is in contrast to a spot contract, which is an agreement to buy or sell
an asset on its spot date, which may vary depending on the instrument.

The price agreed upon is called the delivery price, which is equal to the forward
price at the time the contract is entered into.

The price of the underlying instrument, in whatever form, is paid before control
of the instrument changes.

How Forward Contract Works

Features of Forwards Contract

BILATERAL CONTRACT
Contract is an agreement between the two parties. Buyer and
seller both plays an important role in forward contract to make it
implemented.

 COUNTER PARTY RISK

As this contract involves two parties thus there us exposure of
counter party risk wherein one party can defraud the other.
UNIQUE
Forward contract are Customized in nature made in
accordance with the consent from both parties. Consent could be
obtained un relation to a predetermined price, maturity date,
underlying asset, payment mode etc.
COMPULSORY SETTLEMENT
On date of the expiry a forward contract has to be settled that
means buyer has to take possession of underlying asset
STANDARDISED
Forward contract are not Standardized they differ from parties
to parties
TRADING
Forward contract are traded in OTC (Over The Counter)market

Limitations Of Forwards Contract

COUNTER PARTY RISK
Although derivative product means a product which help to hedge all
type of risk But then too forward being a derivative product is exposed to
counter party risk just because it is not standardized one.
LACK OF CENTRALIZATION OF TRADING
As forward contract are traded in OTC market there is lack of
centralization. There is no proper central authority where frauds in these type
of contracts.
ILLIQUIDITY
Forward are bilateral contract which are not listed on any exchange and
are exposed to counter party risk. If either of the party fails to execute the
contract it led to illiquidity

Who can benefit from using a forward contract?

Importers that purchase goods or services overseas and pay
in a foreign currency
Exporters that sell merchandise outside the United States and
are paid in a foreign currency
Organizations that receive foreign-denominated dividends or
royalties
Businesses that invest in foreign securities or make capital
infusion payments and/or are involved in a foreign acquisition
where the exchange of payment will not be in U.S. dollars

Futures.
A future contract is an agreement between two parties to buy
or sell an asset at a certain time in the future at a certain
price.
A future contract is a standardised forward contract.
It is traded on an organised exchange.
Standardisations
1. Quantity of the underlying
2. Quality of the underlying (not required in financial futures)
3. Delivery dates and procedure
4. Price quotes

Features Of Futures Contract

EXCHANGE TRADED
SETTLEMENT
TRANSPARENCY
INTEGRATED PRICE
SINGLE CLEARING HOUSE
EXPIRATION

Limitations Of Futures Contract

RESRICTION ON TRADED COMMODITIES
TICKS
POSITION LIMITS
CONTROLLING FUTURE EVENTS
TIMING ISSUES

FUTURES TERMINOLOGY.
Spot Price:
The price at which an underlying asset trades in the spot
market.
Futures Price:
The price that is agreed upon at the time of the contract
for the
delivery of an asset at a specific future date.
Contract Cycle:
It is the period over which a contract trades. The index
futures contracts on the NSE have one-month, two-month
and three-month expiry cycles which expire on the last

Expiry date:
Is the date on which the final settlement of the contract takes
place.
Contract size:
The amount of asset that has to be delivered under one contract.
This is also called as the lot size.
Basis:
Basis is defined as the futures price minus the spot price. There
will be a different basis for each delivery month for each
contract. In a normal market, basis will be positive. This reflects
that futures prices normally exceed spot prices.
Cost of Carry:
It is the difference between strike price and current price.

Difference between
Forward and Future contract
Features
Operational
Mechanism

Market

Forward

Future

Traded directly
Traded on the
between two
exchanges.
parties (not traded
on the exchanges).
Traded in OTC
(Over The
Counter) market.

Traded on
Exchanges.

Contract
Specification

Differ from trade

to trade.

Counter-party risk. Level of existence

is high

Liquidity

Less liquid

Contracts are
standardized
contracts.
Risk exists but
clearing
corporation
becomes
counterparty and
helps in
settlement.
Chances of default
are nil.
More liquid.

Settlement

At the end of
maturity period.

Centralisation

Customised due to Listed on

which it is
exchange resulting
decentralised.
in centralisation of
authority
Specifies to whom Chosen randomly
the delivery should by the exchange.
be made.

Physical delivery

Follows daily
settlement.

Frequently used

They are
They are usually
frequently used by used by
hedgers.
speculators.

Settled at

Settled at forward Settled at the

price agreed at the settlement price
start.
agreed at the end.

Transaction
method

Negotiated directly Quoted and traded

by the buyer and
on the exchange.
seller.

Contract size

Depending on the
transaction and
requirement of
contracting parties.

The contract size is

standardized.

Guarantee

No guarantee of
settlement until the
date of maturity.

Both parties must

deposit an initial
guarantee.

Market regulation

It is not regulated.

It is government
regulated market.

Examples

Currency market in
India

Commodities Futures,
Index & Individual
Stock Futures in India.

Options contract
Options give the holder or buyer of the option the
right to do something. An option contract is an
agreement between two parties to buy or to sell
an asset (a stock) at a fixed price and at a fixed
date in the future.
This is because the buyer has the right but not the
obligation to carry out the transaction.

Types of option
Call option

Put option

Right to buy
No obligation to buy

Right to sell
No obligation to sell

Exchange-traded Versus Over-thecounter (OTC) Derivatives.

An exchange traded product is a standardized financial
instrument that is traded on an organized exchange. An
over the counter (OTC) product or derivative product is
a financial instrument traded off an exchange, the price
of which is directly dependent upon the value of one or
more underlying securities, equity indices, debt
instruments, commodities or any agreed upon pricing
index or arrangement.

 The most common types of derivative products are

interest rate swaps, caps and their offshoots. Over
90% of commercial bank derivative trading is
interest rate related due to the natural ebb and flow
of their corporate finance and hedging activity.
The reason derivative products exist is that users
often need customized products as the
standardization of exchange products can lead to
hedging mismatches and gap exposures.

Participants in Derivatives Market.

One of the reason for the success of financial markets is the presence of different
types of traders who add a great deal of liquidity to the market.
The traders in derivative market are classified into three broad types that is
hedgers, speculators and arbitrageurs depending upon the purpose for which the
parties enter into contract.

Hedgers
Speculators
Arbitrageurs

HEDGERS
Hedgers are the traders who wish to reduce the risk to
which they are already exposed.
Hedging usually involves taking a position in a derivative
financial instrument.
Hedgers use future or options markets to reduce or
eliminate the risk associated with the price of asset.
Example:Farmer is a hedger when he enters into a contract for his
crop at a predetermined price for a future date.

SPECULATORS
If hedgers are the traders who wish to reduce the risk
then speculators are those the traders who are willing to
take risk associated with price of an asset.
These people take position in the market and assume risk
to profit from fluctuations in prices. In fact speculators
consume information about the prices and put their
money in these forecasts.
By taking position they are betting that price would go up
or they are betting that it would go down.

ARBITRAGEUR
Arbitrageurs are the brokers who buy security in one
market and sell the same in another market to get profit.
that is arbitrageurs are in business to take advantage of a
difference between prices in two different markets.
Example:SBI stock price on NSE is Rs 2200 per share and on BSE it
is Rs 2300 per share. An arbitrageurs will buy share from
NSE and sell on BSE making profit of Rs 100 per share.

Swaps.
A swap is a derivative in which two counterparties
exchange cash flows of one party's financial instrument
for those of the other party's financial instrument.
The benefits in question depend on the type of financial
instruments involved.
The swap agreement defines the dates when the cash
flows are to be paid and the way they are accrued and
calculated.
Usually at the time when the contract is initiated, at least
one of these series of cash flows is determined by an
uncertain variable such as a floating interest rate, foreign
exchange rate, equity price, or commodity price.

What is FMC?
Forward Markets Commission is a statutory body set up
under Forward Contracts (Regulation) Act, 1952.
TheForward Markets Commission(FMC) is the chief
regulator of commodity futures markets in India. As of July
2014, it regulated Rs 17 trillion worth of commodity
trades in India. It is headquartered in Mumbai and this
financial regulatory agency is overseen by the Ministry of
Finance.

Role of FMC
To advise the central government in respect of or withdrawal of
recognition from association.
To keep forward markets under observation and to take such
action if necessary.
To collect and publish information regarding the trading conditions
in respect of goods applicable, including information regarding
demand, supply, prices and submit periodical reports to central
government.
To make recommendations generally ,with a view to improving the
organization.
To undertake the inspection of the accounts and other documents.

 To perform other duties and exercise powers under FC(R) Act,

1952.
The commission thus is a statutory authority entrusted with
regulatory functions.
Presently, Shri BC Khatua, IAS is the chairman of the
commission. The other members of the commission are Shri
Rajeev Kumar Agarwal
It has its headquarters at Mumbai and a regional office at
Kolkata.
FMC has 5 divisions to carry out various task. These divisions
are formed on 1st August 2005 in order to streamline the work
on functional basis.

 It has its headquarters at Mumbai and a regional office at

Kolkata.
FMC has 5 divisions to carry out various task. These
divisions are formed on 1st August 2005 in order to
streamline the work on functional basis.

Steps taken to benefit

stakeholders
Promoting the participation of hedgers
Increasing the awareness of existence of future markets
and capacity building in the commodity market to all
stakeholders, especially farmers
To enable the farmers to take the benefit of hedging and
manage price risks

Conclusion for FMC

This commission allows future trading in 23 fibres and
manufacturers, 15 spices, 44 edible oils, 6 pulses, 4
energy products, single vegetable, 20 metal futures, 33
other futures.

Financial derivatives
Financial derivatives are financial instruments that are
linked to a specific financial instrument or indicator or
commodity, and through which specific financial risks can
be traded in financial markets in their own right.
Transactions in financial derivatives should be treated as
separate transactions rather than as integral part of the
value of underlying transactions to which they are Linked.
The value of financial derivative derives from the price of
an underlying item, such as an asset or index.

 Financial derivatives enable parties to trade specific

financial risks( such as interest rate risk, currency, equity
and commodity price risk and credit risk, etc) to other
entities who are more willing or better suited to take or
manage risks.
Financial derivate contracts are generally settled by net
payments or cash. This often occurs before maturity for
exchange traded contracts futures.
A separate financial category has been created for
financial derivates in the balance of payments and a
separate instrument in the national accounts.

Types of derivative products

A list of commonly used derivatives by category are

products. Some of the common products are:
Equity derivatives
Interest rate derivatives
Common derivatives
Foreign exchange derivatives
Credit derivatives

Stock Derivatives.

In finance, anequity derivativeis a class ofderivativeswhose value

is at least partly derived from one or more
underlyingequitysecurities. Options and futures are by far the most
commonequity derivatives, however there are many other types
ofequity derivativesthat are actively traded.

The primary difference is standardization versus customization. This

leads to a crucial distinction. When dealing in exchange traded
products terms are standardized and the clearinghouse guarantees
that the other side of any transaction performs to its obligations.

That is, it assumes all contingent default risk so both sides do not
need to know about each others credit quality. This differs from
customized OTC products where there is no clearinghouse to
guarantee performance.

Entities in Trading System.

There are four entities in the trading system.
Trading members
Clearing members
Professional clearing members and
Participants

 Trading members: Trading members are members of

NSE. They can trade either on their own account or on
behalf of their clients including participants. The
exchange assigns a trading member ID to each trading
member. Each trading member can have more than
one user.
Clearing members: Clearing members are members
of NSCCL. They carry out risk management activities
and confirmation/inquiry of trades through the trading
system.
Professional clearing members: A professional
clearing member is a clearing member who is not a
trading member. Typically, banks and custodians
become professional clearing members and clear and

 Professional clearing members: A professional

clearing member is a clearing member who is not a
trading member. Typically, banks and custodians
become professional clearing members and clear and
settle for their trading members.
Participants: A participant is a client of trading
members like financial institutions. These clients may
trade through multiple trading members but settle
through a single clearing member.

Corporate Hierarchy.
Corpora
te
manage
r

Admin

Corpora
te
Hierarc
hy
Dealer

Branch
manage
r

 Corporate manager: The term is assigned to a user placed at the highest level
in a trading firm. Such a user can perform all the functions such as order and
trade related activities of all users, view net position of all dealers and all clients
level, can receive end of day consolidated trade and order reports dealer wise
for all branches of the trading member firm and also all dealers of the firm.
Branch manager: The term is assigned to a user who is placed under the
corporate manager. such a user can perform and view order and trade related
activities for all dealers under that branch.
Dealer: Dealers are user at the bottom of the hierarchy. A dealer can perform ,
view order and trade related activities only for oneself and does access to the
information on other dealers under either the same branch or other branches.
Admin: This is an another user type, admin is provided to every trading
member along with the corporate manager user. This user type facilitates the
trading members and the clearing members to receive and capture on a real
time basis all the trade exercise requests and give up request of all the users
under him.

Client broker relationship in

Derivative segment.
A trader member must ensure compliance particularly with relation to
the following while dealing with clients:
Filling of know your clients form.
Execution of Client Broker agreement.
Bring risk factors to the knowledge of client by getting acknowledgement of
client on risk disclosure document.
Timely execution of orders as per the instruction of clients in respective client
codes.
Collection of adequate margins from the client.

 Maintaining separate client bank account for segregation of

client money.
Timely issue of contract notes as per the prescribed format to
the client.
Ensuring timely pay-in and pay-out of funds to and from the
clients.
Resolving complaint of clients if any at the earliest.
Avoiding receipt and payment of cash and deal only through
account payee cheques.
Sending the periodical statement of accounts to the clients.
Not changing excess brokerage.
Maintaining unique client code as per the regulations.

Foreign exchange derivatives

A foreign exchange derivative is a financial derivative
whose payoff depends on the foreign exchange rate(s) of
two (or more) currencies. These instruments are
commonly used for currency speculation and arbitrage or
for hedging foreign exchange risk. These can be used by
currency or forex traders, as well as large multinational
corporations. Financial instruments that fall into this
category of foreign exchange derivatives include:
currency option contracts, currency swaps, forward
contracts and futures contracts.

FX derivatives reporting
Sum on- balance sheet assets and liabilities.
Sum off- balance sheet FX swap US$ forward purchases
and sales.
Sum of FX outright forward purchase and sales.
Provide a gap report to board with US$ buys and sells
outstanding by month with weighted average rate.

FX derivatives and regulations

Regulations prohibit the use of FX derivatives.
Request in writing an exemption from regulator on usage
of FX derivatives.
State the purpose of the usage of FX derivatives( FX
swaps for liquidity management and FX outrights for
customer business)
State the adjustments made to market policy to measure
and report for this exposure.
Receive response from regulator.

Conclusion.
Derivatives markets have shown tremendous growth over the last 10
years.
While much has been made of recent derivatives-related losses, the
economic benefits provided by derivative securities are more important.
Derivatives help the economy achieve an efficient allocation of risk.
They assist in completing markets, thereby providing firms and individuals
with new investment opportunities.
Derivatives provide information to financial market participants and may
help reduce overall market volatility.

Bibliography.

https://www.cmegroup.com/education/files/growth-through-risk-management.pdf