meaning of deriv

8/11/2019 Meaning of Deriv

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FINANCIAL

DERIVATIVES


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MEANING OF DERIVATIVES

A derivative is a financial instrumentthatderives or gets it value from some real

good or stock. It is in its most basic form

simply a contract between two parties toexchange value based on the action of areal good or service. Typically, the seller

receives money in exchange for anagreement to purchase or sell somegood or service at some specified future

date.
http://www.wisegeek.com/what-is-a-financial-instrument.htmhttp://www.wisegeek.com/what-is-a-financial-instrument.htm


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CONT

The largest appeal of derivatives is that theyoffer some degree of leverage. Leverage is afinancial term that refers to the multiplication thathappens when a small amount of money is usedto control an item of much larger value.

A mortgageis the most common form ofleverage.

For a small amount of money and taking on theobligation of a mortgage, a person gains controlof a property of much larger value than the smallamount of money that has exchanged hands.
http://www.wisegeek.com/what-is-a-mortgage.htmhttp://www.wisegeek.com/what-is-a-mortgage.htm


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HISTORY OF DERIVATIVES

Derivatives made the news in 1995 when

rogue trader Nick Leeson single-handedly

caused the failure of the Barings bankof

England. Nick Leeson was a derivatives

traderwhose trades did not work out, and

due to the enormous leverage of the

trades used, the losses became so largethat the bank was bankrupt when the

results of his trades become due.
http://www.wisegeek.com/what-is-a-barings-bank.htmhttp://www.wisegeekedu.com/what-does-a-derivatives-trader-do.htmhttp://www.wisegeekedu.com/what-does-a-derivatives-trader-do.htmhttp://www.wisegeekedu.com/what-does-a-derivatives-trader-do.htmhttp://www.wisegeekedu.com/what-does-a-derivatives-trader-do.htmhttp://www.wisegeek.com/what-is-a-barings-bank.htm


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CONT.

Warren Buffet, a much revered and verysuccessful investor, has stated in one ofhis annual reports that he is very much

against the use of derivatives and heexpects that they will lead to eventualfailure for anyone who uses them. In spiteof all this negative press, derivativeshave

long been a normal part of business andinvesting and are likely to be so for manymore years.


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FEATURES OF DERIVATIVES

Derivative are of three kinds future or forwardcontract, options and swaps and underlyingassets can be foreign exchange, equity,commodities markets or financial bearingassets.

As all transactions in derivatives takes place infuture specific dates it is easier to short sellthen doing the same in cash markets becausean individual can take of markets and take theposition accordingly because one has moretime in derivatives.


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CONT.

Since derivatives have standardized terms dueto which it has low counterparty risk, alsotransactions costs are low in derivative marketand hence they tend to be more liquid and onecan take large positions in derivative marketsquite easily.

When value of underlying assets change thenvalue of derivatives also changes and henceone can construct portfolio which is needed byone and that too without having the underlyingasset..


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Function of The Derivative Market

As supervision, reconnaissance of the activities ofvarious participants becomes tremendously difficult inassorted markets; the establishment of an organizedform of market becomes all the more imperative.Therefore, in the presence of an organized derivatives

market, speculationcan be controlled, resulting in amore meticulous environment.

A significant accompanying benefit which is aconsequence of derivatives trading is that it acts as afacilitator for newEntrepreneurs. The derivatives

market has a history of alluring many optimistic,imaginative and well educated people with anentrepreneurial outlook, the benefits of which arecolossal.
http://en.wikipedia.org/wiki/Speculationhttp://en.wikipedia.org/wiki/Entrepreneurshttp://en.wikipedia.org/wiki/Entrepreneurshttp://en.wikipedia.org/wiki/Speculation


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CONT

Prices in a structured derivative marketnot only replicatethe discernment of the market participants about thefuture but also lead the prices of underlyingto theprofessed future level. On the expiration of the derivative

contract, the prices of derivatives congregate with theprices of the underlying. Therefore, derivatives areessential tools to determine both current and futureprices.

The derivatives market relocates risk from the peoplewho prefer risk aversionto the people who have anappetite for risk.
http://en.wikipedia.org/wiki/Derivative_markethttp://en.wikipedia.org/wiki/Underlyinghttp://en.wikipedia.org/wiki/Derivative_contracthttp://en.wikipedia.org/wiki/Derivative_contracthttp://en.wikipedia.org/wiki/Risk_aversionhttp://en.wikipedia.org/wiki/Risk_aversionhttp://en.wikipedia.org/wiki/Derivative_contracthttp://en.wikipedia.org/wiki/Derivative_contracthttp://en.wikipedia.org/wiki/Underlyinghttp://en.wikipedia.org/wiki/Derivative_market


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TYPES OF FIN. DERIVATIVES

O. T. C

E. T. C

COMMON DERIVATIVES


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O. T. C.

Over-the-counter(OTC) derivativesare contracts thatare traded (and privately negotiated) directly betweentwo parties, without going through an exchange or otherintermediary. Products such as swaps, forward rate

agreements, exotic options- and otherexoticderivatives- are almost always traded in this way.

The OTC derivative market is the largest market forderivatives, and is largely unregulated with respect to

disclosure of information between the parties, since theOTC market is made up of banks and other highlysophisticated parties, such as hedge funds. perform.
http://en.wikipedia.org/wiki/Over-the-counter_(finance)http://en.wikipedia.org/wiki/Swap_(finance)http://en.wikipedia.org/wiki/Forward_rate_agreementhttp://en.wikipedia.org/wiki/Forward_rate_agreementhttp://en.wikipedia.org/wiki/Exotic_optionhttp://en.wikipedia.org/wiki/Exotic_derivativeshttp://en.wikipedia.org/wiki/Exotic_derivativeshttp://en.wikipedia.org/wiki/Hedge_fundhttp://en.wikipedia.org/wiki/Exchange-traded_derivative_contracthttp://en.wikipedia.org/wiki/Exchange-traded_derivative_contracthttp://en.wikipedia.org/wiki/Hedge_fundhttp://en.wikipedia.org/wiki/Exotic_derivativeshttp://en.wikipedia.org/wiki/Exotic_derivativeshttp://en.wikipedia.org/wiki/Exotic_optionhttp://en.wikipedia.org/wiki/Forward_rate_agreementhttp://en.wikipedia.org/wiki/Forward_rate_agreementhttp://en.wikipedia.org/wiki/Swap_(finance)http://en.wikipedia.org/wiki/Over-the-counter_(finance)http://en.wikipedia.org/wiki/Over-the-counter_(finance)http://en.wikipedia.org/wiki/Over-the-counter_(finance)http://en.wikipedia.org/wiki/Over-the-counter_(finance)http://en.wikipedia.org/wiki/Over-the-counter_(finance)


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E. T. C.

Exchange-traded derivative contracts(ETD)are those derivatives instruments that are tradedvia specialized derivatives exchangesor other

exchanges. A derivatives exchange is a marketwhere individuals trade standardized contractsthat have been defined by the exchange.

A derivatives exchange acts as an intermediaryto all related transactions, and takes initialmarginfrom both sides of the trade to act as aguarantee.
http://en.wikipedia.org/wiki/Exchange-traded_derivative_contracthttp://en.wikipedia.org/wiki/Derivatives_exchangehttp://en.wikipedia.org/wiki/Initial_marginhttp://en.wikipedia.org/wiki/Initial_marginhttp://en.wikipedia.org/wiki/Initial_marginhttp://en.wikipedia.org/wiki/Initial_marginhttp://en.wikipedia.org/wiki/Derivatives_exchangehttp://en.wikipedia.org/wiki/Exchange-traded_derivative_contracthttp://en.wikipedia.org/wiki/Exchange-traded_derivative_contracthttp://en.wikipedia.org/wiki/Exchange-traded_derivative_contract


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COMMON DERIVATIVES

SWAPS

WARRANT

BINARY OPTIONS

OPTION

FUTURE

FORWARD

TYPES


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FORWARD

Forwards: A tailored contract between two

parties, where payment takes place at a

specific time in the future at today's pre-

determined price.
http://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Forward_contract


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FUTURE

Futures: are contractsto buy or sell

an asseton or before a future date at a price

specified today. A futures contract differs from

a forward contract in that the futures contract isa standardized contract written by a clearing

housethat operates an exchange where the

contract can be bought and sold; the forward

contract is a non-standardized contract writtenby the parties themselves.
http://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Contractshttp://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Clearing_house_(finance)http://en.wikipedia.org/wiki/Clearing_house_(finance)http://en.wikipedia.org/wiki/Clearing_house_(finance)http://en.wikipedia.org/wiki/Clearing_house_(finance)http://en.wikipedia.org/wiki/Assethttp://en.wikipedia.org/wiki/Contractshttp://en.wikipedia.org/wiki/Futures_contract


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OPTIONS

Optionsare contracts that give the owner

the right, but not the obligation, to buy (in

the case of a call option) or sell (in the

case of a put option) an asset. The price atwhich the sale takes place is known as

the strike price, and is specified at the time

the parties enter into the option. Theoption contract also specifies a maturity

date.
http://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Call_optionhttp://en.wikipedia.org/wiki/Put_optionhttp://en.wikipedia.org/wiki/Strike_pricehttp://en.wikipedia.org/wiki/Strike_pricehttp://en.wikipedia.org/wiki/Put_optionhttp://en.wikipedia.org/wiki/Call_optionhttp://en.wikipedia.org/wiki/Option_(finance)


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BINARY OPTIONS

Binary optionsare contracts that provide

the owner with an all-or-nothing profit

profile.
http://en.wikipedia.org/wiki/Binary_optionhttp://en.wikipedia.org/wiki/Binary_option


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WARRANTS

Warrants: A part from the commonly

used short-dated options which have a

maximum maturity period of 1 year, there

exists certain long-dated options as well,known as Warrant (finance). These are

generally traded over-the-counter.
http://en.wikipedia.org/wiki/Warrant_(finance)http://en.wikipedia.org/wiki/Warrant_(finance)http://en.wikipedia.org/wiki/Warrant_(finance)http://en.wikipedia.org/wiki/Warrant_(finance)


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SWAPS

Swapsare contracts to exchange cash

(flows) on or before a specified future date

based on the underlying value of

currencies exchange rates, bonds/interestrates, commodities exchange, stocks or

other assets.
http://en.wikipedia.org/wiki/Swap_(finance)http://en.wikipedia.org/wiki/Commodities_exchangehttp://en.wikipedia.org/wiki/Commodities_exchangehttp://en.wikipedia.org/wiki/Swap_(finance)


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