Synopsis of Project report on

OTC Derivatives - Operation

Submitted By:
Harishchandra Singh
Roll no. 54
MFM (V-Sem)

UNDER THE GUIDANCE OF

Prof. Aparna Bhat

K.J. SOMAIYA INSTITUTE OF MANGEMENT STUDIES & RESEARCH

VIDYANAGAR, VIDYA VIHAR (E), MUMBAI- 400 077

Why Derivatives?
Different investment avenues are available with investors. Stock market also offers good
investment opportunity to the investors & alike all investments, they also carry risks. The
investor should compare the risk and expected yields after adjustment off tax on various
instruments while taking investment decisions.
Looking into the risk associated with every investment in market the objective here is to make
the investor aware of the functioning of the derivatives & how an investor can minimize the risk
(by hedging the underlying assets) & maximize the return in Derivatives market.
1) The Company may be small and not qualifying the exchange listing requirements, hence
opting for OTC market
2) It is an instrument that is used for hedging, risk transfer & speculation.
3) OTC gives exposure to different markets as an investment avenue
4) In many cases it implies less financial burden and administrative cost for the end users (e.g.
corporate)
Types of OTC Derivatives

OTC Contracts can be broadly classified on the basis of the underlying asset through which the
value is derived:
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Interest rate derivatives: The underlying asset is a standard interest rate. Examples of interest
rate OTC derivatives include LIBOR, Swaps, US Treasury bills, Swaptions and FRAs.
Commodity derivatives: The underlying are physical commodities like wheat or gold. E.g.
forwards.
Forex derivatives: The underlying is foreign exchange fluctuations.
Equity derivatives: The underlying are equity securities. E.g. Options and Futures
Fixed Income: The underlying are fixed income securities.
Credit derivatives: It transfers the credit risk from one party to another without transferring the
underlying. These can be funded or unfunded credit derivatives. e.g.: Credit default swap (CDS),
Credit linked notes (CLN).
OTC markets have two dimensions to it, namely customer market and interdealer market. In
customer market, bilateral trading happens between the dealers and customers. This is done
through electronic messages which are called dealer-runs providing the prices for buying and
selling the derivatives. On the other hand, in the interdealer market, dealers quote prices to one
other to offset some of the risk in the trade. This is passed on to other dealers within fractions.
This clearly provides a view point on the customer market.
Risks managed using OTC Derivatives:
Interest rate risk: Companies prefer to take loans from banks at a fixed rate of interest in order
to avoid the exposure to rising rates. This can be achieved through interest rate swap which locks
the fixed rate for a term of loan.
Currency Risk: Currency derivatives allow companies to manage risk by locking the exchange
rate, beneficial for importer or exporter companies that face the risk of currency fluctuations.
Commodity Price Risk: Financing in terms of expansion can only be available if the future
selling price is locked. This price risk protection is provided through customized OTC derivative.
E.g. Crude Oil producer would like to increase production in tandem to increase in the demand.
The financing will be done only if the future selling price of the crude is locked.