DERIVATIVES

What are derivatives?

 A derivative is a security whose

price ultimately depends on that of
another assets (called underlying
assets) i.e. its value is entirely
`derived' from the value of the
underlying asset.
 Types of derivative contracts

 FORWARDS
 FUTURES
 OPTION
 SWAPS
FORWARDS
 FORWARDS

 In a Forward contract, the

contracts are made to buy or sell
currencies at a future date.
 The rates of exchange are agreed
upon on the very day the deal is
finalized by the buyer and seller.
 Forward market
hedging
 Forward market hedging is generally
undertaken to reduce the risk due the changes
in the exchange rate.
Example: An Indian exporter exports goods worth $1000 to
USA and the payment will be received after 3months.
SPOT & Forward rate : Rs 40/$
Rate After 3 Months : Rs 39/$
Thus the loss occurring due to the fall in the value of
$ is met through Forward contract.
 Speculation in
Forwards

 Speculation in forward market is

done to reap the benefits of the
changes in the exchange rate i.e.
diff between the forward rate and
the future SPOT rate.
FUTURES
 Futures

 A Future contract is an agreement

between two parties to exchange
one asset to another with the
actual exchange taking place at a
specified date in the future but
with the terms of Exchange.
 Features of a Future
Contract

 Organized Exchanges
 Standardization
 Clearing House
 Initial Margin Money
 Marking to Market
OPTIONS
 OPTIONS
 An Option is a financial contract in
which a buyer of the option has the
right to buy or sell an asset at a
prescribed price on a specified
date however there is no
obligation for him to do so. The
seller has an obligation to execute
the contract if the buyer wishes to
do so.
 Types of Option Market
 Listed currency option Market :
 First set up at the Philadelphia Stock Exchange.
 Small fee for facilitating such contracts.
 Over-the-Counter options market :
 The size of the contract is large.
 European options are found in OTC market
 Currency Future options Market :
 Mixture of currency options and currency futures
 The options are Marked to Market.
 Option Strategies

 Call Option
 Put Option
 Call Option
Buyer Gain = Spot price > Strike price
=S - X - C
Where :S = Spot price ; X = Strike price
C = Premium Paid

 Sellers Gain = Spot price < Strike price

= Strike Price – Spot Price
If the Buyer executes the contract
Contd…
Example:
A firm buys a call option.
Contract Size : 62500
Strike price = Rs.60.50 per pound
Premium = Rs.0.06 per pound
Spot rate at maturity = Rs.60.60
Total Premium paid = 0.06*62500 = Rs.3750
Gain to the option Buyer :
(60.60 - 60.50 - 0.06) * 62500 = Rs.2500
If the spot price is below Rs.60.50per pound
The maximum loss to the buyer = Rs.3750
 Contd…

If the buyer does not execute the

Contract :

Gain for the seller = Amt of Premium

Received
 Put Option
 Buyers gain = Spot price < Strike price
=X–S–C
Where : S = Spot price ; X = Strike price
C = Premium Paid

 Seller gain = Spot price > Strike price

=S-X
 American option v/s European
option

 The Buyer of an American option

has the right to exercise the
contract on or before the maturity
date.
 The buyer of a European option
can execute the contract only on
the maturity of the contract date.
SWAPS
 SWAPS

 In SWAP two parties come into an

agreement to exchange the
currencies at the prevailing rate
and again reverse the transaction
at the same rate at an agreed
upon future date.
 Types of SWAPS

 Interest rate Swaps

 Currency Swaps
Over-The-Counter Derivatives "Swaps"

Currency Sw aps
12%

Interest-Rate Sw aps
88%
 Interest rate Swaps
 An interest rate swap is a swap in
which counterparties exchange
cash flows of a floating rate for
cash flows of a fixed rate or vice-
versa. No notional principal
changes hands, but it is a
reference amount against which
interest is calculated. Interest
swaps can be international or
 Currency swap

 A Currency swap is a swap in

which one party provides a certain
principal in one currency to its
counterparty in exchange for an
equivalent amount in a different
currency
CONCLUSION
THANK YOU