DERIVATIVE

MARKET IN
INDIA
 Financial derivatives are financial
instruments whose prices are
derived from the prices of other
financial instruments which are also
know as underlying. It relates to
equities, loans, bonds, interest rates
and currencies.
 TYPES OF DERIVATIVES

 OPTIONS

 FUTURES

 SWAPS
 OPTIONS
TYPES:
 EXCHANGE TRADED OPTIONS
 OVER THE COUNTER OPTIONS
 EMPLOYEE STOCK OPTIONS
 STOCK INDEX OPTIONS
 INTREST OPTIONS
 CURRENCY OPTIONS
 RANGE FORWARD(RF)
 RATIO RANGE FORWARDS
CONTRACTS(RRF’S)
 SWAPTIONS
 BENEFITS
 CALLS- Control a claim on underlying
asset.
PUTS- Duplicate a short sale without
margin account.
 Possibility of windfall profits.
 Investment opportunities.
 Reduction of total portfolio transaction
cost.
 Participation in overall market movement.
 FUTURES
CHARACTERISTICS:
 TRADING

 RISK

 SETTLEMENT
 SERVICES RENDERED
 Provide hedging facilities to buyers
and sellers to protect them against
unpredictable price fluctuations over
time.
 Introduce an element of stability
market prices.
 Indicate expected future prices.
 SWAPS
 It is an agreement between two
parties to exchange sequences of
cash flows for a set period of
time.
 INTREST RATE SWAP

 EXAMPLE:
TERMS:
Notional amount- 100 lakh
Maturity- 5 years
Fixed rate payer- Alpha Corp.
Floating rate payer-Gamma Corp.
Fixed Rate- 5 %, semiannual
Floating rate- 3 month
 Fixed rate payment
(5% semi-annual)

Alpha Corp Gamma Corp

Floating rate
payment
(3-month Libor)
 Alpha Corp agrees to pay 5 % of 100 lakhs on a semiannual
basis to Gamma Corp. for the next 5 years.
 That is, Alpha will pay 2.5 % of 100 lakhs, or 2.5 lakhs,
twice a year.
 Gamma Corp agrees to pay 3-month LIBOR on a 3-monthly
basis (or quarterly basis) to Alpha Corp for the next 5 years.
 That is, Gamma will pay the 3-month LIBOR rate, divided by
four and multiplied by the notional amount, four times per
year.
 For example, if the 3-month LIBOR is 2.4 % on the reset
date, Gamma will pay 2.4% / 4 = 0.6% of 100 lakhs = 0.6
lakhs every 3 months.
 VALUATION OF
DERIVATIVES
 Pricing futures: Following factors affect
the future prices:
a) Spot Price.
b) Basis=Current cash price – Future
price.
c) Spreads.
d) Expected future spot price
e) Cost of storage
 Pricing options:

Explained with the help of following Model

 THE BLACK SCHOLES MODEL:

 COV = MPS [N (d)] – EP [antilog (-rt)] [N (d2)]

 Where;
 COV= Call option value
 MPS = Current price of underlying asset
 N(d) = Cumulative density function
 EP = Exercise price of option
 R = Continuity compounded risk less rate of interest on an annual basis.
 T = Time remaining before the expiration of option
 N(d2) = Cumulative density function of d2
 IMPORTANCE
 To minimize risk.
 To protect the interest of individual and
institutional investors.
 Offers high liquidity and flexibility.
 Does not create new risk and minimizes
existing ones.
 Lowers transaction cost.
 Provides information on market movement.
 Provides wide choice of hedging.
 Convenient, low cost and simple to operate.