DERIVATIVES MANAGING FINANCIAL RISK

INTRODUCTION

This Chapter describes derivatives. Derivative instruments are defined by the Securities Contracts (Regulation) Act to include (1) a security derived from a debt instrument, share, secured unsecured risk instrument or contract for differences, or any other form of security and (2) a contract derives its value from the prices index of prices of underlying securities. Derivative contracts several variants. The most common variants are forwards, futures and options. Three broad ries of participants hedger, speculators and arbitrageurs arose in the derivatives market gets face risk associated with the price of an asset. They use futures or options markets eliminate this risk. Speculators wish to bet on future movements in the price of an asset res and options contracts can give them an extra leverage, that is, they can increase both the gains and potential losses in a speculative venture. Arbitrageurs are in business to take advantage of a discrepancy between prices in two different market, for example, they see the res price of an asset getting out of line with the cash price, they will take offsetting positions in two markets to lock in a profit.

The derivatives market performs a number of economic functions. First, prices in an organised derivatives market reflect the perception of the market participants about the future and lead the of underlying to the perceived future level. The prices of derivatives converge with the of the underlying at the expiration of the derivatives contract. Thus, derivatives help in the very of the future as well as current prices. Second, the derivatives market helps to transfer from those who have them but may put like them to those who have an appetite for them derivatives, due to their inherent nature, are linked to the underlying cash markets. With the function of derivatives, the underlying market witnesses higher trading volumes because of constipation by more players who would not otherwise participate for lack of an arrangement to risk. Fourth, speculative trades shift to a more controlled environment of derivatives market. In the absence of an organised derivatives market speculators trade in the underlying cash. Marginalizing monitoring and surveillance of the activities of various participant become difficult in these kind of mixed markets. Fifth an important incidental benefit that flows derivatives trading is that it acts as a catalyst for new entrepreneurial activity. Derivatives have attracting many bright creative well educated people with an entrepreneurial attitude often others to create new businesses new products are rule new employment opportunities, the benefit of which are immense. Finally, derivatives markets help increase and the long run. Transfer of risk enables market participants to expand their volume of its sections 1-3 dwell on the three most commonly used derivative contracts, namely, forwards, future and options. The: main points are summarized in the last Section.

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