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    Introduction To Derivatives (Risk Management)

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    Vrutika Shah
    This document provides an introduction to derivatives and risk management. It defines derivatives as financial instruments whose value is based on an underlying asset. The key types of derivatives discussed are forwards, futures, options, and swaps. Forwards and futures are agreements to buy or sell an asset at a future date for a set price, while options provide the right to buy or sell an asset. Swaps involve exchanging cash flows. Derivatives allow hedging to reduce risk, speculation to take on risk for potential profit, and arbitrage to exploit temporary price differences. The document also discusses the various markets and participants involved in derivatives trading.

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    Introduction To Derivatives (Risk Management)

    Uploaded by

    Vrutika Shah
    86 views25 pages
    This document provides an introduction to derivatives and risk management. It defines derivatives as financial instruments whose value is based on an underlying asset. The key types of derivatives discussed are forwards, futures, options, and swaps. Forwards and futures are agreements to buy or sell an asset at a future date for a set price, while options provide the right to buy or sell an asset. Swaps involve exchanging cash flows. Derivatives allow hedging to reduce risk, speculation to take on risk for potential profit, and arbitrage to exploit temporary price differences. The document also discusses the various markets and participants involved in derivatives trading.

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    Introduction to Derivatives (Risk Management)

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    This document provides an introduction to derivatives and risk management. It defines derivatives as financial instruments whose value is based on an underlying asset. The key types of derivatives discussed are forwards, futures, options, and swaps. Forwards and futures are agreements to buy or sell an asset at a future date for a set price, while options provide the right to buy or sell an asset. Swaps involve exchanging cash flows. Derivatives allow hedging to reduce risk, speculation to take on risk for potential profit, and arbitrage to exploit temporary price differences. The document also discusses the various markets and participants involved in derivatives trading.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    86 views25 pages

    Introduction To Derivatives (Risk Management)

    Uploaded by

    Vrutika Shah
    This document provides an introduction to derivatives and risk management. It defines derivatives as financial instruments whose value is based on an underlying asset. The key types of derivatives discussed are forwards, futures, options, and swaps. Forwards and futures are agreements to buy or sell an asset at a future date for a set price, while options provide the right to buy or sell an asset. Swaps involve exchanging cash flows. Derivatives allow hedging to reduce risk, speculation to take on risk for potential profit, and arbitrage to exploit temporary price differences. The document also discusses the various markets and participants involved in derivatives trading.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 25

    Introduction to Derivatives

    (Risk Management)

    Ms. KRISHNA BHATT


    CONTENTS
    Risk
    Managing Risk
    Types of Risk
    Derivatives
    Derivative Products
    Classification of Derivatives
    Participants in Derivatives Market
    Functions of Derivatives
    RISK

    Risk can be defined as deviations of the actual


    results from expected.
    Risk can be classified two ways – 1) risk of small
    losses with frequent occurrence and 2) risk of large
    losses with infrequent occurrence.
    The impact or magnitude of risk is normally
    estimated from following two factors
    1. The probability of an adverse event happening,
    2. In case the event occurs the magnitude of the
    loss can cause.
    MANAGING RISK

    Risk Avoidance
    Risk Reduction
    Insurance
    Risk Transfer
    Hedging
    TYPES OF RISK

    Event Risk
    Business Risk
    Business Risk can be further classified as
    follows:
    1. Price Risk
    2. Exchange Rate Risk
    3. Interest Rate Risk
    •DERIVATIVES

    A derivative can be defined as a financial


    instrument whose value depends on (or derives
    from) the values of other, more basic, underlying
    variables.
    A derivative instrument is a financial contract
    whose payoff structure is determined by the value
    of an underlying commodity, security, interest
    rate, share price index, exchange rate, oil prices,
    etc.
    DERIVATIVES

    They derive value from an underlying


    asset class.
    Asset classes range from financial
    instruments to commodities to even
    classes such as weather and industrial
    effluents.
    •Underlying Asset Class
    It is important to understand the underlying asset
    class before using derivatives.
    Asset classes can be classified into two broad
    categories- financial which includes currencies
    and commodities.
    Financial asset classes can be broadly categorised
    into interest rates, equities and currencies.
    Commodities range from agricultural commodities
    to minerals and metals.
    •Exchange Traded Markets

    ETM is a derivatives exchange where


    individuals trade standardize contracts that
    have been defined by the exchange.
    Traditionally, derivative traders used to meet
    on the floor of an exchange and used shouting
    and a set of hand signals to indicate the
    trades they would like to carry out. This is
    known as open out cry system.
    Electronic Markets
    Exchanges are increasingly replacing the
    open outcry system by electronic
    trading. This involves traders entering
    their desired trades at a keyboard and a
    computer being used to match buyers
    and sellers. (NSE/BSE)
    •Over –The-Counter Markets

    It is a telephone and computer linked network


    of dealers. Trades are done over the phone
    and are usually between two financial
    institutions or between a financial institution
    and one of its clients. Financial institutions
    often act as markets makers for the more
    commonly traded instruments. This means
    that they are always prepared to quote both a
    bid price and an offer price.
    Telephone conversations are in the OTC
    market are usually taped. If there is a
    dispute about what was agreed, the
    tapes are replayed to resolve the issue.
    •Types of Derivative
    Instrument
    ◼Forwards
    ◼Futures
    ◼Options
    ◼Swaps
    •Forward Contracts
    A relatively simple derivative is a forward contract.
    It is an agreement to buy or sell an asset at a
    certain future time for a certain price. It is traded
    in an OTC market.
    A forward contract assumes a long position when
    one of the two parties agrees to buy the
    underlying asset on a certain specified future date
    for a certain specified price.
    The other party assumes a short position and
    agrees to sell the asset on the same date for the
    same price.
    •Payoffs from Forward
    Contracts
    ◼Long Position
    St > K = positive payoff
    St < K = negative payoff
    ◼Short Position
    St < K = positive payoff
    St > K = negative payoff
    •Future Contracts

    ◼It is an agreement between two parties


    to buy or sell an asset at a certain time in
    future for a certain price. It is traded in
    ETM.
    ◼A future contract is referred by its
    delivery month & the exchange specifies
    the period during the month when the
    delivery must be made.
    •Difference between Forward &
    Future Contract
    1.Standardization
    2.Liquidity
    3.Conclusion of contract
    4.Margin
    5.Profit or loss settlement
    •Options

    Options are traded in both OTC and ETM.


    A call option gives the holder the right to
    buy the underlying asset by a certain date
    for a certain price.
    A put option gives the holder the right to
    sell the underlying asset by a certain date
    for a certain price.
    The price in the contract is known as the
    exercise price or strike price.
    The date in the contract is known as
    expiration date or maturity date.
    American option can be exercised at any
    time up to the expiration date.
    European option can be exercised only on
    the expiration date.
    Swaps

    Swaps are agreements between two


    parties to exchange a set of cashflows
    according to a predetermined method.
    •Hedgers

    Hedgers are the traders who wish to


    eliminate the risk (of price change) to
    which they are already exposed.
    •Speculators

    Speculators are those who are willing to


    take risks. These are the people who
    take positions in the market and
    assumes risks to profit from fluctuations
    in prices.
    •Arbitrageurs

    Arbitrageurs thrive on market


    imperfections. An arbitrageur profits by
    trading a given commodity, or other
    item, that sells for different prices in
    different markets.
    FUNCTIONS OF DERIVATIVES

    Enable price discovery


    Facilitate transfer of risk
    Provide leveraging
    Other benefits
    THANK YOU

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