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Derivatives

Derivatives

  • Meaning:-   A derivative in the finance field is a contract whose worth depends on the extent to which an underlying entity performs.  The right or obligation to acquire or sell a certain asset at an agreed-upon price at a particular point in the future is conveyed via derivatives.  Any asset that will be purchased or sold at a future date is regarded to be an underlying asset of the derivative contract.
  • Types of Derivatives:-  

1) Options: They are derivative contracts that grant the buyer the right to purchase or sell the underlying asset at a predetermined value for an agreed-upon period. The option buyer has no obligation to exercise the contract. The option buyer pays the premium to the option seller for his rights. The strike price is the decided price by the option buyer and option seller.

2) Futures: Futures are standard contracts that offer the holder a choice to buy or sell an asset at a predetermined price and date. The parties to the futures contract are obligated to carry out their obligations under the agreement.  Futures contracts' prices are daily marked to market. It denotes that until the contract's expiration date, the contract value fluctuates by market trends.

3) Swaps: Swaps are derivative contracts in which both parties exchange their financial obligations. The cash flows are predicated on a principal sum that both parties have agreed upon without the actual principal being transferred. Based on an interest rate, the cash flow amount is determined. One cash flow is typically constant, whilst the other fluctuates based on a benchmark interest rate. The most popular type of exchange is the interest rate. Swaps are over-the-counter agreements between corporations that are not traded on stock exchanges.

4) Forwards: Forwards contracts are similar to futures contracts in the sense that the holder of the forward contract is required to fulfill the terms of the contract. However, forward contracts are not standardized since they are not traded on the stock exchanges and they may suffer from risks such as illiquidity and default risk.

  • Meaning of Equity Derivative:- A financial instrument called an equity derivative is one whose value is determined by the equity movements of the underlying asset. Such financial assets' worth varies according to stock market price swings and corporate performance.
  • Meaning of Commodity Derivative:- Trading in raw materials and basic goods like metals, energy, and agricultural goods is known as commodity trading. By successfully predicting market price changes, commodity traders hope to turn a profit. Commodity exchanges like the Multi Commodity Exchange of India Limited (MCX) are where these commodities are traded.
  • Meaning of Currency Derivative:- The buying and selling of various national currencies on the foreign exchange market are referred to as currency trading, sometimes known as forex trading. By correctly forecasting changes in foreign exchange rates, currency traders hope to generate a profit. The largest financial market in the world, the foreign exchange market is open twenty-four hours a day, seven days a week.

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