Derivative and Its Impact on Stock Market

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A Paper Presentation
Derivative and its impact on capital market
Derivative and its impact on capital market
On
Prepared by
Ms. Vidhi Joshi
Asst. Professor
MBA Department
T.N.Rao college of Management Studies
Rajkot

1. Introduction to Derivative:

The rapidity with which Indian capital market, corporate finance, banking and investment finance has witnessed a major transformation and structural change from the past one decade and this change in recent years has given birth to a new discipline that has come to be known as Financial Engineering. Financial engineering involves the design, the development, and the implementation of innovative financial instruments and processes, and the formulation of creative solutions to problems in finance. The last decade has witnessed the introduction of ‘derivatives’ as an innovative financial instrument in the Indian markets.

One of the major objectives of these reforms was to bring the Indian capital market up to a certain international standard. Due to such reforming process, one of the significant step taken in the secondary market is the introduction of derivative products in two major Indian stock exchanges viz. National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) , with a view to provide tools for risk management to investors and to improve the informational efficiency of the cash market.

A derivative is financial instrument whose value is ‘derived’ from another underlying security or a basket of securities the underlying is the identification tag for a derivative contract. Derivatives are instruments of risk hedging.

In the Indian context the Securities Contracts (Regulation) Act, 1956 (SCRA) defines “derivative” as a security that is derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security, same as a contract which derives its value from the prices, or index of prices, of underlying securities.

Derivative products includes futures, forwards, options and swaps, and these can be combined with each other or traditional securities and loans to create hybrid instruments.

In other words, a future contract is a standardized agreement between the seller (short position holder) of the contract and the buyer (long position holder), traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a pre-set price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. Equity derivatives trading started on June 9, 2000 with introduction of stock index futures by Bombay Stock Exchange (BSE). National Stock Exchange (NSE) also commenced its trading on 12 June, 2000 based on S&P Nifty. Trading on NIFTY futures was introduced on the 12th of July 2000.Trading on stock futures was introduced in the NSE in the 9th November, 2001. Subsequently, other products like stock futures on individual securities, index options and options on individual securities were introduced.

Forward Contract: A Forward Contract is a transaction in which the buyer and the seller agree upon a delivery of a specific quality and quantity of asset usually a commodity at a specified future date. The price may be agreed on in advance or in future.” Future Contract: It involves an obligation on both the parties i.e. the buyer and the seller to fulfill the terms of the contract (i.e. these are pre-determined contracts entered today for a date in the future) * Obligation to buy or sell

* Stated quantity
* At a specific price
* Stated date (Expiration Date)
* Marked to Market on a daily basis
Options: An Options contract confers the right but not the obligation to buy (call option) or sell (put option) a specified underlying instrument or asset at a specified price – the Strike or...
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