Financial Derivatives and the Future Market

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  • Topic: Futures contract, Derivatives, Derivative
  • Pages : 25 (8376 words )
  • Download(s) : 108
  • Published : August 31, 2013
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INTRODUCTION

Due to the wave of globalization and liberalization, multiple growth in the volume of international trade and business is recorded all over the world. As a result , the demand for the international money and finance instruments increased significantly at the global level. Changes in stock market prices, interest rate and exchange rates at the different financial market have increased the financial risk to the corporate world. In order to manage to such risks, the new financial instruments have been developed in the financial markets, which are popularly known as DERIVATIVES. As Financial Instruments, Derivatives has become very important in last two decades or so. Though the practice of using Derivatives is very old but formal application of these instruments in financial engineering came only recently. A lot of academic research have been carried out on the various aspects of the financial derivatives. Understanding their applications, uses and misuses constitutes an important part of study of the financial engineering. Before explaining the term financial derivatives, let us see the dictionary meaning of ‘Derivatives’. Webster’s dictionary states that the word derivative is formed by derivation. It means something has to be derived or arisen out of underlying variables. For example, financial derivative is an instrument derived from the financial market. Derivatives are structurally related to other substances: the substance that can be made from another substance in one or more steps. In case of financial derivatives they are derived from the combination of cash market instruments or other derivative instruments.

FEATURE OF FINANCIAL DERIVATIVES

• Realated to Future: A Derivative instrument relates to the future contracts between two parties. It means there must be some contracts binding on the parties and same to be fulfilled in future.

• Value Derived from Underlying Asset: The derivative instrument have some value which has been derived from the value of other underlying assets like agricultural commodities, metals, financial assets or intangible assets. The value of derivatives changes as per the changes in the underlying assets.

• Obligation: In general, both the parties have specified obligation under the derivative contract. The nature of the Obligation would be as per the type of instrument of a derivative. Obligations differ in Forwards, Futures, Swaps and it may differ in Options.

• Contract Between Parties: The derivative contracts can be undertaking directly between two parties or through an exchange like financial futures contracts. The derivative traded through exchange are very liquid and have low transaction costs in comparison to tailor-made contracts. Examples of exchange traded derivatives are S&P 500, NIFTY, which are traded through National Stock Exchange(NSE) and Bombay Stock Exchange (BSE).

• Mostly settled by difference: In derivative trading generally the delivery of underlying asset is very rare and almost to nil. They are mostly settled by taking offsetting positions.

• Easier to take Short or Long position: Derivatives are known as deferred delivery or deferred payment instruments. It means it is easier to take Short or Long positions in derivatives in comparison to other assets or securities.

• Secondary Market Instruments: Derivatives are mostly secondary market instruments and have no use in raising fresh capital by the corporate world.

These are some of the basic features of the financial derivatives. These are some few features which represents the features of each and every type of derivative instrument whether it is Forward, Futures, Options or Swaps.

INTRODUCTION TO FUTURE MARKET

A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the...
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