Derivative synopsis

Topics: Futures contract, Derivative, Option Pages: 7 (3241 words) Published: April 20, 2014
Objective Of the Project :

The Project undertaken will try to comprehend on granular level the array of Derivative products available in the OTC as well as Exchange market , their constitution , usages and their Pros and cons. The Aim of the below Synopsis is to furnish a Brief background of the areas which the ongoing project will take in its ambit while elaborating in a gigantic detail their molecular structure in the upcoming time with final presentation.

Derivative Introduction
A derivative is a financial contract which derives its value from the performance of another entity such as an asset, index, or interest rate, called the "underlying". Derivatives are one of the three main categories of financial instruments, the other two being equities (i.e. stocks) and debt (i.e. bonds and mortgages). Derivatives include a variety of financial contracts, including futures, forwards, swaps, options, and variations of these such as caps, floors, collars, and credit default swaps. Most derivatives are traded over-the-counter (off-exchange) or on an exchange such as the Chicago Board Mercantile Exchange . Derivatives may broadly be categorized as "lock" or "option" products. Lock products (such as swaps, futures, or forwards) obligate the contractual parties to the terms over the life of the contract. Option products (such as interest rate caps) provide the buyer the right, but not the obligation to enter the contract under the terms specified. Derivatives can be used either for risk management (i.e. to "hedge" by providing offsetting compensation in case of an undesired event, a kind of "insurance") or for speculation (i.e. making a financial "bet"). This distinction is important because the former is a prudent aspect of operations and financial management for many firms across many industries; the latter offers managers and investors a risky opportunity to increase profit, which may not be properly disclosed to stakeholders. Along with many other financial products and services, derivatives reform is an element of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. The Act delegated many rule-making details of regulatory oversight to the Commodity Futures Trading Commission and those details are not finalized nor fully implemented as of late 2012. Forwards

A customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward contract can be used for hedging or speculation, although its non-standardized nature makes it particularly apt for hedging. Unlike standard futures contracts, a forward contract can be customized to any commodity, amount and delivery date. A forward contract settlement can occur on a cash or delivery basis. Forward contracts do not trade on a centralized exchange and are therefore regarded as over-the-counter (OTC) instruments. While their OTC nature makes it easier to customize terms, the lack of a centralized clearinghouse also gives rise to a higher degree of default risk. As a result, forward contracts are not as easily available to the retail investor as futures contracts. Consider the following example of a forward contract. Assume that an agricultural producer has 2 million bushels of corn to sell six months from now, and is concerned about a potential decline in the price of corn. It therefore enters into a forward contract with its financial institution to sell 2 million bushels of corn at a price of $4.30 per bushel in six months, with settlement on a cash basis.

In six months, the spot price of corn has three possibilities: 1. It is exactly $4.30 per bushel: In this case, no monies are owed by the producer or financial institution to each other and the contract is closed. 2. It is higher than the contract price, say $5 per bushel: The producer owes the institution $1.4 million, or the difference between the current spot price and the contracted rate of $4.30. 3. It is lower than the contract price, say $3.50 per bushel:...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Derivative Essay
  • Derivative Essay
  • Derivative Security Essay
  • Contracts Derivatives Essay
  • Derivative and Its Impact on Stock Market Research Paper
  • Currency Derivatives Essay
  • Report on Financial Derivative Essay
  • Essay on derivatives-financial risk

Become a StudyMode Member

Sign Up - It's Free