Derivatives
About
- Derivatives refers to the financial instruments which derive their value from an underlying security or financial instrument. The underlying products can be equity, commodity, currency, etc.
- The basic principle behind entering into derivative contracts is to earn profits by speculating on the value of the underlying asset in future.
Types of Derivatives:
- Most common types of derivative instruments are forwards, futures, options, and swaps.
- Options: Options are derivative contracts that give the buyer a right to buy/sell the underlying asset at the specified price during a certain period of time. The buyer is not under any obligation to exercise the option.
- Futures: Futures are standardised contracts that allow the holder to buy/sell the asset at an agreed price at the specified date. The parties to the futures contract are under an obligation to perform the contract.
- Forwards: Forwards are like futures contracts wherein the holder is under an obligation to perform the contract. But forwards are unstandardised and not traded on stock exchanges. These are available over-the-counter and are not marked-to-market.
- Swaps: Swap derivatives allow two parties to let go of their current financial instruments’ liabilities or cash flows by swapping them with other liabilities or cash flows from a different financial instrument.