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A look at financial derivatives in India

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  1. Introduction
  2. Foreword
  3. Preface
  4. Introduction of derivatives
  5. Research methodology
  6. Derivatives described
    1. Types of derivatives
    2. Forward contract
    3. Future contract
    4. Option contracts
  7. Analysis and data interpretation
  8. Conclusion
  9. Annexures
  10. Bibliography

The derivatives markets has existed for centuries as a result of the need for both users and producers of natural resources to hedge against price fluctuations in the underlying commodities. Although trading in agricultural and other commodities has been the driving force behind the development of derivatives exchanges, the demand for products based on financial instruments?such as bond, currencies, stocks and stock indices?have now far outstripped that for the commodities contracts. India has been trading derivatives contracts in silver, gold, spices, coffee, cotton and oil etc for decades in the gray market. Trading derivatives contracts in organized market was legal before Morarji Desai's government banned forward contracts. Derivatives on stocks were traded in the form of Teji and Mandi in unorganized markets. Recently futures contract in various commodities were allowed to trade on exchanges. For example, now cotton and oil futures trade in Mumbai, soybean futures trade in Bhopal, pepper futures in Kochi, coffee futures in Bangalore etc.In June 2000, National Stock Exchange and Bombay Stock Exchange started trading in futures on Sensex and Nifty. Options trading on Sensex and Nifty commenced in June 2001. Very soon thereafter trading began on options and futures in 31 prominent stocks in the month of July and November respectively. Derivatives are financial contracts whose value/price is dependent on the behavior of the price of one or more basic underlying assets (often simply known as the underlying). These contracts are legally binding agreements, made on the trading screen of stock exchanges, to buy or sell an asset in future. The asset can be shares, index, interest rate, bond, rupee dollar exchange rate, sugar; crude oil, soybean, cotton, coffee and whatever have you.

[...] the holder of the former call can buy the underlying securities at Rs.180 and can be in the same position as the holder of the other call who could but the same security at Rs.190,plus the cash left over .Obviously, therefore the cal with a higher exercise price cannot be valued higher Time of maturity:-The effect of time to expiration on the option price depends on whether the option is of the American or European Style. The American call and put option become more valuable as the time to expiration increases. [...]

[...] From July 1996 onwards, with NSCC guaranteeing trades on the NSE, this prerequisite for a derivatives market now exists in India. The human capabilities that go into creating a clearing corporation can also be easily redeployed to new markets, such as the foreign exchange market which has such a deep need for trading derivatives. Sophistication of traders Derivatives are complex. The payos that buyer and seller face, the risks that buyer and seller face, and the economic theory that is used for pricing derivatives: all these are considerably more difficult than that seen on the equity or the debt market. [...]

[...] FUTURES Futures are exchange-traded contracts to buy or sell an asset in future at a price agreed upon today. The asset can be share, index, interest rate, bond, rupee-dollar exchange rate, sugar, crude oil, soybean, cotton, coffee etc. The price of a futures contract is spot price of the underlying plus the cost of carry. Futures are not about predicting future prices of the underlying assets. In general, Futures Price = Spot Price + Cost of Carry The Cost of Carry is the sum of all costs incurred if a similar position is taken in cash market and carried to expiry of the futures contract less any revenue that may arise out of holding the asset. [...]

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