Derivative:A derivative is a security that derives value from the value or return of another asset or security.

The derivative itself is merely a contract. Forward contracts, future contracts and option contracts are derivatives Physical exchanges exists for many options contracts and futures contracts. Exchange traded derivatives are standardised and backed by clearing houses.

Types of contracts:-

FORWARD CONTRACT: F T !E "#$T!A"T% %wap "ontracts #ption "#$T!A"T

FORWARD CONTRACT: &t is a bilateral contract that obligates one party to buy and the

other to sell a specific 'uantity of an asset, at a set price, on a specific date in the future. $either party to the contract pays anything to get into the contract. &f the expected future price of the asset increases over the life of the contract, the right to buy at the contract price will have a positive value and the obligation to sell will have an e'ual negative value and vice(versa.
A party seeks to enter into a forward contract to hedge a risk it

already has.
Forward contracts can be on(e'uities, stock index. &t can also

be on )ero(coupon bonds an coupon bonds.*the contract with bonds must settle before the contract ends.

FUTURE CONTRACTS:-

A future contract is a forward contract that

is standardised and exchange(traded.

These are like forward contracts and are

most common for delivery of commodities and financial assets at a future date.
The main differences with forwards are that

futures are traded in an active secondary market, which are regulated, backed by the clearing house and re'uire a daily settlements of gains and losses

Swap Contracts: A swap is a series of forward contracts. &n the simplest

swap, one party agrees to pay the short(term *floating+ rate of interest on some principal amount, and the counterparty agrees to pay a certain*fixed+ rate of interest in return. %waps of different currencies and e'uity returns are also there.
The length of swap is termed the tenor of the swap and the

contract ends on the termination date.

A swap can be decomposed into a series of forward

contracts*F!A,s + that expire on settlement dates.

 Forwards and swaps are customi-ed

contracts *over( the( counter derivatives+ and are created.traded by dealers and by financial institutions in a market with no central location *they are largely unregulated markets +.There is very limited trading of these contracts in the secondary markets and default risk is there. *when the counter party does not honour their commitment+.

Swaps are similar to forwards in followin ways:swaps re'uire no payment by either party on initiation.
swaps are custom instruments swaps are not traded in any organi-ed secondary market swaps are largely unregulated /efault risk is an important aspect of the contracts 0ost participants in the swaps market are large institutions. &ndividuals are rarely swap market participants. There are swap facilitators who bring together parties with need for

the opposite sides of swaps.

Difference !etween forward and f"t"re contracts

Compared to forward contracts, future contracts: Are more li'uid, trade on exchanges and can be closed out by an offsetting trade. /o not have counterparty risk as the clearing house acts as counterparty to each

side of the contract.

1ave lower transaction costs !e'uire margin deposits and are marked to market daily Are standardised contracts as to asset 'uantity,'uality,settlement dates and

delivery re'uirements.

Option CONTRACT:
An option contract gives its owner the right, but not the legal obligation ,to

conduct a transaction involving an underlying asset at a predetermined future date and at a predetermined price
A call option on a financial or physical asset gives the option,s owner the

right but not the obligation to buy a specified 'uantity of the asset from the option writer at the exercise price specified in the option for a given time period. The writer of a call option is obligated to sell the asset at the exercise price if the option,s owner chooses to exercise it.
A put option on a financial or physical asset gives the option,s owner the

right, but not the obligation, to sell a specified 'uantity of the asset to the option writer at the exercise price if the option,s owner chooses to exercise it.
The owner*buyer+of an option is said to be long the option. And the

writer*seller+ of the option is said to be s ort the option.

#ptions are available on Financial securities ,future contracts, interest rates

and commodities.