CHAPTER I

INTRODUCTION TO DERIVATIVES

A derivative security is a security whose value depends on the value of together more basic
underlying variable. These are also known as contingent claims. Derivatives securities have been
very successful in innovation in capital markets.

The emergence of the market for derivative products most notably forwards, futures and options
can be traced back to the willingness of risk -averse economic agents to guard themselves against
uncertainties arising out of fluctuations in asset prices. By their very nature, financial markets are
markets by a very high degree of volatility. Through the use of derivative products, it is possible
to partially or fully transfer price risks by locking – in asset prices. As instruments of risk
management these generally don’t influence the fluctuations in the underlying asset prices.

However, by locking-in asset prices, derivative products minimize the impact of fluctuations in
asset prices on the profitability and cash-flow situation of risk-averse investor.

Derivatives are risk management instruments which derives their value from an underlying asset.
Underlying asset can be Bullion, Index, Share, Currency, Bonds, Interest, etc.

In 1887, they formally established in Bombay, the "Native Share and Stock Brokers' Association"
(which is alternatively known as "The Stock Exchange"). In 1895, the Stock Exchange acquired a
premise in the same street and it was inaugurated in 1899. Thus, the Stock Exchange at Bombay
was consolidated.

Thus in the same way, gradually with the passage of time number of exchanges were increased
and at currently it reached to the figure of 24 stock exchanges.

TRANSACTION CYCLE:
 Decision to Placing
trade Order

Funds or
Securities
Transaction Trade
Cycle Execution

Settlement
of trades Clearing of
Trades

A person holding assets (Securities/Funds), either to meet his liquidity needs or to reshuffle his holdings in
response to changes in his perception about risk and return of the assets, decides to buy or sell the
securities. He selects a broker and instructs him to place buy/sell order on an exchange. The order is
converted to a trade as soon as it finds a matching sell/buy order. At the end of the trade cycle, the trades
are netted to determine the obligations of the trading member’s securities/funds as per settlement cycle.
Buyer/seller delivers funds/ securities and receives securities/funds and acquires ownership of the
securities.