c
  





 is a financial instrument whose value depends on other, more basic,
underlying variables[1]. Such variables can be the price of another financial instrument (the underlying asset[2]),
interest rates, volatilities, indices, etc. There are many kinds of derivatives, with the most common
being swaps, futures, and options. Derivatives are a form of alternative investment.

A derivative is not a stand-alone asset, since it has no value of its own. However, more common types of
derivatives have been  

 
 

 




 
 Among the oldest
of these are rice futures, which have been traded on the Dojima Rice Exchange since the eighteenth century.[3]

Derivatives are usually broadly categorized by:

0 the relationship between the underlying asset and the derivative (e.g., forward, option, swap);
0 the type of underlying asset (e.g., equity derivatives, foreign exchange derivatives, interest rate derivatives,
commodity derivatives or credit derivatives);
0 the market in which they trade (e.g., exchange-traded or over-the-counter); and
0 their pay-off profile.


c
  

 is a derivative in which counterparties exchange certain benefits of one

party's financial instrument for those of the other party's financial instrument. The benefits in question depend on
the type of financial instruments involved. For example, in the case of a swap involving two bonds, the benefits in
question can be the periodic interest (or coupon) payments associated with the bonds. Specifically, the two
counterparties agree to exchange one stream of cash flows against another stream. These streams are called
the a
 of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way they
[1]
are calculated. Usually at the time when the contract is initiated at least one of these series of cash flows is
determined by a random or uncertain variable such as an interest rate,foreign exchange rate, equity price or
[1]
commodity price.

The cash flows are calculated over a notional principal amount, which is usually not exchanged between
counterparties. Consequently, swaps can be in cash or collateral.

Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on changes in the expected
direction of underlying prices.
[1]
The first swaps were negotiated in the early 1980s. David Swensen, a Yale Ph.D. at Salomon Brothers,
engineered the first swap transaction according to "When Genius Failed: The Rise and Fall of Long-Term Capital
Management" by Roger Lowenstein. Today, swaps are among the most heavily traded financial contracts in the
world: the total amount of interest rates and currency swaps outstanding is more thɚn $426.7 trillion in 2009,
according to International Swaps and Derivatives Association(ISDA).
Types of swaps

The five generic types of swaps, in order of their quantitative importance, are: interest rate swaps, currency swaps,
credit swaps, commodity swaps and equity swaps. There are also many other types.
c  



A is currently paying floating, but wants to pay fixed. B is currently paying fixed but wants to pay floating. By entering into an interest

rate swap, the net result is that each party can 'swap' their existing obligation for their desired obligation. Normally the parties do not

swap payments directly, but rather, each sets up a separate swap with a financial intermediary such as a bank. In return for matching
the two parties together, the bank takes a spread from the swap payments.

The most common type of swap is a ³plain Vanilla´ interest rate swap. It is the exchange of a fixed rate loan to a
floating rate loan. The life of the swap can range from 2 years to over 15 years. The reason for this exchange is to
take benefit from comparative advantage. Some companies may have comparative advantage in fixed rate markets
while other companies have a comparative advantage in floating rate markets. When companies want to borrow
they look for cheap borrowing i.e. from the market where they have comparative advantage. However this may lead
to a company borrowing fixed when it wants floating or borrowing floating when it wants fixed. This is where a swap
comes in. A swap has the effect of transforming a fixed rate loan into a floating rate loan or vice versa. For
example, party B makes periodic interest payments to party A based on a „
 a interest rate of LIBOR +70 basis
points. Party A in return makes periodic interest payments based on a fixed rate of 8.65%. The payments are
calculated over the  a amount. The first rate is called „
 a , because it is reset at the beginning of each
interest calculation period to the then current reference rate, such as LIBOR. In reality, the actual rate received by A
and B is slightly lower due to a bank taking a spread.

è  


å 
a 




A currency swap involves exchanging principal and fixed rate interest payments on a loan in one currency for
principal and fixed rate interest payments on an equal loan in another currency. Just like interest rate swaps, the
currency swaps also are motivated by comparative advantage. Currency swaps entail swapping both principal and
interest between the parties, with the cashflows in one direction being in a different currency than those in the
opposite direction.
è 


å 
a 


A commodity swap is an agreement whereby a floating (or market or spot) price is exchanged for a fixed price over
a specified period. The vast majority of commodity swaps involve crude oil.
¢ 


å 
a   


An equity swap is a special type of total return swap, where the underlying asset is a stock, a basket of stocks, or a
stock index. Compared to actually owning the stock, in this case you do not have to pay anything up front, but you
do not have any voting or other rights that stock holders do.
è 




å 
a 
  a


A credit default swap (CDS) is a swap contract in which the  
of the CDS makes a series of payments to
the  aa
and, in exchange, receives a payoff if a credit instrument - typically a bond orloan - goes into default (fails
to pay). Less commonly, the credit event that triggers the payoff can be a company
undergoing restructuring, bankruptcy or even just having its credit rating downgraded. CDS contracts have been
compared with insurance, because the buyer pays a premium and, in return, receives a sum of money if one of the
events specified in the contract occur. Unlike an actual insurance contract the buyer is allowed to profit from the
contract and may also cover an asset to which the buyer has no direct exposure.

c
  

  
   is a standardized contract between two parties to buy or sell a
specified asset (e.g. oranges, oil, gold) of standardized quantity and quality at a specified future date at a price
agreed today (the  

 or the strike price). The contracts are traded on a futures exchange. Futures
contracts are not "direct" securities like stocks, bonds, rights or warrants. They are still securities, however, though
they are a type of derivative contract. The party agreeing to buy the underlying asset in the future assumes a long
position, and the party agreeing to sell the asset in the future assumes a short position.

The price is determined by the instantaneous equilibrium between the forces of supply and demand among
competing buy and sell orders on the exchange at the time of the purchase or sale of the contract.

In many cases, the underlying asset to a futures contract may not be traditional "commodities" at all ± that is,
for   a 
, the underlying asset or item can becurrencies, securities or financial instruments and intangible
assets or referenced items such as stock indexes and interest rates.

The future date is called the  a„
  or  a a    . The official price of the futures contract at the
end of a day's trading session on the exchange is called the  a  
 for that day of business on the
exchange.[1]

A closely related contract is a forward contract; they differ in certain respects. Futures contracts are very similar to
forward contracts, except they are exchange-traded and defined on standardized assets.[2] Unlike forwards, futures
typically have interim partial settlements or "true-ups" in margin requirements. For typical forwards, the net gain or
loss accrued over the life of the contract is realized on the delivery date.
A futures contract gives the holder the a
 to make or take delivery under the terms of the contract, whereas
an option grants the buyer the

 but  a
 to establish a position previously held by the seller of the
option. In other words, the owner of an options contract   exercise the contract, but both parties of a "futures
contract"   fulfill the contract on the settlement date. The seller delivers the underlying asset to the buyer, or, if it
is a cash-settled futures contract, then cash is transferred from the futures trader who sustained a loss to the one
who made a profit. To exit the commitment prior to the settlement date, the holder of a futuresposition has to offset
his/her position by either selling a long position or buying back (covering) a short position, effectively closing out the
futures position and its contract obligations.

In the United States, a mutual fund is registered with the Securities and Exchange Commission (SEC) and is
overseen by a board of directors (if organized as a corporation) or board of trustees (if organized as a trust). The
board is charged with ensuring that the fund is managed in the best interests of the fund's investors and with hiring
the fund manager and other service providers to the fund. Under Internal Revenue Service (IRS) rules, a U.S.
mutual fund must distribute effectively all of its net income and net realized gains from the sale of securities at least
annually.

Since 1940, with the passage of the Investment Company Act of 1940 (the '40 Act), there have been three basic
types of registered investment companies in the United States: open-end funds (or mutual funds), unit investment
trusts (UITs); and closed-end funds. Recently, exchange-traded funds (ETFs), which are a type of open-end fund or
unit investment trust that trades on an exchange, have gained in popularity. Hedge funds are not considered a type
of mutual fund; while they are another type of commingled investment scheme, they are not governed by
the Investment Company Act of 1940 and are not required to register with the Securities and Exchange
Commission.

In the rest of the world,   a  is used as a generic term for various types of collective investment vehicles
available to the general public, such as unit trusts, open-ended investment companies (OEICs, pronounced
"oyks"), unitized insurance funds, UCITS (Undertakings for Collective Investment in Transferable Securities,
pronounced "YOU-sits") and SICAVs („     a„
 a , pronounced "SEE-cavs").


In finance, an  is a derivative financial instrument that establishes a contract between two

parties concerning the buying or selling of an asset at a reference price. The buyer of the option gains the right, but
not the obligation, to engage in some specific transaction on the asset, while the seller incurs the obligation to fulfill
the transaction if so requested by the buyer. The price of an option derives from the difference between the
reference price and the value of the 
a
asset (commonly astock, a bond, a currency or a futures contract)
plus a premium based on the time remaining until the expiration of the option. Other types of options exist, and
options can in principle be created for any type of valuable asset.

An option which conveys the right to buy something is called a 

; an option which conveys the right to sell is
called a  . The reference price at which the underlying may be traded is called the strike price or exercise price.
The process of activating an option and thereby trading the underlying at the agreed-upon price is referred to
as 

it. Most options have an expiration date. If the option is not exercised by the expiration date, it
becomes void and worthless.

In return for granting the option, called


the option, the originator of the option collects a payment,
the 
 , from the buyer. The writer of an option must make good on delivering (or receiving) the underlying
asset or its cash equivalent, if the option is exercised.

An option can usually be sold by its original buyer to another party. Many options are created in standardized form
and traded on an anonymous options exchange among the general public, while other over-the-counter options are
customized ad hoc to the desires of the buyer, usually by an investment bank

An investment bank is a financial institution that assists individuals, corporations and governments in raising
capital by underwriting and/or acting as the client's agent in the issuance of securities. An investment bank may
also assist companies involved in mergers and acquisitions, and provide ancillary services such as market making,
trading of derivatives, fixed income instruments, foreign exchange, commodities, and equity securities.

There are two main lines of business in investment banking. Trading securities for cash or for other securities (i.e.,
facilitating transactions, market-making), or the promotion of securities (i.e., underwriting, research, etc.) is the "sell
side", while dealing with pension funds, mutual funds, hedge funds, and the investing public (who consume the
products and services of the sell-side in order to maximize their return on investment) constitutes the "buy side".
Many firms have buy and sell side components.


The primary market is that part of the capital markets that deals with the issuance of new securities.
Governments or public sector institutions can obtain funding through the sale of a new stock or bond issue.
This is typically done through a syndicate of securities dealers. The process of selling new issues to investors is
called underwriting. In the case of a new stock issue, this sale is an initial public offering (IPO. Primary markets
creates long term instruments through which corporate entities borrow from capital market.

Features of primary markets are:

0 This is the market for new long term equity capital. The primary market is the market where the securities are
sold for the first time. Therefore it is also called the new issue market (NIM).
0 In a primary issue, the securities are issued by the company directly to investors.
0 The company receives the money and issues new security certificates to the investors.
0 Primary issues are used by companies for the purpose of setting up new business or for expanding or
modernizing the existing business.
0 The primary market performs the crucial function of facilitating capital formation in the economy.
0 The new issue market does not include certain other sources of new long term external finance, such as loans
from financial institutions. Borrowers in the new issue market may be raising capital for converting private
capital into public capital; this is known as "going public."
0 The financial assets sold can only be redeemed by the original holder.
 ë
  
 , also called   , is the financial market where previously
issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold.
Another frequent usage of "secondary market" is to refer to loans which are sold by a mortgage bank to investors

The term "secondary market" is also used to refer to the market for any used goods or assets, or an alternative use
for an existing product or asset where the customer base is the second market (for example, corn has been
traditionally used primarily for food production and feedstock, but a "second" or "third" market has developed for
use in ethanol production).

With primary issuances of securities or financial instruments, or the primary market, investors purchase these
securities directly from issuers such as corporationsissuing shares in an IPO or private placement, or directly from
the federal government in the case of treasuries. After the initial issuance, investors can purchase from other
investors in the secondary market.

The secondary market for a variety of assets can vary from loans to stocks, from fragmented to centralized, and
from illiquid to very liquid.

=========
 
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A forward contract or µforward¶ is an agreement between two parties, wherein one will sell an asset to the other on
a certain future date at an agreed price. The quantity and quality specifications of the asset and place of delivery
are mutually decided while entering into the agreement.
Essentially, the agreement takes place after a one-to-one negotiation between the buyer and the seller and hence,
forward contracts offer a lot of flexibility in terms of duration of the contract, quality and quantity of assets and so
on.
Illustration
Suppose you plan to sell your house to a friend for Rs 50 lakh one year down the line for which you enter into a
contract today. In this case the asset sold is unique, the price is fixed and so is the date of delivery. This amounts
to a forward contract.

As Forward contracts are negotiated on a one-to-one basis, they offer a high degree of flexibility in terms of price,
quantity and delivery time. However their drawbacks are poor liquidity (as they are customised/unique to the two
parties in the contract, they cannot be traded with any other party) and default risk (either of the parties could fail to
fulfil their obligations).
In India, forward contracts are regularly used in the foreign exchange markets to hedge currency risk and in the
commodities market to hedge price risk.


£ ë
¢

Futures contracts or µfutures¶ are an improvement over forward contracts as they are standardized and tradable.
A futures contract is a legal agreement between a buyer and a seller and both parties are bound to uphold the
agreement. As per the contract, the seller agrees to sell a specific asset to the buyer at an agreed price on a
particular date in the future. The contract specifies quantity, quality, delivery time, place and date of delivery.
Futures contracts are highly liquid since they are standardized (i.e. all contracts are structured so that they
conform to certain combinations of parameters in terms of quality, quantity, expiration date, etc.) and can be
traded on an exchange. Besides, there is no counter party risk or risk of default, as a clearing corporation or
clearing house assumes this risk. In fact, in a futures contract you are unlikely to even know your counter party,
just as is the case with buying or selling stocks through a stock exchange. The clearing corporation plays a
crucial role as it takes care of transaction processing and settlement and also guarantees trades. Further, as
futures contracts are standardized and liquid, price discovery is far better than in the case of forward contracts,
where direct negotiation takes place between two parties.

ëc

An option is a contract where the writer of the option grants the buyer of the option the right to purchase from
(call option) or sell to (put option) him a specific asset at a specific price within a specified period. In return the
buyer of the option (also called the option holder) pays a price called an option premium to the writer for this
right. In common market parlance, the writer of the option is also called the µseller¶ of the option.
The option seller has the obligation to honour the contract, whether he is required to sell or buy the asset, if
the buyer chooses to exercise his option to buy or sell. The potential downside or risk for the option seller is
unlimited, while his upside or profit is limited to the premium that he receives. On the other hand, the
maximum loss that the buyer could face is the option premium that he pays, but his potential profit is
unlimited.




ë

A warrant is a call option, which gives you the right (but you are not obliged) to buy a predetermined number
of equity shares within a stipulated time frame at an agreed price. Normally, a nominal margin of about 10 per
cent of the agreed price, is payable when warrants are subscribed by the investor.
The important difference between a normal call option and a warrant is that warrants are for a longer duration
(1 to 5 years) as against the duration of a call option which is usually only a few months (normally up to 3
 months in the case of stock options on the NSE and BSE).
Warrants are normally issued by companies for the benefit of a certain class of shareholders (i.e. promoters
or institutional investors) or to raise capital over a period of time or reduce interest cost (by attaching warrants
to debt instruments).



A swap is an agreement between two parties to exchange their cash flow streams, without liquidating the
asset that generates those flows. The best example of a swap is applicable to the case of a floating rate
housing loan. If you expect interest rates to go up in the near future, you could swap your floating rate loan for
a fixed rate, without having to prepay your loan and take a fresh one. Even corporations with floating rate debt
could swap their liabilities to a fixed rate obligation, without having to retire and reissue debt.
Swaps can be used either for hedging or for speculation, as the party to the contract who does not wish to
bear the risk of an uncertain cash flow position swaps it with one who is able to take on this risk, in
anticipation of returns. Currency and interest rates are popular underlyings for swaps.


A  

  is a professionally-managed type of collective investment scheme that pools money from many
investors to buy securities (stocks, bonds, short-term money market instruments, and/or other securities).[1] A
mutual fund has a fund manager that trades (buys and sells) the fund's investments in accordance with the fund's
investment objective.

ë
c

c

When private companies i.e. companies that are wholly owned by their promoters, invite the public to subscribe
to their shares, this issue of shares is called an Initial Public Offering (IPO). The shares issued could be in the
form of fresh equity and/or the promoters sell a portion of their equity to the public. These shares are then listed
on a stock exchange where they can be bought and sold by investors. IPOs are a very popular way of investing
in the stock market as they allow investors a simple entry route to buying stocks.


ë
c

£

When an already listed company makes either an offer for sale to the public or a fresh issue of shares, this
issue of shares is called Follow on Public Offer (FPO).





¢
ë¢
cë¢
¢
c
c¢
c

c

Merchant Banker or Book Running Lead Managers (BRLM) to the issue, Syndicate Members, Underwriters to
issue, Registrars to issue, Bankers to issue, Auditors etc. are the intermediaries to an issue. Contact details of
all intermediaries like, contact person, Telephone number, address, email address etc are disclosed by the
issuer.



 The most commonly used derivatives contracts are forwards, futures and options, which we shall discuss
in detail later. Here we take a brief look at various derivatives contracts that have come to be used.

£   A forward contract is a customized contract between two entities, where settlement takes
place on a specific date in the future at today's pre-agreed price.

£   A futures contract is an agreement between two parties to buy or sell an asset at a certain time
in the future at a certain price. Futures contracts are special types of forward contracts in the sense that
the former are standardized exchange-traded contracts.

  Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to
buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give
the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price
on or before a given date.

 Swaps are private agreements between two parties to exchange cash flows in the future
according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two
commonly used swaps are:

@ Interest rate swaps: These entail swapping only the interest related cash flows between the parties
in the same currency.
@ Currency swaps: These entail swapping both principal and interest between the parties, with the
cash flows in one direction being in a different currency than those in the opposite direction.

   Options generally have lives of upto one year, the majority of options traded on options
exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and
are generally traded over-the-counter.