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DERIVATIVE

&
TYPES OF
DERIVATIVE

Derivative

A derivative is asecuritywith a price that is dependent


upon or derived from one or more underlyingassets. The
derivative itself is a contract between two or more parties
based
upon
the
asset
or
assets.
Common underlying instruments include: bonds, commodities,
currencies, interest rates, market indexes and stocks.

TYPES OF DERIVATIVE

Futures contracts
forward contracts
Options
swaps

Future contract
Futures contractsare one of the most common types of
derivatives. A futures contract (or simplyfutures, colloquially) is
an agreement between two parties for the sale of an asset at an
agreed upon price.
It is a standardized contract .
suppose that on July 31, 2014 Diana owned ten thousand shares
of Wal-Mart (WMT) stock, which were then valued at $73.58 per
share. Fearing that the value of her shares would decline, Diana
decided that she wanted to arrange a futures contract to protect
the value of her stock. Jerry, a speculator predicting a rise in the
value of Wal-Mart stock, agrees to a futures contract with Diana,
dictating that in one years time Jerry will buy Dianas ten
thousand Wal-Mart shares at their current value of $73.58.

Forward contract

A customized contract between two


parties to buy or sell an asset at a
specified price on a future date.
A forward contract can be used for
hedging or speculation, although its nonstandardized nature makes it particularly
apt for hedging.

Forward Contract Example


Farmer

I agree to sell
500kgs wheat
at Rs.40/kg
after 3
months.

Bread
Maker

3 months
Later

Farmer

500kgs
wheat
Rs.20,00
0

Bread
Maker

Option contract
An option is a derivative financial
instrument that specifies a contract
between two parties for a future
transaction on an asset at a
reference price.
Two option of contract: Call Option
Put Option

Call Option Example


Premium =
Rs.25/share
Amt to buy
Call option =
Rs.2500

CALL
Right to buy
OPTION
100 Reliance
shares at a
price of Rs.300
per share after
3 months.

Suppose after a
month, Market price
is Rs.400, then the
option is exercised
i.e. the shares are
bought.
Net gain = 40,000-

Current Price =
Rs.250

Strike
Price
Expir
y
date

Suppose after a month,


market price is Rs.200,
then the option is not
exercised.
Net Loss = Premium amt
= Rs.2500

Put Option Example


Premium =
Rs.25/share
Amt to buy
Call option =
Rs.2500

PUT OPTION
Right to sell
100 Reliance
shares at a
price of Rs.300
per share after
3 months.

Suppose after a
month, Market price
is Rs.200, then the
option is exercised
i.e. the shares are
sold.
Net gain = 30,000-

Current Price =
Rs.250

Strike
Price
Expir
y
date

Suppose after a month,


market price is Rs.300,
then the option is not
exercised.
Net Loss = Premium amt
= Rs.2500

Swaps
Swaps are financial agreements to
exchangecashflows. Swaps can be
based on interest rates,stock
indices, foreigncurrencyexchange
rates and even commodities prices.