instrument, whose value is derived from underlying assets. • The general practice is to use derivatives as a risk management tool that allows an investor to transfer the risks attached with the underlying asset to the party who is willing to take it. • There can be a number of risks such as market risks, credit risk and liquidity risk. • Types: Forwards, Futures, Options, etc. • Forward: it is a customized contract between two entities, where settlement takes place on a specified date in the future at todays agreed price. It is OTC traded instruments. Example, Rice farmers wish to sell their rice at a safe price in future. They enter into a forward contract and any loss caused by the fall in the price will then be offset by profits on the forward contract. Hedging by derivatives is equivalent of insurance facility against risks. Here agreed future price is strike price. Market price on the future date is spot price • Futures: It is an agreement between two parties for the purchase and delivery of an asset at an agreed upon price at a future date. Futures are exchange traded, and the contracts are standardized. Traders will use a futures contract to hedge their risk or speculate on the price of an underlying asset. • Swap: An OTC derivative. A barter or exchange. Currency Swaps result in exchange of one currency with another, where interest rate swap help exchange a fixed rate interest with a variable rate. • Options: are another common form of derivative. An option is similar to a futures contract in that it is an agreement between two parties to buy or sell an asset at a predetermined future date for a specific price. The key difference between options and futures is that, with an option, the buyer is not obligated to "exercise" the option, while the option seller is obligated to either buy or sell the underlying asset if the buyer chooses to exercise the contract. As with futures, options may be used to hedge or speculate on the price of the underlying asset. – Put option: Investor owns 100 shares of a stock worth 50. investor could buy a put option that gives him the right to sell 100 shares of stock for Rs.50 per share (strike price) until a specific day in the future (expiration date). (SELL) – Call option - Investor does not own the stock that is currently worth 50 per share. This investor could buy a call option that gives him the right to buy the stock for Rs.50 before or at expiration. (BUY) – In both examples, the put and call sellers are obligated to fulfill their side of the contract if the call or put option buyer chooses to exercise the contract. – LEAPS: options having maturity upto 3 years. (Long term Equity Anticipation Securities) • 2(d) of SCRA, 1956 “option in securities” means a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities. • Derivative Markets: • The derivatives market is the financial market for derivatives, financial instruments like futures contracts or options • Trading in Futures and Options were introduced in India – NSE (2000) – BSE (2001) • Section 11AA of the SEBI Act, 1992 - Collective investment scheme. • (1) Any scheme or arrangement which satisfies the conditions referred to in sub-section (2) or sub-section (2A) shall be a collective investment scheme: • Provided that any pooling of funds under any scheme or arrangement, which is not registered with the Board or is not covered under sub - section (3), involving a corpus amount of one hundred crore rupees or more shall be deemed to be a collective investment scheme. • (2) Any scheme or arrangement made or offered by any [person] under which,— – (i) the contributions, or payments made by the investors, by whatever name called, are pooled and utilized for the purposes of the scheme or arrangement; – (ii) the contributions or payments are made to such scheme or arrangement by the investors with a view to receive profits, income, produce or property, whether movable or immovable, from such scheme or arrangement; – (iii) the property, contribution or investment forming part of scheme or arrangement, whether identifiable or not, is managed on behalf of the investors; – (iv) the investors do not have day-to-day control over the management and operation of the scheme or arrangement • (2A) Any scheme or arrangement made or offered by any person satisfying the conditions as may be specified in accordance with the regulations made under this Act. • (3) Notwithstanding anything contained in sub - section (2) [or sub - section (2A)],any scheme or arrangement – – (i) made or offered by a co-operative society registered under the Co-operative Societies Act, 1912 (2 of 1912) or a society being a society registered or deemed to be registered under any law relating to co -operative societies for the time being in force in any State; – (ii) under which deposits are accepted by non-banking financial companies as defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934); – (iii) being a contract of insurance to which the Insurance Act, 1938 (4 of 1938), applies; – (iv) providing for any Scheme, Pension Scheme or the Insurance Scheme framed under the Employees Provident Fund and Miscellaneous Provisions Act, 1952 (19 of 1952) – (v) under which deposits are accepted under section 58A of the Companies Act, 1956 (1 of 1956); – (vi)under which deposits are accepted by a company declared as a Nidhi or a mutual benefit society under section 620A of the Companies Act, 1956 (1 of 1956); – (vii) falling within the meaning of Chit business as defined in clause (d) of section 2 of the Chit Fund Act, 1982 (40 of 1982); – (viii) under which contributions made are in the nature of subscription to a mutual fund; – [(ix) such other scheme or arrangement which the Central Government may, in consultation with the Board, notify,] • shall not be a collective investment scheme. • security receipt: • defined in clause (zg) of section 2 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. • (zg) "security receipt" means a receipt or other security, issued by a securitisation company or reconstruction company to any qualified institutional buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitisation; • Section 2 (z) "securitisation" means acquisition of financial assets by any securitisation company or reconstruction company from any originator, whether by raising of funds by such securitisation company or reconstruction company from qualified institutional buyers by issue of security receipts representing undivided interest in such financial assets or otherwise; Financial Market • Financial system is essentially concerned with borrowing and lending. • Lending occurs either directly to borrowers (e.g. equity held by an individual) or indirectly via financial intermediaries. • Financial Instruments – Debt Instruments, Deposit Instrument (Variation of debt instrument) and Equity Instruments. • Financial Market: The institutional arrangement and conventions that exist for the issue and trading dealing of the financial instruments. • It brings buyers and sellers together to trade financial instruments. • Primary – Market for issue of new securities • Secondary – trading securities that are already issued. • It includes money market (short term debt instruments mainly OTC – directly between parties) and capital market (Exchange driven markets). • Capital market is the market in which prime borrowers are able to access long term and or permanent funding. • Equity Market: It is a part of the capital market. • The ‘Equity market is the mechanisms/conventions that exist for the ‘issue of’, ‘investing in’, and the ‘trading of marketable equity instruments that represent the permanent/semi-permanent capital of the issuers companies. • Equity represent part-ownership and not a debt of a company. • Equity include preference shares which is are redeemable. • Bond Market/debt market/ credit market : • Debt instruments represent either marketable debt (MD) or non-marketable debt, either short term (upto 1 year) or long term in terms of maturity. • MD with long duration makes up the bond market. • Issuer: Government sector, corporate sector, and foreign sector. • Primary market and secondary market