* RISK

In every aspect of life, things are constantly

“changing.”
Benjamin Franklin observed that ‘in this world
nothing can be said to be certain, except
death and taxes’.
Among the basic types of risks like Pure Risk,
Speculative Risk, Fundamental Risk and
Unique Risk, many of which are not possible
to be provided with insurance coverage.

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 *Market risk: Market risk arises when security prices
go up due to reasons affecting the sentiments of
the whole market.
*Interest rate risk: This risk arises in the case of
fixed income securities, such as treasury bills,
government securities, and bonds, whose market
price could fluctuate heavily if interest rates
change.
*Exchange rate risk: In the case of imports, exports,
foreign loans or investments, foreign currency is
involved which gives rise to exchange arte risk.

*MAJOR PRICE
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RISKS 02/24/2025
 *What follows will be a brief
introduction and insight into the
world of derivatives.

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 *AFINANCIAL PRODUCT WHICH HAS BEEN
DERIVED FROM ANOTHER FINANCIAL
PRODUCT OR COMMODITY. WITHOUT THE
UNDERLYING ASSET OR MARKET, THE
DERIVATIVES WOULD HAVE NO
INDEPENDENT EXISTENCE.

* DERIVATIVES IN
FINANCIAL MARKET

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 *DERIVATIVES HAVE RISEN FROM THE NEED
TO MANAGE THE RISK ARISING FROM
MOVEMENTS IN MARKETS BEYOND OUR
CONTROL, WHICH MAY SEVERELY IMPACT
THE REVENUES AND COSTS OF THE FIRM.

*PRIMARY NEED
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 * A DI Relates to future contract between two parties.
* DI’S return derives from the values of other
underlying assets, such as agriculture commodities,
metals, financial assets, natural resources etc.
* Derivativescan be undertaken directly between the
two parties or through the particular exchange.
* The investor pays only a fraction of the investment
amount to take an exposure. The investor can take
large positions even when he does not hold the
underlying security.

*FEATURES OF
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 *Market view is important in the derivatives market.
The profit/loss positions are dependent on the
market view. Derivatives are double edged swords.
*Derivatives contracts have a definite lifespan or a
fixed expiration date.
*The derivatives market is the only market where an
investor can go long and short on the same asset at
the same time.
*Most of the cases, in Derivatives Trading, ‘THE
TAKING OR MAKING OF DELIVERY OF
UNDERLYING ASSETS IS NOT INVOLVED’.

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 *HEDGERS

*SPECULATORS

*ARBITRAGEURS

*PLAYERS/
TRADERS
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 DERIVATIV
E CO
A L M
C I M
N TY O
A DI
N
FI

*TYPES
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 FINANCIAL

BASIC COMPLEX

WARRANTS
&
FORWARDS FUTURES OPTIONS SWAPS EXOTICS
CONVERTIBL
ES

*TYPES OF
FINANCIAL
DERIVATIVES
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 *A forward contract is a contract
between two parties obligating
each to exchange a particular
good or instruments at a set
price on a future date. It is an
over the counter agreement.

*FORWARDS
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 *Mr. RM agreed with Mr. SS to sell
200kg. Of wheat on 9th of Sept. 2013
at the rate of ₹ 10/kg.

*On the day of expiry, the market price is

below the contracted price, Mr. RM will gain
and Mr. SS will fetch a loss. And vice versa

* Example:

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*Forward contracts are bilateral contracts, and
hence, they are exposed to counter-party risk.
There is risk of non-performance of obligation
either of the parties, so these are riskier than to
future contracts.

*Each contract is custom designed, and hence, is

unique in terms of contracts size, expiration date,
the asset type, quality etc.

*FEATURES of
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Forwards 02/24/2025
*One party takes long position and other party
assumes short position.

*Party with no obligation offsetting the forward

contract is said to have an open position.

*Party with a closed position is sometimes, called a

hedger.

*The specified price in a contract is referred to as the

delivery price.

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*Cont. 02/24/2025
*The forward price for a particular forward contract at a
particular time is the delivery price that would apply if the
contract were entered into at that time. Both are equal at
the time the contract is entered into. However, as time
passes, the forward price is likely to change whereas the
delivery price remains the same.

*In the forward contract, derivative assets can often be

contracted from the combination of underlying assets, such
assets are known as synthetic assets in the forward market.
*In the FM, most of contracts are settled by delivery of the
assets on expiration date.

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* Cont.
02/24/2025
 *Futures are standardized contracts
between the buyers and sellers, which
fix the terms of the exchange that will
take place between them at some fixed
future date.
*A futures contract is a legally binding
agreement.
* Futures are special types of forward
contracts which are exchange traded,
that is traded on an organized
exchange.

*FUTURES
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*Standardisation: The contract has certain standardised
specification, like, quantity of the asset, the date and
month of delivery, the units of price quotation, location of
settlement etc.

*Clearing House: In the futures, the exchange clearing

house is an adjunct of the exchange and acts as an
intermediary or middlemen in futures. It gives the
guarantee for the performance of the parties to each
transaction.

*Daily Settlement and Margin: When a party enters

into a contract, he is required to deposit funds with the
broker, which is called as margin. The basic objective of
margin account is to act as collateral security in order to
minimise the risk of failure by either party in the futures
contract.
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*The exchange used to compute the profit or loss on each
contract for that day. Accordingly, the members accounts
are credited and debited.
*Tick Size: The future prices are expressed in currency
units, with a minimum price movement called a tick size.
This means that the future prices must be rounded to the
nearest tick.
*Cash Settlement: Most of the futures are settled in
cash by having the short or long to make a cash
payment on the difference between the futures price at
which the contract was entered and the cash price at
expiration date. This is done because it is inconvenient
or impossible to deliver some times, the underlying
asset. Eg: Stock indices futures.

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*Cont. 02/24/2025
*Delivery: The futures contracts are executed on the
expiration date. The counter parties with a short position
are obliged to make delivery to the exchange, whereas the
exchange is obligated to make delivery to the longs. The
period during which the delivery will be made is set by the
exchange .

*Regulation: The important difference between futures

and forward markets is that the futures contracts are
regulated through a exchange, but the forward contracts
are self regulated by the counter parties themselves.

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*Cont. 02/24/2025
 * Options are contracts between the option writers
and buyers which obligate the former and entitles
(without obligation) the latter to sell/buy stated
assets as per the provisions of contracts.
* Options are of two types: calls and Puts.
* A call option gives a buyer/holder a right but not an
obligation to buy the underlying on or before
specified time at a specified price (usually called
strike/exercise price) and quantity.
* A put option gives a holder of that option a right but
not an obligation to sell the underlying on or before
specified time at a specified price and quantity.

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*OPTIONS 02/24/2025
*Parties of the Option Contract: There are two parties to an
option contract; the buyer (the holder) and the writer (the
seller). The writer grants the buyer a right to buy or sell a
particular asset in exchange for a certain sum of money for
the obligation taken by him in the option contract.

*Exercise Price: The price at which the underlying asset may

be sold or purchased by the option buyer from the option
writer is called as exercise or strike price. At this price the
buyer can exercise his option.

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*Option 02/24/2025
* Expiration Date and Exercise Date: The date on which an option
contract expires is called as expiration date or maturity date.
The option holder has the right to exercise his option on any
date before the expiration date. Exercise date is the date upon
which the option is actually exercised whereas the expiration
date is the last day upon which the option may be exercised.

* Option Premium: The price at which option holder buys the right
from the option seller. The consideration for the seller to offer
the right to the buyer is the premium. Thus Premium is the fee
payable by the buyer of the option to the seller at the time of
entering into the contract. The premium paid is not refundable
whether the buyer ultimately exercise his right or not.
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*EXECUTION: Based on the period when the buyer can
exercise hid right under the contract, options are
classified as American and European Options.

*An American Option can be exercised only at any time

up to and including the expiration date.

*A European option can be exercised only at the

expiration date.

*Option
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Terminology 02/24/2025
*When the underlying future price/stock price is greater
than the strike or exercise price, the call option will be
in-the-money, and if the future price is lesser than the
strike price, it will be called out-of-the money call
option. Further, if the future price is equal to the strike
price, it is said that call option is at-the-money.

*The reverse is the position in case of put options.

* Option ‘In’, ‘Out’ and ‘At-the-

money’
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 PAY OFF PROFILE OF OPTION

CALL PUT

In-the-money Futures > Strike Futures < Strike

At-the-money Futures = Strike Futures = Strike

Out-of the- money Futures < Strike Futures > Strike

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 *Warrants: It allows the holder the right to buy
shares of a specified company at a certain
price during the given time period. Warrants
are sweeteners attached to bonds to make
these bonds more attractive to the investor.
Most of the warrants are detachable and can
be traded in their own right or separately.
*Convertibles: They can be fully or partially
converted into the equity shares of the issuing
company at the predetermined specified
terms.

* WARRANTS &
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 *Swaps are generally customized
arrangements between counterparties to
exchange one set of financial obligations for
another as per the terms of agreement.

*The major types of swaps are currency

swaps, and interest rate swaps.

*SWAPS
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 *THESE ARE NON-STANDARD DERIVATIVES.
THERE IS NO BOUNDARY FOR DESIGNING
THE NON-STANDARD FINANCCIAL
DERIVATIVES, AND HENCE, THEY ARE
TERMED AS ‘EXOTICS’.

*EXOTICS
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 *Thank you

* C.T. SUNIL KUMAR

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