This document provides an introduction to derivatives, including the different types. It discusses how derivatives allow companies and individuals to transfer unwanted risk to other parties. The main types of derivatives covered are options, forwards, futures, and swaps. Options give the buyer the right but not obligation to buy or sell an asset at a future date. Forwards involve an obligation to buy or sell an asset at a future date. Futures are like forwards but trade on an organized exchange. Swaps involve exchanging cash flows between two parties. Overall, the document provides a high-level overview of derivatives and their use in managing financial risk.

1. Derivatives Basics
By: Ajay Mishra
JSSGIW faculty of Management,Bhopal

2. Introduction
 In business decisions are made in the presence
of RISK
 A decision maker confront two types of risk
Business Financial
Risk Risk

3. Business Risks
 Uncertainity of future
sales.
 Cost of Inputs.

4. Financial Risks
 Interestrates
 Exchange rates
 Stock prices
 Commodity prices

5.  Our financial system is replete
with risk
 It also provides a means of
dealing with risk in form of
deriavatives.

6. Derivatves
 They are the financial instruments whose
returns are derived from those of other
financial instruments.
 Their performance depends on how other
financial instruments performs.
 Derivatives serve a valuable purpose in
providing a means of managing financial risk.

7. Derivatives
 By using derivatives companies and individuals can
transfer, for a price, any undesired risk to other
parties.
 The vast majority of derivatives, however created in
private transactions in over the counter markets.
 Derivative can be based on real assets, which are
physical assets and include agricultural
commodities, metals, and source of energy.
 It also be based on financial assets which are Stocks,
Bons/Loans and currencies.

8. Derivative Markets and Instruments
 What is an Instrument?
Instrument
An asset or an item of ownership A Liability or an item of ownership
Having a positive monetary value having a negative monetary value

9. Derivative Markets and Instruments
 A security is a tradable instrument
representing a claim on a group of assets.
 We know that A contract is an enforceable
legal agreement.
 For a asset transaction the required asset be
delivered immediately or shortly thereafter.
 Payment usually is made immediately or
sometime credit arrangements are made.

10. Derivative Markets and Instruments
 On the first basis the markets are known as
cash market or spot market. Where:
 Sale is made
 Payment is remitted
 Goods or security is delivered

11. Derivative Markets and Instruments
 For other type of arrangements which allow
the buyer or seller to choose whether or not to
go through with the sale.
 These type of arrangements are conducted in
derivatives market.

12. Derivative Markets and Instruments
 Derivatives markets are market for
contractual instrument whose performance is
determined by the way in which another
instrument or asset performs.
 Like all other contracts they are also
agreements between two parties as a buyer
and a seller, with a price where the buyers try
to buy as cheaply as possible and sellers try to
sell as dearly as possible,

13. Derivative Markets and Instruments
 Various types of
derivative contracts
OPTIONS, FORWARDS
OPTIONS, FORWARDS
FUTURES AND SWAPS AND
FUTURES AND SWAPS AND
RELATED DERIVATIVES
RELATED DERIVATIVES

14. Option (Introduction)
 Contract between two parties a buyer and a seller.
 Gives the buyer the right but not the to obligation,
to purchase or sell something at a later date at a price
agreed upon today
 Buyer pays a sum of money called price or premium
 Seller stands ready to sell or buy according to the
terms and when the buyer so desires.

15. Option (Introduction)
 An option to buy something is referred to a CALL
 An option to sell something is called a
PUT.
 Major options are for the purchase or sale of
financial assets such as stocks and bonds, but there
are also options on future contracts, metals, and
currencies and even loan guarantees and insurance
are forms of options.
 Stock itself is equivalent to an option.

16. Forward Contracts (Introduction)
 Contract between two Parties to purchase or
sell something at a later date at a price agreed
upon today
 The two parties in a forward contract incur
the obligation to ultimately buy and sell the
good
 They trade strictly in an over the counter
market consisting of direct communication.

17. Futures Contracts (Introduction)
 Contract between two parties to buy or sell
something at a future date at a price agreed upon
today.
 The contract trades on a future exchange and is
subject to a daily settlement procedure.
 Unlike forward contracts however the future
contracts trade on organised exchanges.
 The buyer of a future contract who has the obligation
to buy the good at the later date, can sell the
contract in future market, which relieves him of the
obligation. Likewise the seller can buy the contract
back relieving him of the obligation to sell the good.

18. Swaps and other Derivatives
 A Swap is a contract in which two parties agree to
exchange cash flows.
 The firm and the dealer in effect swap cash flow
streams. Depending on what later happens to price or
interest rates.
 In this one party might gain at the expense of others.
 An option to enter into a swap is called swaption.

19. Return and Risk
Return
Return
RISK