Hi all,

I am back after a very long break. I would now try my best to post articles on the blog regularly.

The topic for today is Derivatives

What are Derivatives?

Derivatives are financial contracts that derive their value from the value of the underlying. The underlying could be an Asset, a stock, index, interest rates etc.

Transaction Types

     A)     Long – The long is the transaction wherein one party agrees to buy the contract.

           B)      Short- The short is the transaction wherein the other party agrees to sell the contract.

Structure of Derivative Markets

            1)      Exchange Traded – Salient Features are:

a.       The terms of the contract are standardized except for Price

b.      They  are more liquid (a market is available to buy and sell easily)

c.       Transparent

d.      There is a clearing and a settlement process

e.      The participants have to furnish some deposit (margin)

            2)      Over the Counter – Salient Features are:

a.       It is a market where the terms are customized

b.      It has an informal network of market participants

c.       It is less liquid

Types of Derivatives – There are many types of derivatives but for simplicity I would discuss only 2 of the important types:

     

                1)      Forward Commitments

                2)      Contingent Claims

Forward Commitments – In this type of contract, the two parties come together at a point in time and mutually agree to engage in a transaction at some later point in time.

Types: Forward Contracts, Swaps and Futures

Contingent Claims – It is also same as a forward commitment, but with an additional feature, the holder has the option of executing the contract.

Types: Options and Credit Backed Securities

Will be back with more stuff. Keep visiting this page.