A Brief Note On Financial Derivatives

Futures are a contract or legal agreement, where an investor agrees to purchase a certain amount of a physical good or financial asset on a specific date for a set price.

Derivative contracts were either negotiated with specific counterparties (over-the-counter) or were standardized contracts executed and traded on an exchange. Negotiated over-the-counter derivatives were comprised of forwards, swaps, and specialized options contracts. Over the counter derivatives can be tailored to meet the customers’ needs with respect to time and quantity and they are not traded in an organized exchange. On the other hand, standardized exchange-traded derivatives consisted of futures and options contracts. Even though over-the-counter derivatives were usually not traded like securities in an exchange, they might be terminated or assigned to an alternative counterparty. Standardized derivatives trade on an exchange and have time and quantity that are fixed.

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The Seller will not be liable in any way for any delay, non-delivery or default in shipment due to labor disputes, transportation shortage, delays in receipt of material, priorities, fires, accidents and other causes beyond the control of the Seller or its suppliers. If the Seller, in its sole judgment, will be prevented directly or indirectly, on account of any cause beyond its control, from delivering the Goods at the time specified or within one month after the date of this Agreement, then the Seller will have the right to terminate this Agreement by notice in writing to the Purchaser, which notice will be accompanied by full refund of all sums paid by the Purchaser pursuant to this Agreement.

Analyze the derivatives market and determine the use of derivatives to efficiently manage investment risks in an investment portfolio.

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​Futures price is defined as the price at which the two participants in a futures contract agree to transact on the settlement date (Futures Price, n.d.). If I were to go into agreement to buy shares of

An option contract allows the option holder the right to purchase something within in a certain time period for a particular price from the seller.

Derivative is a financial instrument whose value is derived from underlying asset. The underlying may be shares, commodities, indices such as NSE and BSE sensexs and even consumer price index. In case of common stocks (shares) the investors can purchase equity derived securities representing a claim i.e an option on a particular stock on certain index.

Among the most fundamental risks, associated with exchange-traded derivatives, is variable degree of risk. According to Ernst, Koziol, & Schweizer (2011), the transactions in

ic: Show how transactions in derivative instruments can be used to either hedge risks or to open speculative positions.

The first category of derivatives is traded on a regulated and standardized market on which these derivative contacts have certain standard terms and their operation is centrally controlled through the exchange mechanisms that include collateral requirements given by the exchange members.[footnoteRef:3] On the contrary, OTC derivatives have the commercial advantage to be more flexible, as they are structured on bilateral terms, and thus, they attract market participants who want to hedge the specific risks arising from their financial activity, who become individually responsible for accomplishing their contractual obligations. [3: Ibid, p 5-6]

Over-the-counter, or OTC, markets are used to trade securities outside of the formal exchange systems that sell different types of derivatives and unlisted stocks. Smaller companies often have their stocks traded on OTC markets because they are not able to meet the extensive requirements of the formal exchanges. These markets are not subject to the same strict regulations as formal stock exchanges and the companies that use them are not required to be as transparent as larger companies trading on the formal exchanges (“Over-the-counter,” 2016). One of the most important economic functions of over-the-counter markets is that it provides a way for “participants to hedge exposures” and “manage risks” (“Over-the-counter derivatives,” 2013). This fills an important need for businesses that the money markets and stock markets are not able to meet. While they provide a place to unite investors seeking to earn returns and borrowers seeking financing, those markets do not trade instruments that allow businesses to hedge against specific risks and exposures. OTC markets are critical components of the economy that fulfil this need.

An option is a contract that gives buyer the right or option to either buy or sale underlying asset at the particular price on or before the expiration date. The underlying asset can be any type of investment with unsustainable price such as stock, bond, property, currency, commodity, and so on.