1. What are derivatives?

A derivative is an instrument whose value is derived from the value of an underlying asset. The underlying asset can be equity, index, commodity or any other asset. Derivatives are all about risk. Risk can be bought or sold like any other commodity. Derivatives are instruments through which risk is transferred. There are various kinds of derivative instruments viz. index futures, stock futures, options, forward contracts, etc.

2. What kinds of underlying assets are derivatives generally available on?

Common underlying assets for derivatives are:

---Equity Shares
---Equity Indices
---Debt Market Securities
---Interest Rates
---Foreign Exchange
---Commodities
---Derivatives themselves


3. What is a Forward contract?

A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today's pre-agreed price.

4. What is an Option?

Options are deferred contracts that give buyers the right, but not the obligation, to buy or sell a specified underlying at a set price on or before a specified date.

5. What is a Future contract?

A futures contract is an agreement between two parties to buy or sell an asset at a specified price and time in the future. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts.

6. What is Swap transaction?

A Swap transaction is the simultaneous buying and selling of a similar underlying asset or obligation of equivalent capital amount where the exchange of financial arrangement with more favorable conditions than they would otherwise expect.

7. Who uses Derivatives?

Derivatives can be used by a party who is exposed to an unwanted risk to pass this risk on to another party willing to accept it. In this case he will be called a Hedger. A speculator takes an opposite position to a hedger and exposes him/herself in the hope of profiting from price changes to his or her advantage. There are also arbitrageurs who trade derivatives with a view to exploit any price differences within different derivatives markets or between the derivative instruments and cash or physical prices in the underlying assets.

8. How are Derivatives traded?

There are three basic ways in which trading can take place: Over The Counter; On an exchange floor using open outcry; and Using an electronic, automated matching system. Usually brokers act intermediaries between traders and clients. Brokers do not usually trade on their own account but earn commissions on the deals that they arrange.

9. How are future contracts traded?

Both commodity and financial futures contracts are traded on exchanges worldwide. Futures contracts share the following common features- they are standardised, traded on an exchange, open and their prices are published and organized by a Clearing House.

10.How are forward contracts traded?

Forward contracts are traded between the two parties involved and through an exchange. A forward contract involves a credit risk to each party. Forward contracts are not normally negotiable and the contract has no value when it is made. No payment is involved, as the contract is simply an agreement to buy or sell at a future date. Therefore, the contract is neither an asset nor a liability.

11. Who is a hedger?

These are market players who wish to protect an existing asset position from future adverse price movements.

12. Who is an arbitrageur?

These are traders and market makers who deal in buying and selling futures contracts hoping to profit from price differentials between markets and/or exchanges.

13. What are call and put options?

A call option gives the option buyer the right but not the obligation to buy a financial instrument or a commodity at a specific price on or before a particular date in the future.A put option gives the option buyer the right but not the obligation to sell a financial instrument or a commodity at a specific price on or before a particular date in the future.

14. What do you mean by At-the-Money (ATM), In-the-Money (ITM) and Out-of-the-Money (OTM) Options?

At-the-money option is an option whose exercise price is the same as the market price.In-the-Money option is an option whose exercise price is lower than the market price for call options and higher than the market price for put options.Out-of-the-Money option is an option whose exercise price is higher than the market price for call options and lower than the market price for put options.