Explain about derivatives in finance.

Finance ManagementAccountingAcademic Content

A derivative is a financial instrument which measures the value of an underlying assets. The value is depending on market conditions. Most common derivatives are forwards, futures, options and swaps.

  • Derivatives provide leverages.
  • Derivatives makes profit.
  • Derivatives mitigate risk.
  • Derivatives create option ability.

Hedgers, speculators, margin traders and arbitrageurs participates in derivatives market.

Derivative categories are as follows −

  • Forward commitments.
  • Contingent claims.

Some of the advantages of derivatives are as follows −

  • Decrease the risk.
  • Market efficiency.
  • Diversification of portfolio.
  • Price lock.
  • Choice of leverage.

Some of the disadvantages of derivatives are as follows −

  • High risks.
  • More speculations.
  • More complicated.
  • Hard to value.
  • Sensitive to supply and demand factors.

Derivatives used in India are as follows −

  • Forward contracts − Two parties made an agreement to buy/sell its underlying asset on particular date at an agreed priced in future.

  • Future contracts − is an agreement to buy or sell an underlying asset at a specific price on a future date.

  • Option contracts − These contracts does not give obligation to buy or sell an underlying asset. These are sub classified into two types.

  • Call − Call means the buyer can buy underlying asset at a specific price after entering into contract.

  • Put − Put means, the buyer can’t sell the underlying asset at a specific price after entering into contract.

  • Swap contracts − Parties can exchange their cash flows in future with predetermined formula.

raja
Published on 14-Aug-2020 06:36:01
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