Derivatives And New Investment Avenues


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I had given this presentation at the National Convention in Jaipur for which i got the 2nd Best Paper Award.

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Derivatives And New Investment Avenues

  1. 1. Derivatives and New Investment Avenues By Kisan Rajpurohit- National Convention, Jaipur
  2. 2. School of Thought… By far the most significant event in finance during the past decade has been the extraordinary development and expansion of derivatives and emergence of new investment avenues. These instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it - a process that has undoubtedly improved national productivity growth and standards of living. – Alan Greenspan, Former Federal Reserve Chairman
  3. 3. Contents <ul><li>Introduction and history of derivatives </li></ul><ul><li>Growth of derivatives in India </li></ul><ul><li>Types- Forwards, Futures, Options, Swaps </li></ul><ul><li>Benefits of Derivatives </li></ul><ul><li>The dark side of Derivatives </li></ul><ul><li>Future of Derivatives Market </li></ul>
  4. 4. Introduction <ul><li>Derivative is a mathematical term and is a variable which derives its value from another variable </li></ul><ul><li>In Financial terms a derivative derives its value from an underlying asset </li></ul><ul><li>e.g. the derivative of ICICI Bank shares (underlying asset) will derive its value from the share price of ICICI Bank. Similarly a derivative contract on commodity like cotton will depend on the price of cotton </li></ul>
  5. 5. ..contd Commodities Bullion Weather etc COMMODITY DERIVATIVES Equity shares Debt instrument Forex Index Interest Rate etc FINANCIAL DERIVATIVES Underlying asset
  6. 6. History of Derivatives Genesis chapter 29 of the Bible in 1700 B.C Jacob purchased an option from Laban costing him seven years of labor. This option gave Jacob the right to marry Laban's daughter Rachel. However Laban, defaulted, perhaps making this not only the first derivative but the first default on a derivative. Jacob did derivatives, one way or the other.
  7. 7. History of Derivatives.. Contd <ul><li>Establishment of Chicago Board of Trade </li></ul><ul><li>Birth of Financial derivatives in 1970 </li></ul><ul><li>BSE launched BSE 30 Index Futures in 2000 </li></ul><ul><li>NSE followed suit and introduced S&P CNX Nifty Futures. </li></ul>
  8. 8. Growth of Derivatives Market in India
  9. 9. Types of Derivatives FUTURES SWAPS FORWARDS OPTIONS
  10. 10. Forwards <ul><li>Agreement entered today where </li></ul><ul><ul><li>one party agrees to buy and the other agrees to sell an asset </li></ul></ul><ul><ul><li>on a specified future date </li></ul></ul><ul><ul><li>at an agreed price </li></ul></ul><ul><li>Example: </li></ul><ul><ul><li>You will be receiving dollars after 3 months </li></ul></ul><ul><ul><li>Present dollar rate Rs 45 per $ </li></ul></ul><ul><ul><li>Rate after 3 months Rs 38 per $ </li></ul></ul><ul><ul><li>You will lose Rs 7 per dollar </li></ul></ul><ul><ul><li>Therefore you enter into a forward contract to sell dollars at Rs 43 </li></ul></ul><ul><ul><li>You have locked in the dollar rate at Rs 43 </li></ul></ul>
  11. 11. Futures <ul><li>Standardized form of a forward contract </li></ul><ul><li>Illustration: </li></ul>Rs 43920 Margin amount to be paid (say)15% Margin Rs 292800 (Rs488*600) Future Contract Price Rs 488 Share Price 600 shares Lot Size Satyam Futures
  12. 12. Forwards Vs Futures Done on daily basis Not Done Valuation Margins required Not Required Margins Very High Poor Liquidity Exchange Any entity Counterparty Standardized Customized Nature of the contract Futures Forwards
  13. 13. Options Is a right But not an obligation To buy or sell something At a stated date At a stated price What is an option?
  14. 14. Options: Types Call Gives a right but not an obligation to buy Put Gives a right but not an obligation to sell
  15. 15. Options Illustration: 20 1730   Situation 3 0 1770   Situation 2 230 2000   Situation 1 Gain/(Loss) Market price after 3 months   1750 Exercise price   1700 Current market price   20 Option premium
  16. 16. Swaps <ul><li>Exchange of one cash flows for another </li></ul><ul><li>Used to hedge interest rate, forex fluctuation risk </li></ul><ul><li>Interest rate swaps and currency swaps the most common types </li></ul>
  17. 17. Swaps Party A Fixed rate Party B Floating Rate Lender Lender Interest rate swaps
  18. 18. Underlying Assets Gold Futures, Oil Futures, Metal Futures, Commodity Futures Commodities Currency Futures, Currency Options, Currency Swaps, Foreign Exchange Interest Rate Futures, Interest Rate swaps, Interest Rate Options, Currency Swaps, Forward Rate Agreements etc Fixed Income Securities Stock Options, Stock Futures, Index Options, Index Futures Equities DERIVATIVES CASH MARKET
  19. 19. Derivatives: A useful innovation <ul><li>Tool for hedging </li></ul><ul><li>Risk management </li></ul><ul><li>Ability to raise finance in global markets </li></ul><ul><li>Price discovery </li></ul>
  20. 20. The Dark Side
  21. 21. Future of Derivatives Market <ul><li>Derivatives market not as developed as US and European markets </li></ul><ul><li>But bound to become sophisticated as equity markets develop </li></ul><ul><li>More and more derivatives products to be introduced </li></ul>
  22. 22. Thank You-Kisan Rajpurohit