The document discusses the derivative market in India and risk management in banks. It defines derivatives and their various types like futures, options, and swaps. It explains how derivatives help banks manage risks like credit risk, interest rate risk, and liquidity risk. The history of derivatives trading in India is also summarized dating back to 1875. Key players in the market like hedgers, speculators, and arbitrageurs are identified along with their roles.

1. DERIVATIVE MARKET IN
INDIA

2. RISK IS THE BASIS OF BANKING…
TO WIN WITHOUT RISK IS TO TRIUMPH WITHOUT GLORY………
No NO
Risk !!!! GAIN!!

3. INTRODUCTION- RISK
MANAGMENT
 Risk management is a discipline that helps bringing risks
to manageable extent .
 One risk does not get transformed into undesirable risk.
PLAYERS:
Hedgers, Speculators and Arbitrageurs - Market Role
 Hedgers and investors provide the economic substance to
any financial market. Without them the markets would
lose their purpose and become mere tools of gambling.
(E.g. Banks)
 Speculators provide liquidity and depth to the market.
 Arbitrageurs

4. VARIOUS TYPES OF RISKS IN BANKS
 Solvency Risks- Risk of total financial failure of a
bank.
 Liquidity Risk- Inability to meet the repayment
requirements
 Credit Risk- Loss of Bank as a result of default
 Interest Rate Risk- Changes in Interest rate.
 Price Risks- Risk of loss/gain in value of assets &
liabilities due to volatility in exchange rates.
 Operating Risks- Risks arising from out of failures in
operations, supporting system, sabotage, fraud etc.
 Market & Foreign exchange Risk.

5. PROCESS OF RISK MANAGEMENT
IN BANKS
 Identification of risks
 Quantification of risks
 Policy Formulation
 Strategy Formulation
Derivatives come in
play
 Monitoring Risks

6. HISTORY OF DERIVATIVES AND
THE MARKET IN INDIA
According to Mr. Asani Sarkar’s research work,
Derivatives market has been in existence in India since
1875
He also mentions that in early 1900s India had the
largest Futures Industry
In 1952, Indian Government banned the options and
futures trading
But, by 2000 various reforms assisted in lifting all
such bans and the derivatives market is booming since
then

7. Contd..
 The exchange traded derivative market is
the largest in terms of number of contracts
made
 In 2004, the daily trading value was 30
billion USD
 The commodities eligible for futures trading
was 8 and in 2004 it was increased to 80

8. DERIVATIVES
 Derivatives are financial contracts whose value/price is dependent
on the behavior of the price of one or more basic underlying assets
(often simply known as the underlying). These contracts are
legally binding agreements, made on the trading screen of stock
exchanges, to buy or sell an asset in future. The asset can be a
share, index, interest rate, bond, rupee dollar exchange rate,
sugar, crude oil, soybean, cotton, coffee and what have you.
EX: derivatives is curd, which is derivative of milk. The price of
curd depends upon the price of milk which in turn depends upon
the demand and supply of milk.

9. Financial derivatives are financial instruments whose
prices are derived from the prices of other financial
instruments which are also know as underlying. It
relates to equities, loans, bonds, interest rates and
currencies.
Section 2(ac) of Securities Contract Regulation Act
(SCRA) 1956 defines Derivative as:
a) “a security derived from a debt instrument, share, loan
whether secured or unsecured, risk
instrument or contract for differences or any other form of
security;
b) “a contract which derives its value from the prices, or
index of prices, of underlying securities”.

10. MOTIVES OF USING DERIVATIVES
 Spreads trade
 Currency risk management.
 Interest risk Real time trading in the market
( Treasury Activities)

11. ApplicAtions of finAnciAl
DerivAtives
1. Management of risk:
2. Efficiency in trading:
3. Speculation:
4. Price discover:
5. Price stabilization function:

12. Derivatives
Derivatives
Commodity
Commodity Financial
Financial
Complex
Complex
Basic Instrument
Basic Instrument Instruments
Instruments
Exotic,
Exotic,
Swaptions and
Swaptions and
LEAPS etc.
LEAPS etc.
Forward
Forward Futures
Futures Options
Options Swaps
Swaps

13. strAteGies of risK
MAnAGeMent in BAnKs.
 Hedging the Risk . – Derivatives
Forwards
Futures
Options
Swaps
Credit Derivatives (Not available in
India)

15. eXAMple
Jewelry manufacturer Gold buyer agrees to buy gold at
Rs. 600 (the forward or delivery price) three months
from now (the delivery date) from gold mining concern
Gold seller. This is an example of a forward contract.
No money changes hands between Gold buyer and
Gold seller at the time the forward contract is created.
Rather, Gold buyer’s payoff depends on the spot price
at the time of delivery. Suppose that the spot price
reaches Rs. 610 at the delivery date. Then Gold buyer
gains Rs. 10 on his forward position (i.e. the difference
between the spot and forward prices) by taking
delivery of the gold at Rs. 600.
.

16. feAtures of forwArD
contrAct…
 It is a negotiated contract between two parties and hence
exposed to counter party risk.
 Each contract is custom designed and hence unique in
terms of contract size, expiration date, asset type, asset
quality etc.
 A contract has to be settled in delivery or cash on
expiration date.
 In case one of the two parties wishes to reverse a contract,
he has to compulsorily go to the other party. The counter
party being in a monopoly situation can command the
price he wants.

19. the stAnDArD feAture in Any
futures contrAct
 Obligation to buy or sell
 Stated quantity
 At a specific price
 Stated date (Expiration Date)
 Marked to Market on a daily basis
EX: when you are dealing in March 2002 Satyam futures
contract, you know that the market lot, ie the minimum
quantity you can buy or sell, is 1,200 shares of Satyam,
the contract would expiry on March 28, 2002, the price is
quoted per share, the tick size is 5 paise per share or
(1200*0.05) = Rs60 per contract/ market lot, the contract
would be settled in cash and the closing price in the cash
market on expiry day would be the settlement price.

20. Motives BehinD usinG futures
Hedging: It provides an insurance against an
increase in the price.
The futures market has two main types of
foreseeable risk:
- price risk
- quantity risk

21. Interest rate Futures
An interest rate futures contract is an
agreement to buy or sell a standard quantity
of specific interest bearing instruments, at a
predetermined future date and a price
agreed upon between parties

23. OPtIOns
Options contracts grant their purchasers the
right but not the obligation to buy or sell a
specific amount of the underlying at a
particular price within a specified period.

24. OPtIOns termInOlOgy …
Commodity options
Stock Options
Buyer of an option
Writer of an option
Call option
Put option
Option price

26. Buyer OF call OPtIOns : lOng
call

27. WrIter OF call OPtIOns : shOrt
call

28. Buyer OF Put OPtIOns : lOng Put

29. WrIter OF call OPtIOns : shOrt
Put

30. DIstInguIshIng OPtIOns &
Futures

31. SWAPS
Swaps are derivatives involving exchange
of cash flows over time, typically between
two parties. One party makes a payment
to the other depending upon whether a
price is above or below a reference price
specified in the swap contract.

32. ChArACteriStiCS of SWAPS
1. Basically a forward
It is combination of Forwards. It has all the
properties of Forward contract.
2. Double coincidence of wants
It requires that two parties with equal and opposite
needs must come into contact with each other.
3. Comparative credit advantage
Borrowers enjoying comparative credit advantage in
floating rate debts will enter into swap agreement.

33. Contd..
4. Flexibility
Lenders have the flexibility to exchange
floating rates according to the conditions
prevailing in the market.
5. Necessity of an intermediary
It requires two counter parties with
opposite and matching needs. Thus it has
created the necessity of an intermediary.

34. Contd..
6. Settlements
Even though the principal amount is
mentioned it is not exchanged. Here stream
of fixed rate is exchanged for floating rate
interest.
7. Long term agreement
Forwards are for short term. Long dated
forward contracts are not preferred because
they involve more risk.

35. BuSineSS GroWth of DerivAtiveS At
nSe from 2000-2009

36. imPortAnCe
 To minimize risk.
 To protect the interest of individual and institutional
investors.
 Offers high liquidity and flexibility.
 Does not create new risk and minimizes existing
ones.
 Lowers transaction cost.
 Provides information on market movement.
 Provides wide choice of hedging.
 Convenient, low cost and simple to operate.