Derivatives are financial instruments whose value is based on an underlying asset such as commodities, precious metals, currencies, bonds or stock indices. The two main types are forwards, which are private contracts, and futures, which are exchange-traded standardized contracts. Derivatives markets originated in the middle ages and the Chicago Board of Trade was the first formal exchange established in 1848 to trade agricultural commodity derivatives. The Chicago Mercantile Exchange was later established in 1874 and also trades futures on currencies, interest rates, stock indices and other commodities.

1. 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”.
• Underlying Asset in a Derivatives Contract
As defined above, the value of a derivative instrument depends upon the underlying asset. The
underlying asset may assume many forms:
i. Commodities including grain, coffee beans, orange juice;
ii. Precious metals like gold and silver;
iii. Foreign exchange rates or currencies;
iv. Bonds of different types, including medium to long term negotiable debt securities
issued by governments, companies, etc.
v. Shares and share warrants of companies traded on recognized stock exchanges and Stock
Index
vi. Short term securities such as T-bills; and
vii. Over- the Counter (OTC) money market products such as loans or deposits.
History:
The Derivatives markets can be traced back to the middle Ages. They originally developed to meet
the needs of farmers and merchants.
The Chicago Board of Trade (CBOT) was the first derivatives market established in 1848 to bring
farmers and merchants together. Initially, its main task was to standardize the quantities and
qualities of the grains that were traded.
Within a few years, the first futures type contract was developed. It was known as to-arrive
contract.
Speculators soon became interested in the contract and found trading the contract to be an
attractive alternative to trading the gain itself. The Chicago Board of Trade now offers futures
contracts on many different underlying assists, including corn, oats, soybeans, soybean oil wheat,
silver, treasury bonds, and treasury notes.
• The Chicago Mercantile Exchange:
In 1874, the Chicago Produced Exchange was established. This provided a market for butter, eggs,
poultry, and other perishable agricultural products. In 1898, the butter and egg dealers withdrew
from this exchange to form the Chicago Butter and Egg Board. In 1919, this was renamed the

2. Chicago Mercantile Exchange (CME) and was reorganized for futures trading. Since then, the
exchange has provided a futures market for many commodities including pork bellies (1961), live
cattle (1964) live hogs (1966) and feeder cattle (1971). In 1982, it introduced a futures contract, and
a Eurodollar futures contract on the S&P 500 Stock Index.
The International Monetary Market (IMM) was formed as a division of the Chicago Mercantile
Exchange in 1972 for futures trading in foreign currencies. The currency traded on the IMM now
include the British Pound, the Canadian futures Dollar, the Japanese Yen, the (Swiss Franc, the
German mark) European Euro and the Australian dollar. The IMM also trades a gold futures
contract, a treasury bill futures contract, and a Eurodollar futures contract.
• Features of Derivates Market:
1. Derivatives are popular instruments traded globally.
2. Gain or loss depends on the underlying asset’s value.
3. Change in value of underlying asset will have effect on values of derivatives.
4. They are traded on exchange.
5. They are liquid and transaction cost is lower.
• Kinds of Derivatives
• Forward
• Futures
• Option
• Swap
• Forward Contract
• A one to one bipartite contract, which is to be performed in future at the terms decided
today.
• Eg. A and B enter into a contract to trade in one stock on Infosys 3 months from today the
date of the contract @ a price of Rs4675/-
• Note: Product ,Price ,Quantity & Time have been determined in advance by both the
parties.
• Delivery and payments will take place as per the terms of this contract on the designated
date and place. This is a simple example of forward contract.
• Future contracts are organized/standardized
contracts in terms of quantity, quality, delivery
time and place for settlement on any date in future. These contracts are traded on exchanges.
• These markets are very liquid
• In these markets, clearing corporation/house
becomes the counter-party to all the trades or

3. provides the unconditional guarantee for the
settlement of trades i.e. assumes the financial
integrity of the whole system. In other words, we
may say that the credit risk of the transactions is
eliminated by the exchange through the clearing corporation/house.
• The key elements of a futures contract are:
– Futures price
– Settlement or Delivery Date
Underlying Asset.
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