derivatives

DERIVATIVES

Introduction

          The liberalization policy of India, 1991 makes our economy more market oriented and expanding the role of private and foreign investment by giving reduction in import tariffs, deregulation of markets, reduction of taxes and greater foreign investment. With the introduction of liberalization India is facing  a lot of risk in India economy as increased inequality, poverty, economic degradation etc. this  has exposed various types of risk to manufactures, business man, banks and others such as  economic risk, foreign exchange risk, political risk etc. Companies and individuals would like to protect their profit by shifting some of the risks to those who are willing to take up. The process of sharing and reducing the risk is risk management.

Derivatives are the most influential tool in risk management system. SEBI has introduced derivative trading in stock market. Derivatives are a set of instruments whose values depend on some underlying basic assets. It is a promise to convey ownership.  It is a contract which derives its value from the prices or index of prices of underlying securities. It is a legally binding contract between a buyer and a seller that have no intrinsic value, but are based on the value of some underlying basic assets such as shares, bonds, interest rates, exchange rate, stock index or commodity.

In accordance with Robert L McDonald, a derivative is “a financial instrument or an agreement between two people, which has a value determined by the price of something else”. There are two types of derivatives namely commodity derivatives and financial derivatives. In a commodity derivative the underlying assets will be a commodity like gold, agriculture produce, oil, metal etc. in a financial derivative,the underlying assets will be shares, currency, stock indices etc.

Features

·         Derivatives are contracts tradable through stock exchanges.

·         It is regulated by Securites Contracts (regulation)  Act, 1952.

·         The value of derivatives depends on the price movements of the underlying assets.

·         Derivatives enhance liquidity in markets for underlying assets