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Any alteration may come. The study has only made a humble attempt at evaluation derivatives market only in India context. With modern technology in hand, these institutions did set benchmarks and standards for others to follow. Microstructure changes brought about reduction in transaction cost that helped investors to lock in a deal faster and cheaper.
The reforms process have helped to improve efficiency in information dissemination, enhancing transparency, prohibiting unfair trade practices like insider trading and price rigging. Introduction of derivatives in Indian capital market was initiated by the Government through L C Gupta Committee report. The L.
Gupta Committee on Derivatives had recommended in December the introduction of stock index futures in the first place to be followed by other products once the market matures. The preparation of regulatory framework for the operations of the index futures contracts took some more time and finally futures on benchmark indices were introduced in June followed by options on indices in June followed by options on individual stocks in July and finally followed by futures on individual stocks in November The underlying asset can be equity, forex, commodity or any other asset.
Emergence of Financial Derivative Products Derivative products initially emerged as hedging devices against fluctuations in commodity prices, and commodity-linked derivatives remained the sole form of such products for almost three hundred years. Financial derivatives came into spotlight in the post period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by s, they accounted for about two-thirds of total transactions in derivative products.
In recent years, the market for financial derivatives has grown tremendously in terms of variety of instruments available, their complexity and also turnover. In the class of equity derivatives the world over, futures and options on stock indices have gained more popularity than on individual stocks, especially among institutional investors, who are major users of index-linked derivatives.
Even small investors find these useful due to high correlation of the popular indexes with various portfolios and ease of use. The lower costs associated with index derivatives vis—a—vis derivative products based on individual securities is another reason for their growing use. They use futures or options markets to reduce or eliminate this risk. Futures and options contracts can give them an extra leverage; that is, they can increase both the potential gains and potential losses in a speculative venture.
Index Copernicus Value: 3. FUTURES A futures contract is an agreement between two parties to buy or sell an asset in a certain time at a certain price, they are standardized and traded on exchange. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date.
Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Longer-dated options are called warrants and are generally traded over-the counter. These are options having a maturity of up to three years. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options. SWAPS Swaps are private agreements between two parties to exchange cash floes in the future according to a prearranged formula.
They can be regarded as portfolios of forward contracts. Thus a swaption is an option on a forward swap. Gupta develop the appropriate regulatory framework for derivative trading in India. The committee submitted its report in March On May 11, SEBI accepted the recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index Futures.
The provision in the SCR Act governs the trading in the securities. The exchange shall regulate the sales practices of its members and will obtain approval of SEBI before start of Trading in any derivative contract. The members of the derivatives segment need to fulfill the eligibility conditions as lay down by the L. Gupta committee. Exchange should also submit details of the futures contract they purpose to introduce.
While futures and options are now actively traded on many exchanges, forward contracts are popular on the OTC market. In this chapter we shall study in detail these three derivative contracts. Forward Contracts A forward contract is an agreement to buy or sell an asset on a specified future date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price.
Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges. The salient features of forward contracts are: They are bilateral contracts and hence exposed to counter—party risk. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality.
The contract price is generally not available in public domain. On the expiration date, the contract has to be settled by delivery of the asset. If the party wishes to reverse the contract, it has to compulsorily go to the same counterparty, which often results in high prices being charged. However forward contracts in certain markets have become very standardized, as in the case of foreign exchange, thereby reducing transaction costs and increasing transactions volume.
This process of standardization reaches its limit in the organized futures market. Forward contracts are very useful in hedging and speculation. The classic hedging application would be that of an exporter who expects to receive payment in dollars three months later.
He is exposed to the risk of exchange rate fluctuations. By using the currency forward market to sell dollars forward, he can lock on to a rate today and reduce his uncertainty.