Risk Managementfinance lavanya murali.pptx

Risk management

1. DERIVATIVE TRADING IN INDIA LAVANYA MURALI

2. LIST OF CONTENTS DERIVATIVES TYPES OF DERIVATIVES STOCK EXCHANGES WERE DERIVATIVES ARE TRADED UNDERLYING ASSETS TYPES OF UNDERLYING ASSETS RECENT TRENS OF DERIVATIVE TRADING

3. DERIVATIVES MEANING : Derivatives are financial contracts whose value is dependent on an underlying asset or group of assets. The commonly used assets are stocks, bonds, currencies, commodities and market indices. The value of the underlying assets keeps changing according to market conditions. The basic principle behind entering into derivative contracts is to earn profits by speculating on the value of the underlying asset in future.

4. TYPES OF DERIVATIVE CONTRACTS TRADED IN INDIA FORWARD CONTRACTS: Forward contracts mean two parties come together and enter into an agreement to buy and sell an underlying asset set at a fixed date and agreed on a price in the future. In simpler words, it is an agreement formed between both parties to sell their asset on an agreed future date. The forward contracts are customized and have a high tendency of counterparty risk. Since it is a customized contract, the size of the agreement entirely depends on the term of the contract. Forward contracts do not require any collateral as they are self-regulated. The settlement of the forward contract gets done on the maturity date, and hence they are reserved by the expiry period.

5. FUTURE CONTRACTS : Future contracts are similar to forward contracts. Future contracts mean an agreement made by the two parties to buy or sell an underlying instrument at a fixed price on a future date. Future contracts do not allow the buyer and seller to meet and enter into an agreement. In fact, the deal gets fixed through exchange mode. In futures contracts, the counterparty risk is low because it is a standardized contract. In addition, the clearinghouse plays the role of a counterparty to the parties of the contract, which reduces the credit risk in the future. The size of future contracts is fixed, and it is regulated by the stock exchange just because it is known as a standardized contract . Since these contracts are standard, the futures contracts listed on the stock exchange cannot be changed or modified in any possible way. In simpler words, future contracts have pre-decided size, pre-decided expiry period, pre-decided size. In futures contracts, an initial margin is required because settlement and collateral are done daily.

6. OPTIONS CONTRACTS : Options contracts are the third type of derivative contracts in India. Options contracts are way different than future and format contracts because these contracts do not require any compulsion to discharge the contract on a specific date. Options contracts provide the right but not the commitment to buy or sell an underlying instrument. PUT OPTION :   in put option, the buyer has all the right but not obligation to sell an underlying asset at a fixed price while entering the contract. CALL OPTION :In call option, the buyer has all the right to purchase an underlying asset at a fixed price while entering the contracts . However, in both call and put option contracts, the buyer chooses to settle all the contracts on or before the expiry period. Thus, anyone who regularly trades in the option contract can take any of the four different positions, i.e., short or long, either in the call or the put option. These options are traded at the stock exchange and over the counter market.

7. SWAPS CONTRACTS : Out of all three derivatives contracts, swap contracts are one of the most complex contracts. Swap contracts mean the agreement is done privately between both parties. The parties who enter into swap contracts agree to exchange their cash flow in the future as per the pre-determined formula. Under swap contracts, the underlying security is the interest rate or currency, as these contracts protect both parties from several major risks. These contracts are not traded to the Stock Exchange as investment banker plays the role of a middleman between these contracts.

8. EXCHANGES IN WHICH DERIVATIVES ARE ALLOWED BOMBAY STOCK EXCHAGE (BSE ): BSE Limited , also known as the  Bombay Stock Exchange  ( BSE ), is an Indian stock exchange  which is located on Dalal Street, known as the Wall Street of Mumbai ,  in turn described as the New York of India .  Established in 1875 by cotton merchant Premchand Roy Chand, it is the oldest stock exchange in  Asia, and also the tenth oldest in the world. The BSE is the world's 8th largest stock exchange  with a market capitalization exceeding US$4.5 trillion as of January 2024 .

9. NATIONAL STOCK EXCHANGE( NSE ) : National Stock Exchange of India Limited  ( NSE ) is one of the leading stock exchanges in India, based in Mumbai .NSE is under the ownership of various financial institutions such as banks and insurance companies. It is the world's largest derivatives exchange by number of contracts traded and the third largest in cash equities by number of trades for the calendar year 2022. It is the 7th largest stock exchange in the world by total market capitalization , as of January 2024. NSE's flagship index, the NIFTY 50, a 50 stock index is used extensively by investors in India and around the world as a barometer of the Indian capital market. The NIFTY 50 index was launched in 1996 by NSE.

10. UNDERLYING ASSET The underlying asset refers to the financial instrument or asset upon which a derivative contract is based. In derivative markets, such as options, futures, or swaps, the value of the derivative is derived from the performance or price movements of this underlying asset. For instance, in the case of a stock option, the underlying asset would be the stock itself.

11. VARIOUS UNDERLYING ASSETS Stocks : Shares of publicly traded companies are a common underlying asset for options, futures, and other derivative contracts. Bonds : Debt securities issued by governments or corporations can serve as underlying assets, particularly in bond options or futures contracts. Indices : Stock market indices, such as the S&P 500, NASDAQ, or Dow Jones Industrial Average, can be underlying assets for various derivatives. Commodities : Physical goods such as gold, silver, oil, wheat, or coffee can be underlying assets in commodity futures contracts and options .

12. Currencies : Foreign exchange (Forex) rates or currency pairs (e.g., EUR/USD, GBP/JPY) can serve as underlying assets in currency futures, options, or forwards. Interest Rates : The interest rates on government bonds or other debt instruments can be underlying assets in interest rate futures, swaps, or options. Real Estate : Real estate properties or indices tracking real estate prices can be underlying assets in certain derivatives, such as real estate investment trusts (REITs). Cryptocurrencies : Digital currencies like Bitcoin, Ethereum, or Ripple can serve as underlying assets for derivatives such as cryptocurrency futures or options. Exchange-Traded Funds (ETFs) : ETFs, which represent a basket of underlying assets such as stocks, bonds, or commodities, can themselves be used as underlying assets for certain derivative contracts.

13. RECENT TRENDS IN DERIVATIVE TRADE IN INDIA Increased Participation : There has been a notable increase in participation from retail investors in derivative markets, facilitated by online trading platforms and increased awareness about derivatives. Growth in Options Trading : Options trading has seen significant growth in India, with investors attracted to the flexibility and limited risk associated with options strategies. Introduction of New Derivative Products : Indian exchanges have been introducing new derivative products to cater to investor demand and to enhance market depth. This includes products like weekly options contracts, commodity options, and volatility index futures. Regulatory Changes : Regulatory changes, such as margin requirements and position limits, have impacted derivative trading practices in India. Regulators have been focusing on measures to enhance risk management and market integrity.

14. Shift Towards Structured Products : There has been a shift towards structured derivative products in India, including index-based structured products and structured warrants, offering investors tailored risk-return profiles. Rise of Algorithmic Trading : Algorithmic trading has gained traction in derivative markets, with institutional investors and proprietary trading firms employing automated trading strategies to capitalize on market inefficiencies and execute trades at high speeds. Increased Focus on Risk Management : With the growing complexity of derivative products and trading strategies, there has been an increased focus on risk management practices among market participants, including the use of risk management tools and hedging techniques.

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