Learn the Basics of Future/Forward/Option Contracts, Swaps
Derivatives: – A derivative is an instrument, whose importance is derived from the significance of one or more essential variables called the bases (underlying benefit, index, reference rate) in a contractual way. The fundamental asset can be forex, equity, commodity or any other benefit. The major monetary derivative products are the Forwards, Options, Futures and Swaps. We will initiate with the idea of a Forward contract and then move on to understand Future & Option contracts.
Forward Contracts: –
A forward contract or agreement is an agreement to sell or buy an asset on a particular date for a particular price. The major features of this meaning are
- There is an agreement or contract.
- Contract is to sell or buy the fundamental asset.
- The transaction gets place on a prearranged future date.
- The rate at which the deal will get place is also predetermined.
A future contract or agreement is efficiently a forward contract, which is the standardized in nature and is exchange bought & sold. The Future contracts eliminate the lacunas of the forward agreements as they are not uncovered to counterparty peril and are also too more liquid. The consistency of the agreement is with respect to
- Quality of underlying
- Quantity of underlying
- Term of the agreement
An option contract or agreement is a contract which provides one party the correct to buy or sell the fundamental asset on a upcoming date at a pre-determined rate. The further party has the compulsion to sell/buy the fundamental asset at this pre-determined rate (called the hit rate). The option, which provides the correct to buy is called the “CALL” option while the option, which provides the correct to sell is called the “PUT” option. Let us think a few examples: –
i) The buyer of Nifty July “Call option” of strike at the 4500: It provides the accurate to buy Nifty at the 4500.
ii) The buyer of “Infosys” July Put option of strike at the 1550: It provides the accurate to sell Infosys at the 1550.
iii) Seller of the Nifty July “Call option” of strike at the 4500: The seller has the compulsion to sell “Nifty” at the 4500
iv) Seller of “Infosys” July Put option of hit the1550: The seller of the “Put Option” has the compulsion to buy Infosys at the 1550
A swap is a derivative, in which 2 counter parties agree to the exchange single stream of the cash flows opposite another stream. Mainly, Swaps can be utilized to hedge interest rate perils or to speculate on the changes in the fundamental rates. Since, swaps are not utilized in stock markets in India market, we would not leave into additional details of swaps.
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