What is derivative?
Derivative is a product whose value is derived from underlying assets, index or reference rate.
Examples of underlying assets: – Equity, commodity and Forex.
Users of Derivatives: –
- Individual Investors.
- Dealers
- Institutional investor.
- Corporation
Cash Vs Derivative Market
| Cash | Derivative |
|---|---|
| Tangible assets are traded. | Contract based on tangible or intangibles. |
| Can purchase even one share. | Minimum lots are fixed |
| Risky | Risk is limited |
| for investment | for hedging, speculation |
| Requires trading account with depository participants | requires future trading account. |
| Purchase shares of the company and get ownership. | does not happen as in cash market. |
Difference between Forward and Future Contract
| Sr. No | Forward | Future |
|---|---|---|
| 1. | A forward contract is an agreement between two parties [buyer & a seller] that obligates the seller to deliver a specified asset of specified quality and quantity to the buyer on a specified date at a specified place and buyer as well, in turn, to pay a pre negotiated price at the time of delivery. | A future contract is an agreement between two parties in which both parties agree to buy and sell a particular underlying financial instrument [stock, bond or currency] or commodity [gold or natural gas] at a predetermined price at a future date. |
| 2. | Example: -A and B agree to do a trade in 50 tolas of gold on 31.12.2023 at 15000/tola [forward price] here the buyer A is in long position and the seller B is in short position. | Example: – Buyer A and B enter into a 2500 kgs Corn future contract at 4 per kg. |
| 3. | Forward contracts are traded on personal telephonic basis or otherwise. | Future contracts are traded in a competitive arena. |
| 4. | Forward contracts have no standard size. | Future contracts are standardized in terms of quantity or amount. |
| 5. | Forward contracts are traded in an over the counter market. | Future contracts are traded on exchanges with a physical location. |
| 6 | Settlement takes place on agreement date. | Settlements are on daily basis. |
| 7 | Actual Delivery. | There is no actual delivery. |
| 8 | Forward contracts is based on bid-asked spread. | Future contracts entails brakeage fees. |
| 9 | Margins are not required. | Margins are required. |
| 10. | Credit risk | No credit risk. |