Page 15 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes Forwards: A forward contract is a customized contract between two entities, where settlement
takes place on a specific date in the future at today’s pre-agreed price.
Futures: A futures contract is an agreement between two parties to buy or sell an asset at a
certain time in the future at a certain price.
Interest Rate Swaps: An agreement between two parties (known as counter-parties) where one
stream of future interest payments is exchanged for another based on a specified principal
amount.
Options: An option represents the right (but not the obligation) to buy or sell a security or other
asset during a given time for a specified price (the “strike “price).
OTC contracts: Privately negotiated derivative contracts are called OTC contracts.
Swaps: Swaps are private agreements between two parties to exchange cash flows in the future
according to a prearranged formula.

1.7 Review Questions

1. Explain the term 'derivatives', using suitable examples.
2. What are the underlying assets for a derivative instrument?

3. What are the various important features of derivatives?
4. Discuss the growth and developments of derivatives in the Indian context.
5. Explain the different types of derivatives along with their features, in brief.

6. 'Derivatives are effective risk management tools'. Comment on the statement.
7. 'Future contracts are obligations, whereas options are rights'. Do you agree?
8. Bring out the similarities and dissimilarities between Forwards, Futures, Options and
Swaps.
9. Can you think of a cash market in which options or futures could be useful but does not yet
exist?

10. Highlight the various functions of derivatives and its significance.
Answers: Self Assessment

1. Financial contracts 2. Ownership
3. Contract 4. Commodity
5. Financial 6. Forward
7. Certain price 8. Option

9. Swaps 10. Portfolios
11. True 12. True
13. False 14. False
15. True

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