CS Professional TYPES OF DERIVATIVE
Any business deal or activity contains some level of uncertainty with regards to its operation and activity. Many activities contain various types of risk which will obstruct business growth. There are various types of business risk which can be hedged with the help of derivative. The derivative is a type of financial security of which value is derived from a group of the underlying asset. With its effective techniques and tools, derivative comes up with an effective tool to help business.
The individuals and firms who wish to avoid risk can deal with others who will take the risk for the price. There is a place where all this transaction takes place known as the “derivatives market”. Various types of derivatives include futures contracts, forward contracts, options, and swaps.
TYPES OF DERIVATIVE
- OVER THE COUNTER: -This type of derivative is not regularized and it is privately negotiated. It can be customized according to the customer need and that’s why they don’t go through a clearing corporation.
- EXCHANGE DERIVATIVE:- as clear from the name, this derivative is standardized and traded on stock exchanges and it can be exchanged on a clearinghouse.
COMMON TERMS OF DERIVATIVE
- FUTURE CONTRACT: -A future contract is a contract where an agreement is made to sell/purchase a standard quantity of goods at a predetermined future date and the price is uncertain and depends on various factors. Price is a variable factor in the future contract and depends upon interest rate, currency, and stock index. The future contract can be offset before the due date and the margin can be paid instead of obligating the whole contract. The motive of this type of contract is to hedge the risks and speculation. It is traded on a stock exchange.
- FORWARD CONTRACT: – in this contract buyer and seller make an agreement on a specified asset of specified quality and quantity to be fulfilled on a specified date and at the specified place. Price is pre-decided by both the parties. Here parties are obligated to perform their promises and each party will face the default risk. Compared to future contracts these contracts are tailored made contracts and can’t be changed. A forward contract is less liquid compared to future contracts. No margin money is involved in the forward
- OPTION: – option means a type of choice people get from different options. Options are valuable derivatives as they provide against uncertain events. In an option, the buyer has the right to buy or sell but not an obligation to fulfill. A buyer can take advantage of its position but not liable to take losses. While seller, on the other hand, has the obligation to deliver or take delivery at a price agreed upon. There are a various option named as a stock option, commodity option, index option, and future option
- SWAPS: – a swap refers to an exchange of future cash value of security or assets with or without disturbing any cash flow generating in present.
With the help of the dealer, both the parties can swap or exchange their set of predetermined cash flow with each other with predetermined terms.
Different types of swaps:-
- Swap of interest
- Swap of currency
- Swap of commodity
- Swap of equity
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