Derivatives

Derivative is a product whose value is derived from the value of one or more basic variables, called underlying asset. The underlying asset can be equity, foreign exchange, commodity or any other asset.

There are basically three types of participants.
i) Hedgers: They are the producer (like farmer, mining company) or a user’s (business entity, consumer) who faces the risk associated with the price of an asset and they use derivatives markets to reduce or eliminate this risk.
ii) Speculators: They are the traders who wish to bet on future movements in the price of an asset.
iii) Arbitrageurs: They are in business to take advantage of a discrepancy between prices in two different markets.

i) Price discovery: It helps in discovery of price of the underlying asset in future;
ii) Transferability of risk: It transfers risks from those who have them but may not like them to those who have an appetite for them.

Basically, there are only two types of derivative instrument

i) Forward Contract
ii) Option Contract