Group 7

Nikhil A001
Sahil Chaudhary A008
Venkatesh A013
Manav Gulati A018
Sushant Kaul A033
Salil Mathur A040
Aditi Singh A049
Vaishali Singh A050

Introduction to the Derivatives market
Originated as an alternative for insurance to guard against
risk.
Financial instrument whose value is derived from an
underlying asset.
However, unlike other financial instruments, derivatives are
merely contracts rather than assets.
3
Agriculture .......................... Soymeal DCE (Dalian)
Energy .................................. Crude oil, WTI NYMEX (New York)
Industrial materials ............. Rubber SHFE (Shanghai))
Precious metals ................... Gold COMEX (New York)

Many products and events underlie derivatives ... here are only a few of the listed derivatives that are available:
Credit default ...................... iTraxx Europe 5-year index Eurex (Frankfurt)
Shipping ............................... Freight swap futures, Singapore to Japan. NYMEX (New York)
Weather ............................... U.S. wind event, $20 bin loss trigger Chicago Climate Exch.
Emissions ............................ European Union CO2 allowance ICE (London)
Housing ............................... S&P Case-Shiller housing composite CME (Chicago)
Product/Event Derivative Contract (Most active) Exchange
Currencies ......................... $US Russian ruble MICEX (Moscow)
Equities .............................. S&P500 E-mini CME (Chicago)
Money market rates ........... 28-day Interbank Interest Rate Mexder (Mexico City)
Bonds ................................. Euro Schatz Eurex (Frankfurt)
Some startling facts and figures
The estimated value of world GDP as
of 2013 stood at $85 trillion.
The value of the international equity and
bond market stood at $212 trillion.
The notional value of the world derivatives
market stood at $1.2 quadrillion.
Derivatives are financial weapons of mass destruction.
- Warren Buffet
The crisis is far from over and derivatives offer a license to kill.
- George Soros
The subprime disaster was a result of financial time bombs -
derivatives - exploding in financial institutions throughout the world.
- Robert Kiyosaki
The Downside of Derivatives
MARKETS
International Standardized Futures Market
World OTC Market
The Derivatives Market in India
PRODUCTS
Futures, options, swaps
Structured Derivative Products
Exotic Products

Presentation Snapshot
What is an Exchange?
An exchange is a location, either physical or electronic, where people gather to locate
other market participants, determine a fair price and exchange the risk associated with
holding on an asset that may fluctuate in price.
A farmer, alone in his field, may not know that a potential buyer for his crop exists
half way around the world

When market participants gather at a centralized location, transactions occur
hundreds or thousands of times a day providing valuable information about price and
ample opportunity to transfer risk.

Unlike a transaction that is negotiated between two individuals, exchange enforces
strict rules and guarantees the performance of its market participants.

The security of doing business in a safe and regulated environment allows businesses
to better identify their risk and manage it more efficiently.
Exchange-Traded Derivatives?
1. Exchange-traded derivatives, are fully standardized and their contract terms are
designed by derivatives exchanges.

2. Once a product matures, exchanges industrialize it, creating a liquid market for a
standardized and refined form of the new derivatives product. The OTC and
exchange-traded derivatives then coexist side by side.
Terms of the Contract at an Exchange
Contract Size
Standardized exchange traded equity options are exercisable into 100
shares of the underlying security
Standardized exchange traded future options are exercisable into one
futures contract

Expiration Date
Standardized exchange traded equity options expire the third Saturday of
the month
The last trading day is the Friday preceding the third Saturday.
Standardized exchange traded future options expire in accordance with
rules for the underlying future
What do investors like about exchange?
Provides a central market place
Provides Liquidity
Has financial safeguards
Takes credit risk
Provides clearing house
Minimizes operational risk
Has transparent pricing
Segregated accounts

For the most part, OTC derivatives trading does not have a mechanism that is
similar.
Clearinghouse
Clearinghouse intermediates every trade made on the exchange.
Main functions are :
Intermediate the credit of the various market participants
Administrator collection of margin/performance bond
Ensure smooth, timely settlement of all outstanding obligations.

These functions lead to greater liquidity and greater price discovery
than in OTC markets.
The Role of the Clearinghouse
Clearing members assume responsibility for all transactions

Clearing houses provide centralized, multilateral netting of an
exchanges futures contracts.
What is Clearing?
Activities that take place between the time a transaction is originated and
the time it is settled

Intended to ensure that trades are settled in accordance with market
rules.
Securities world: T+3
Derivatives world : risk management for the life of a trade.
Bilateral clearing (OTC market)
Central counterparty clearing (exchange traded markets)

Advantages of central counterparty model
EUREX Exchange
Eurex Exchange is a German derivatives exchange that offers more than 1,900 products
covering all major as well as alternative asset classes. The online marketplace is the
gateway to some heavily traded EUR-denominated equity index and fixed income
derivatives.
The exchange was established in 1998 with the merger of Deutsche Terminbrse
(DTB, the German derivatives exchange) and SOFFEX (Swiss Options and Financial
Futures)

On 1 January 2012, SIX Swiss Exchange sold its 50-percent share in the company.
Since then, Deutsche Brse Group is the sole shareholder of Eurex.

In February 2004 Eurex started the derivatives exchange Eurex US and enlarged its
business model to the trading and clearing of USD-dominated products in the US.

In 2005, EUREX expanded into the Asian market by co-operating with Osaka Securities
Exchange.
Product Offering
Interest Rate Derivatives
These include:
1. Euro-Schatz Futures (notional short-term debt instrument issued by the
Federal Republic of Germany with a term of 1.75 to 2.25 years)
2. Euro-Bobl Futures (notional medium-term debt instrument issued by the
Federal Republic of Germany with a term of 4.5 to 5.5 years)
3. Euro-Bund Futures (notional long-term debt instrument with a term of 8.5 to
10.5 years)
4. Euro-Buxl Futures (notional long-term debt instrument issued by the Federal
Republic of Germany with a term of 24 to 35 years)
5. CONF-Futures (notional long-term debt instrument issued by the Swiss
Confederation with a term of eight to 13 years)
6. Three-Month EURIBOR Futures

In the equity segment, investors can choose between nearly 200 options on
Dutch, Scandinavian, French, German, Italian, Russian, Spanish, Swiss, and U.S.
equities.
With Single Stock Futures Eurex offers futures on individual equities on all
component issues of the European benchmark indexes EURO STOXX 50 and DAX,
on all EUR- and CHF-denominated STOXX Europe 600 constituents, as well as all
components of the Swiss SMI.
The number of Single Stock Futures on equities which can be traded has grown
constantly up to around 400.

Equity Derivatives



Eurex Exchange's equity index portfolio covers futures and options on the most liquid
global, European and national indexes like:
Dow Jones Global Titans 50 IndexSM
EURO STOXX 50 Index
DAX
SMI
Derivatives on all 19 EURO STOXX/STOXX Europe 600 Supersectors
Futures on five Dow Jones Sector Titans Indexes
MSCI Indexes
RDX USD Index
SENSEX


Equity Index Derivatives

Over-The-Counter Derivatives Market
Trading Over the Counter Exchange Traded
Flexibility
Privacy
Recent Development
The OTC derivative market continued to expand in the second half of 2013.
The Notional amount totaled $710 trillion
Gross Market Value stood at $19 trillion


Notional Amount
Gross Market Value
Gross Credit Exposure
Notional Amount Gross Market Value Gross Credit Exposure
Interest Rate Derivatives
Gross Market Values, By Currency Notional Amounts, by Maturity Notional Amount, by Counterparty
Interest rate segments accounts for the majority
Notional Amount totaled $584 trillion, which accounts for 82% of OTC
Gross Market Value declined to $14 trillion


Foreign Exchange Derivatives
Second largest segment of the global OTC derivative market
At end of December 2013, notional amount of foreign exchange contracts stood at $71 trillion
Forwards and Foreign Exchange Swaps accounted for clos to half of notional amount

Credit Default Swaps
In 2007, CDS had come close to being the second largest segment in OTC derivative
Notional amounts fell to $21 trillion
The Gross Market Value fell to $0.7 trillion

Derivatives in India- history
June 9, 2000 -launched the first
Exchange-traded Index
Derivative Contract in India
June 1, 2001-BSE commenced
trading in Index Options on
Sensex July 9, 2001- Stock
Options were introduced on 31
stocks , Single Stock Futures
were launched on November 9,
2002.
February 29, 2008-BSE
introduced 'Long Dated
Options' on its flagship index -
Sensex
October 1, 2008 -BSE launched
its currency derivatives
segment in dollar-rupee
currency futures
BSE re-launched its
Derivatives Segment by
enabling trading of Index and
Stock Futures on its BOLT
Terminal
Derivatives market in India
Derivatives
Market in India
(major players)
BSE
NSE
Started derivatives trading on
June 9
th
2000 ,when equity
derivatives were launched.
Launch of various products
Index options
Single stock
futures
Currency
futures
US dollar-
rupee future
Started derivatives trading on
June 12,2000 , when Index
futures S & P CNX Nifty
was launched
Launch of various products
Index options
Stock
options
Stock
futures
Interest
rate
Bank nifty
futures and
options
Long term
options
Currency
fututre on
USD -
Rupee
Infrastr
ucture
indices
Derivative Contracts permitted for Trading in India
Indian Derivatives Market vis--vis Global Derivatives Market-The growth Story
More than 15 billion futures and options contracts were traded during 2007. on
the 54 important exchanges that report to the FIA, reflecting a remarkable
increase of 28% from the previous year
Over the period 2000-07, the US exchanges alone constituted as much as 35
percent.
The turnover of the NSE derivatives segment in 2003-04 stood at Rs. 2130610
crores. and Rs.13090477 crores during the year 2007-08.
Indian Derivatives market showed more than six-time increase over the five
year period. In marked contrast, at the global level the increase was less than even
two-fold: the turnover was $ 8163 million in 2003 and $ 15187 million in 2007.

Global Trend in Turnover of Derivatives Trading
Global Derivatives Volume Growth 2002-2007
Derivatives Volume by Region Jan-Dec 2008
Types Derivative Instruments according to underlying assets
Futures and Forwards Options Swaps
Commodity Financial
Credit
Default
Interest
Rate
FX Swap
Commodity Index Bond Equity Future
Difference between Futures and Forwards
FUTURES FORWARDS
FORWARD CONTRACTS
Forward contract is relatively a simple derivative. It is an agreement to buy or sell an asset at a certain future time
for a certain price.

It can be contrasted with a spot contract, which is an agreement to buy or sell an asset today.
One of the parties to a forward contract assumes a long position and agrees to buy the underlying asset on a certain
specified future date for a certain specified price.

The other party assumes a short position and agrees to sell the asset on the same date for the same price.
The payoff from a long position in a forward
contract on one unit of an asset is
S X

The payoff from a short position in a forward
contract on one unit of an asset is
X S

Where Delivery Price= X and
Price of Asset at Contract Maturity= S
FUTURES CONTRACTS

Unlike forward contracts, futures contracts are normally traded on an exchange.

To make trading possible, the exchange specifies certain standardized features of the contract

The largest exchanges on which futures contracts traded are the CBOT and CME.

.
The 100 ounce gold futures contract on the COMEX dominates
this activity and accounts for 85% of gold futures trading.
COMEX has mild competition from 1kg gold futures contracts
traded on the SHFE (Shanghai) and TOCOM (Tokyo)
which account for 7% each of the futures market.
SWAPS AND OPTIONS
Options are traded both on exchanges and in the over-the-counter market.

There are two types of option:
Call option gives the holder the right to buy the underlying asset by a certain date for a certain price.
Put option gives the holder the right to sell the underlying asset by a certain date for a certain price.
The price in the contract is known as the exercise price or strike price.

The date in the contract is known as the expiration date or maturity.

1. Buyers of calls
2. Seller of calls
3. Buyer of puts
4. Seller of puts
There are four types of participants in the
Options markets:
SWAPS AND OPTIONS
FORWARDS
A swap is an agreement to exchange cash flows at specified future times according to certain specified rules.
These cash flows are most commonly the interest payments associated with debt service.

If the agreement is for one party to swap its fixed interest rate payments for the floating interest rate payments
of another, it is termed an interest rate swap.

If the agreement is to swap currencies of debt service obligation, it is termed a currency swap.

A single swap may combine elements of both interest rate and currency swaps.
The swap itself is not a source of capital, but rather an alteration of the cash flows associated with payment.

What is often termed the plain vanilla swap is an agreement between two parties to exchange fixed-rate for
floating-rate financial obligations.
This type of swap forms the largest single financial derivative market in the world.
Credit Default Swap
Credit default swaps (CDS) are the most widely used type of credit derivative.
The first CDS contract was introduced by JP Morgan in 1997
A CDS contract involves the transfer of the credit risk of municipal bonds, emerging market bonds, mortgage-backed
securities, or corporate debt between two parties.
Like insurance regular payments are made.
Generally used for hedging or speculation
Recently huge payoffs of 2.6 billion dollars were made in the Greek Crisis

Credit Linked Notes
It is structured as a security with an embedded credit default swap allowing the issuer to transfer a specific credit risk
to credit investors
The trust will also have entered into a default swap with a dealer. In case of default, the trust will pay the dealer par
minus the recovery rate, in exchange for an annual fee which is passed on to the investors in the form of a higher yield
on their note.
A bank lends money to a company, XYZ, and at the time of loan issues credit-linked notes bought by investors. The
interest rate on the notes is determined by the credit risk of the company XYZ. The funds the bank raises by issuing
notes to investors are invested in bonds with low probability of default. If company XYZ is solvent, the bank is
obligated to pay the notes in full. If company XYZ goes bankrupt, the note-holders/investors become the creditor of
the company XYZ and receive the company XYZ loan.
One of the factors of Parmalat scandal is because of use of CLN where they sold themselves their credit linked notes.
Interest Rate Swap
An interest rate swap (IRS) is a popular and highly liquid financial derivative instrument in which two parties agree to
exchange interest rate cash flows, based on a specified notional amount from a fixed rate to a floating rate (or vice
versa) or from one floating rate to another.
Amount of the contract is mostly notional and is only used for calculating interest payments
Different types of IRS
Fixed for floating same currency, different currency
Floating to floating same and different currency
Fixed-for-fixed rate swap, different currencies
These are the products that can not be classified into any other category.
Its meaning depends on time and place.
These derivatives are more complex than vanilla products.
A nonstandard derivative with e.g. an unusual pay-off structure.
Their value is derived using specialized simulation techniques.
Risk Management, Customizability, Higher returns.
Regulator Roles
Exotic derivatives:

Derivatives with a non-standard subject matter, developed for a particular client or a particular market.
For example, a telecommunications company might use a derivative whose underlying subject matter is
bandwidth.
Options with a more complicated pay-off profile. Eg - if the price of the underlying asset rises above a
certain threshold level, the option holder is guaranteed a minimum payout, even if the price
subsequently falls.
The more complex forms of structured product. Eg- A corporate bond with an attached equity warrant
Exotic derivatives examples:

.
Trademarked ticker symbol for the Chicago Board Options Exchange Market Volatility Index
Popular measure of the implied volatility of S&P 500 index options.
Represents measure of the market's expectation of stock market volatility over the next 30 day period.

VIX-based derivative instruments:
VIX futures contracts, which began trading in 2004
Exchange-listed VIX options, which began trading in February 2006.

In India VIX index is maintained at NSE : India VIX.
VIX Contracts:
Weather
Derivatives
protection against weather-related risks
Temperature as a Commodity
1997 the first over-the-counter(OTC) weather
derivative trade took place
In 1999 Chicago Mercantile Exchange (CME)
introduced exchange-traded weather futures and
options on futures - the first products of their
kind.
Other
contracts:
Freight rates derivatives.
Economic indicator derivatives(eg. Employment
rate)
Exotic Derivatives
THANK YOU