Types of Ancient Derivatives

Meaning of Derivatives

Definition: Derivatives derive value from the performance of underlying assets (e.g., commodities, stocks, bonds, interest rates, and currencies).
Purpose: Used to reduce risk (hedging).

Definition: Customized contract to buy/sell an asset at a future date at a pre-agreed price.
Parties Involved: Buyer and Seller
Specific Terms: Includes price, quantity, quality, delivery date, and place.
Private Nature: Not regulated by a market; takes place between two parties.
Customization: Tailored to parties' needs.
Obligations: Both buyer and seller obligated to transact.
Example: Agreement to purchase 100 kg of wheat at ₹40 per kg after 6 months.
Risks: Counterparty risk (uncertainties about future conditions).

Similarities with Forward Contracts: Agreed upon future transaction for hedge purposes.
Differences:
- Settlement: Daily settlement (Mark-to-Market).
- Regulation: Traded on stock exchanges, executed through brokers.
- Market Type: Standardized contracts, opposite of customized forward contracts.
- Risk: Lower counterparty risk due to standardized processes.
Execution: Performed in future markets like stock exchanges.
Example: Commodified futures contracts are highly traded in regulated markets with clearly defined terms and daily settlement, providing flexibility.

Forwards offer customization but come with higher risks and private settlement.
Futures provide regulated, standardized contracts with daily risk management and lower counterparty risk.

Note: Understanding of these concepts is essential for business risk management and investment planning.