Book contents
- Frontmatter
- Dedication
- Contents
- List of Tables, Figures and Boxes
- Foreword
- Preface to the First Edition
- Preface to the Second Edition
- Acknowledgements
- Part–I Introduction
- 1 Introduction
- 2 Some Basic Concepts
- Part–II Forwards and Futures
- Part–III Swaps
- Part–IV Options
- Part–V Other Derivatives and Derivative-like Instruments
- Part–VI Accounting, Taxation and Regulatory Framework
- Part–VII Portfolio Management and Management of Derivative Risks
- Bibliography
- Index
1 - Introduction
from Part–I - Introduction
Published online by Cambridge University Press: 02 August 2019
- Frontmatter
- Dedication
- Contents
- List of Tables, Figures and Boxes
- Foreword
- Preface to the First Edition
- Preface to the Second Edition
- Acknowledgements
- Part–I Introduction
- 1 Introduction
- 2 Some Basic Concepts
- Part–II Forwards and Futures
- Part–III Swaps
- Part–IV Options
- Part–V Other Derivatives and Derivative-like Instruments
- Part–VI Accounting, Taxation and Regulatory Framework
- Part–VII Portfolio Management and Management of Derivative Risks
- Bibliography
- Index
Summary
In the early 1980s, the word ‘derivative’ was used mainly in chemistry (as in, hydrocarbon derivatives) or mathematics (as in, the second derivative of a function). Today, it is most commonly used in the context of financial markets. This is a reflection of the phenomenal speed with which these new financial instruments have evolved. Derivative markets today have an estimated value of over 378 crore crores or 3.78 x 1016. To put this figure in perspective, it is several times larger than the whole world's Gross Domestic Product (GDP)! Once considered exotic instruments used only by the high priests of international finance, these have now become ubiquitous. More and more companies and even some governments are using, or being forced to use, derivatives in a fast-changing world of unprecedented opportunities and unprecedented risks. An understanding of derivatives is thus a necessity for anyone interested in the financial markets.
Definition of derivative
A derivative security (commonly shortened to derivative) is a security or contract designed in such a way that its price or value is derived from the price of an underlying asset.
For instance, the price of gold ‘futures contracts for October maturity’ is derived from the price of gold. The value of a ‘September call option’ on sugar is derived from the price of sugar. The value of a ‘five year interest rate swap’ is derived from the prevailing rate of interest. The price of a derivative security is not arbitrary; it is linked to the price of the underlying asset. A rise in the price of the underlying may lead to a rise (or fall) in the price of the derivative, but in a predictable way. Because the relationship is predictable, transactions in derivatives can be used as a method to compensate for, or offset, the risk of price changes in the underlying asset. Formulae can usually be used to calculate the effect of the price of the underlying in the price of the derivative. However, the relationship is not always precise and the formulae are not always accurate and hence derivatives may not always work exactly as intended.
- Type
- Chapter
- Information
- Derivatives , pp. 3 - 20Publisher: Cambridge University PressPrint publication year: 2017