Financial Derivatives

1. What are derivative securities? Discuss the uses and types of derivatives.
Ans: A financial instrument whose values depend upon the value of another asset is
known as derivative securities. Its security includes security derived from a debt
instrument, share, loan whether secured or unsecured, risk instrument or contract for
differences or any other form of security.
There are two types of derivatives. They are: Commodity derivatives and Financial
derivatives.
Commodity derivatives (Uses)

They are investment instruments that allow the investors to profit from certain
commodities without possessing them. The buyer of a derivatives contract buys the
right to exchange a commodity for a certain price at a future date, they may be buying
or selling them.
Financial derivatives (Uses)

Financial derivatives can also be derived from a combination of cash market
instruments or other financial derivative instruments. Most of the financial derivatives
are not new instruments, they are a combination of older derivatives.
2. Explain different types of financial derivatives along with their features in brief.
Ans: The different types of financial derivatives are as follows:
Forward: A forward contract is a customized contract between two entities, where

settlement takes place on a specific date in the future at today’s pre-agreed price.
Futures: A futures contract is an agreement between two parties to buy or sell an asset
at a certain time in the future at a certain price. Futures contracts are special types of
forward contracts in the sense that the former are standardized exchange-traded
contracts.
Options: This varies considerably from futures and forward contracts when there is no
commitment on a particular date to discharge the contract. Option contracts are those
contracts that give the right to buy or sell an underlying asset.
Swaps: Swaps are private agreements between two parties to exchange cash flows in
the future according to a prearranged formula. They can be regarded as portfolios of
forward contracts.
3. Distinguish between futures and forward contracts with suitable examples.
Ans:
Future Contract Forward Contract
Marked to market No marking to market
They trade on exchange Trade in OTC
Easy to terminate Difficult to terminate
5. Explain the terms futures, forward, option and swaps.
Ans:
Forward: A forward contract is a customized contract between two entities, where
settlement takes place on a specific date in the future at today’s pre-agreed price.
Futures: A futures contract is an agreement between two parties to buy or sell an asset
at a certain time in the future at a certain price. Futures contracts are special types of
forward contracts in the sense that the former are standardized exchange-traded
contracts.
Options: This varies considerably from futures and forward contracts when there is no
commitment on a particular date to discharge the contract. Option contracts are those
contracts that give the right to buy or sell an underlying asset.
Swaps: Swaps are private agreements between two parties to exchange cash flows in
the future according to a prearranged formula. They can be regarded as portfolios of
forward contracts.
6. Throw light on evolution of derivatives?
Ans: Although financial derivatives have been in operation for a long time, they have
become a major force in financial markets in the early 1970s. The basic reason behind
this development was the failure of Bretton Wood System and the fixed exchange
regime was broken upon market forces came into existence. But due to pressure on
demand and supply on different currencies, the exchange rate was constantly changing.
As a result, the business firms faced a new risk known as currency or foreign currency
exchange risk. A new financial instrument has therefore been developed in order to
overcome the risk in the financial environment.
7. Write a detailed account of functions of derivatives
Ans: The functions are:
Discovery of price: Prices in an organised derivatives market reflect the perception of

market participants about the future and lead the prices of underlying assets to the
perceived future level.
Risk transfer: The derivatives market helps to transfer risks from those who have them
but may not like them to those who have an appetite for them.
Increases savings and investments: Derivatives markets help increase savings and
investment in the long run. The transfer of risk enables market participants to expand
their volume of activity

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1. What are derivative securities? Discuss the uses and types of derivatives.

Commodity derivatives (Uses)

Financial derivatives (Uses)

Ans: The different types of financial derivatives are as follows:

Forward: A forward contract is a customized contract between two entities, where

3. Distinguish between futures and forward contracts with suitable examples.

They trade on exchange Trade in OTC

Easy to terminate Difficult to terminate

5. Explain the terms futures, forward, option and swaps.

6. Throw light on evolution of derivatives?

7. Write a detailed account of functions of derivatives

Ans: The functions are:

Discovery of price: Prices in an organised derivatives market reflect the perception of

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