Consider the following statements regarding Derivatives: It is a contr...
The Securities and Exchange Board of India (SEBI) recently clarified that it was not looking to reduce retail participation in the derivatives segment.
About Derivatives:
- A derivative is a contract between two parties which derives its value/price from an underlying asset.
- The commonly used assets are stocks, bonds, currencies, commodities and market indices.
- These instruments allow investors and traders to speculate on the price movements of the underlying asset without owning it directly.
- The value of the underlying assets keeps changing according to market conditions. The basic principle behind entering into derivative contracts is to earn profits by speculating on the value of the underlying asset in future.
- Derivatives serve various purposes, including hedging against risks, providing leverage, and facilitating price discovery.
- The most common types of derivatives are:
- Futures Contracts: A futures contract is an agreement between two parties to buy or sell an asset at a predetermined price on a specific future date. The underlying asset can be commodities, financial instruments, or indices.
- Options Contracts: An options contract gives the holder the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price (strike price) on or before a predetermined expiration date.
- Swaps: Swaps are agreements between two parties to exchange cash flows based on specific financial variables. Common types of swaps include interest rate swaps, currency swaps, and commodity swaps. Swaps are often used to manage interest rate risks, currency risks, or to change the nature of a debt obligation.
- Forwards: Forwards are similar to futures contracts but are not standardized or traded on exchanges. They are customized agreements between two parties to buy or sell an asset at a specified price on a future date.
Hence both statements are correct.
Consider the following statements regarding Derivatives: It is a contr...
Overview:
Derivatives are financial instruments that derive their value from an underlying asset. They allow traders to speculate on the future value of the underlying asset and earn profits. Both statements provided in the question are correct.
Explanation:
1. Derivatives as a contract:
Derivatives are contracts between two parties, where the value or price of the derivative is derived from an underlying asset. The underlying asset can be commodities, currencies, stocks, bonds, or indices. The derivative itself does not have any intrinsic value but derives its value from the underlying asset. Examples of derivatives include futures, options, swaps, and forwards.
2. Profits through speculation:
One of the primary purposes of derivatives is to allow traders to earn profits by speculating on the future value of the underlying asset. Traders can take positions in derivatives based on their belief about the future direction of the asset's price. They can either go long (buy) or go short (sell) the derivative contract, depending on whether they anticipate the price of the underlying asset to increase or decrease.
For example, if a trader believes that the price of a stock will increase in the future, they can buy a call option on that stock. If the price of the stock indeed rises, the value of the call option will increase, allowing the trader to earn a profit. Similarly, if a trader expects the price of a commodity to decline, they can sell a futures contract on that commodity and profit if the price indeed falls.
Conclusion:
In conclusion, derivatives are contracts that derive their value from an underlying asset. They enable traders to earn profits by speculating on the future value of the underlying asset. Therefore, both statements given in the question are correct.
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