DERIVATIVES

DERIVATIVES
In India, different derivatives instruments are permitted and regulated by various regulators, like Reserve Bank of India (RBI),
Securities and Exchange Board of India (SEBI) and Forward Markets Commission (FMC). Broadly, RBI is empowered to regulate
the interest rate derivatives, foreign currency derivatives and credit derivatives.
Definition : A derivative is a financial instrument:
(a) whose value changes in response to the change in a specified interest rate, security price, commodity price, foreign
exchange rate, index of prices or rates, a credit rating or credit index, or similar variable (sometimes called the 'underlying');
(b) that requires no initial net investment or little initial net investment relative to other types of contracts that have a
similar response to changes in market conditions; and
(c) that is settled at a future date.
For regulatory purposes, derivatives have been defined in the Reserve Bank of India Act, as "an instrument, to be settled at a
future date, whose value is derived from change in interest rate, foreign exchange rate, credit rating or credit index, price of
securities (also called "underlying"), or a combination of more than one of them and includes interest rate swaps, forward
rate agreements, foreign currency swaps, foreign currency-rupee swaps, foreign currency options, foreign currency-rupee
options or such other instruments as may be specified by the Bank from time to time.
Derivatives Markets
There are two distinct groups of derivative contracts:
Over-the-counter (OTC) derivatives: Contracts that are traded directly between two eligible parties, with or without the use
of an intermediary and without going through an exchange.
Exchange-traded derivatives: Derivative products that are traded on an exchange.
Participants : Participants of this market can broadly be classified into two functional categories, namely, (a) users (who
participates in the derivatives market to manage an underlying risk) and (b) the market-maker who provides continuous bid
and offer prices to users and other market-makers. A market-maker need not have an underlying risk.
Purpose : Derivatives serve a useful risk-management purpose for both financial and nonfinancial firms. It enables transfer of
various financial risks to entities who are more willing or better suited to take or manage them.
Users can undertake derivative transactions to hedge - specifically reduce or extinguish an existing identified risk on an
ongoing