1. Treasury uses derivatives to manage risk including ATL, to cater needs of corporate customers and to trade.
2. The value of a Derivative is derived from on underlying market.
3. Derivatives always refer to future price.
4. The Derivatives that can be directly negotiated and obtained from banks and investment institutions are known as over the counter (OTC) products.
5. Derivatives are of two types OTC products and Exchange traded products.
6. The value of trade in OTC products is much larger than that of Exchange traded products.
7. Derivative products can be broadly categorized into Options, Futures & Swaps.
8. Options refer to contracts where the buyer of an Option has a right but no obligation to exercise the contract.
9. Put Option gives a right to the holder to sell an underlying product at a pre-fixed rate on a specified date.
10. Call option gives a right to the holder to buy the underlying product at a pre-fixed rate on a specified date or during a specified period.
11. The pre-fixed rate is known as Strike Rate.
12. Options are two types, an American type option can be executed at any time before expiry date and European type option can be exercised only on expiry date. In India we use only European type of Option.
13. A Dollar put Option gives right to the holder to sell Dollars.
14. If the strike price is same as the spot price, it is known as at the money.
15. The option is in the money (ITM), if the strike price is less than the forward rate in case of a Call Option or strike price is more than the forward rate in case of a put option.
16. The Option is out of Money (OTM) if the strike price is more than the forward rate in case of call option or if the strike price is less than forward rate in case of a put Option.
17. In the context of Options spot rate is the rate prevailing on the date of maturity.
18. The profit potential of buyer of an option is unlimited .
19. The option seller’s potential loss is unlimited.
20. Payment of differences between strike price & market price on expiry is known as cash settlement.
21. The buyer of an option pays premium to the seller for purchase of Option.
22. The option premium is paid upfront.
23. A USD put Option on TJY is right to sell USD against JPY at ‘X’ price.
24. A stock option is the right to buy or sell equity of a company at the strike price.
25. Options are used to hedge against price fluctuations.
26. A convertible option may be the bond holder option of converting the debt into equity on specified terms.
27. A bond with call option gives right to the issuer to prepay the debt on specified date.
28. Futures are forward contracts.
29. Under Futures contract the seller agrees to deliver to the buyer specified security / Currency or commodity on a specified date.
30. Future Contracts are of standard size with prefixed settlement dates.
31. A distinct feature of Futures is the contracts are marked to market daily and members are required to pay margin equivalent to daily loss if any.
32. In case of Futures the exchange guarantees all trades roughted through its members and in case of default or insolvency of any member the exchange will meet the payment out of its trade protection fund.
33. Currency Futures serve the same purpose as Forward Contracts, conventionally issued by banks in foreign exchange business.
34. Futures are standardized and traded on exchanges but Forward Contracts are customized OTC Contracts.
35. The Futures can be bought only for fixed amounts and fixed periods.
36. A Swap is an exchange of cash flow.
37. An interest rate Swap is an exchange of interest flows on an underlying asset or liability.
38. The cash flows representing the interest payments during the Swap period are exchanged.
39. For USD the bench mark rates are generally LIBOR ( London Inter Bank Offer Rate)
40. MIBOR is announced daily at 9.50 A.M by NSE.
41. MIBOR is used as a base rate for short term and Medium Term lending.
42. Interest rate Swap is shifting of interest rate calculation from fixed rate to floating or floating rate to fixed rate or floating rate to floating rate.
43. A Floating to Floating rate Swap involves change of bench mark.
44. Quanto Swaps refer to paying interest in home currency at rate s applicable to foreign currency.
45. Coupon Swaps refer to floating rate in one currency exchanged to fixed rate in another currency.
46. In Indian Rupee market only plain vanilla type Swaps are permitted.
47. A Currency Swap is an exchange of cash flow in one currency with that of another currency.
48. The need for Currency Swap arises when loan raised in one currency is actually required to be used in another currency.
49. The Interest rate Swaps (IRS) and Forward rate agreements (FRA) were first allowed by RBI in 1998.
50. Banks and counter parties need to execute ISDA master agreement before entering into any derivative contracts.
51. A right to buy is Call Option and a right to Sell is Put Option.
52. Swaps are used to minimize cost of borrowings and also to benefit from arbitrage in two currencies.
53. Currency and interest rate Swaps with basic structure without in built positions or knock-out levels are plain vanills type Swaps.