"Derivative” concept was first introduced in Chicago Board of Trade in 1848. After 152 years, from 2000 year on wards this concept was introduced in India.
Why Derivative concept was introduced worldwide?,
The main Purpose and benefits of derivatives instruments are described below:
The financial markets are very risky markets as unexpected incidents also influence the market. To ensure, these unexpected incidents risk, this concepts was introduced as a “Hedging” product. The main purpose of derivative markets is:
Changes in equity markets around the world.
Currency exchange rate shifts.
Changes in interest rates around the world.
Changes in global supply and demand for commodities such as agricultural products, precious and industrial metals and energy products such as oil and natural gas.
“Derivatives” are financial instruments. These represent the value the asset such as Equity, Bullion, Currency, Commodity etc. So when you invest in derivatives, you actually place a bet on whether the value of the asset represented will increase or decrease by a certain percentage and within a set period of time. Therefore, derivatives are merely contracts or bets that get their value from existing or future prices of underlying securities. In derivatives, you are essentially buying a promise from the original owner of the asset to transfer ownership of the asset rather than the asset itself.
The benefits of derivative instruments are described below,
Futures market prices of the assets depend on a continuous flow of information from around the world. A broad range of factors (such as climatic conditions, political situations, debt default, refugee displacement, environmental condition etc.) can influence the demand and supply of assets and thus the current and future prices of the underlying asset on which the derivative contract is based, changes the price as per the kind of information. This process is known as “Price Discovery”.
Risk management is the process of identifying the desired (future) level of risk, identifying the actual (Present) level of risk and altering the latter to equal the former. This process is widely termed as hedging and speculation. “Hedging” is defined as a strategy for reducing the risk in holding a market position while “Speculation”is taking a position in the way the markets will move.
They improve Market efficiency for the Underlying Asset.
For example, investors who want exposure to the NIFTY 50 can buy an NIFTY Bees stock index fund or replicate the fund by buying NIFTY 50 futures and investing in risk-free bonds. Either of these methods will give them exposure to the index without the expense of purchasing all the underlying assets in the NIFTY 50 Stocks.
Derivatives help to reduce “Market Transaction” costs.
Because derivatives are a form of insurance or risk management, the cost of trading in them has to be low or investors will not find it economically sound to purchase such “insurance” for their positions.
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