Derivatives for CFP – 1
Posted by Prashant Shah on December 7, 2011
Forwards
A forward contract or simply a forward is a contract between two parties to buy or sell an asset at a certain future date for a certain price that is pre-decided on the date of the contract.
Features of Forwards:
- The price fixed now for future exchange is the forward price.
- The party with a “long position”(“Short position) will be the buyer(seller) of the underlying asset or commodity.
- Custom tailored
- Traded over the counter (not on exchanges)
- No money changes hands until maturity
- Counter-party risk
Settlement of Forward Contracts:
- Physical Settlement
- Cash Settlement
Futures
Like a forward contract, a futures contract is an agreement between two parties in which the buyer agrees to buy an underlying asset from the seller, at a future date at a price that is agreed upon today. However, unlike a forward contract, a futures contract is not a private transaction but gets traded on a recognized stock exchange. Futures contract is standardized by the exchange.
Features:
- Standardized contracts in terms of:
- Underlying commodity or asset
- Quantity
- Maturity, delivery date and delivery terms
- Exchange traded
- Guaranteed by the clearing house — no counter-party risk
- Gains/losses settled daily
- Margin account required as collateral to cover losses
Margins:
Initial Margin: The payment which investors have to pay to a broker to trade on margin, commonly used in trading futures and contracts for difference. Initial margin is usually set at a percentage of the value of the contracts being traded.
Maintenance Margin: The lowest balance of funds that a broker will allow a counterparty to maintain when trading on margin.
Variation Margin: Profits and losses on open futures contracts, which are revalued daily at the settlement price, which are subsequently paid to or received from the clearing house.
Basis:
The difference between the current cash price and future price is defined as basis.
Basis = Current cash price – Futures price
Negative basis refers to Contango market where futures prices are higher than cash prices. Positive basis refers to backwardation market where futures prices are lesser than cash prices.
References:
NCFM Books of NSE.
PVS (Prashant V Shah) 
abhishek1414 said
Thank You so much Sir for your valuable notes . Its of a great help.
I just wanted an answer to a derivative sum. I have my exams after 2 days. Please if you can help.
Q. The current market price of a equity share of XYZ Ltd is Rs. 70 per share. It may either be Rs.90 or Rs.50 after a year. A call option with a strike price of Rs. 66 (time one year) is available. The rate of interest applicable to investor is 10%. He wants to create a replicating portfolio in order to maintain his pay off on the call option for 100 shares.
Q1. The Hedge Ratio will be :
a, 1
b. 0.6 (ans)
c. 1.6
d. None
Q2. In order to create a replicating portfolio. He should buy- shares at the price of each:
a. 60,70(ans)
b. 70,60
c. 60,90
d. 60,50
Q3. The amount of borrowing required for creating a replicating portfolio is:
a. Rs. 2757(ans)
b. Rs. 4200
c. Rs. 5400
d. Rs. 3000
Q4. Value of Call (100 shares ) will be :
a. Rs.4200
b. Rs.2727
c. Rs.1473(ans)
d. Rs.None
Am not able to get any answers . Your help will be of great impotance .
Thank You Sir