What is a derivative?Types of derivatives?

What is a derivative?

Derivatives is a contract whose value is derived from the underlying assets.so, now what’s an Underlying asset???

The underlying asset can be anything like you can say a stock on which you are going to take a bet with your friend that next week it’s price will increase, in this case underlying is that particular stock.

Types of Derivatives?

There are many derivatives but initially, we’ll understand some of them

Forwards contract:

So, just for understanding let’s understand with an example of betting. let’s say you and your friend while talking take a bet on a particular cricket team you said that the team will make more than 100 runs and your friend says they will make less than 100 runs, here your reward is 1000 rs per run.

So, now you both entered into a contract where no money is initially going out of your pocket, and suppose the team makes 120 runs your friend will pay you 20x1000= 20000 and vice versa. This is a forward contract, in reality, it is done Over The Counter (OTC) with banks. It’s a private and customizable contract.

Futures Contract:

Here in Futures contract, it’s the same as a forward contract the difference is that it is traded on exchanges and not done over the counter. There are regulations for futures contracts as it is traded on an exchange, here there is no default risk. It is a standardized contract, unlike forward contracts.

Swaps:

Let’s understand it by the example of that cricket match, lets say now you and your friend bet that this team xyz is gonna score more than 100 runs in all 10 matches in the tournament. So now you are betting for the next 10 matches we can say you are doing a series of forward contracts. It’s called swaps.