CLASSIFICATION OF DERIVATIVES

 

Classification of derivatives


         Derivatives are financial instruments that are used to earn money. Derivatives are contracts between two parties for easily marketable assets. The contract is written.

Derivatives can be classified into three types.

  • Based on the nature of the contract
  • Based on underlying assets
  • Based on a trading mechanism

these are explained below

Based on the nature of the contract

Based on the nature of the contract, derivatives may be classified into forwards futures options swaps, etc.

  • Forwards: is a contract in which the parties which means buyer and seller agree to exchange an asset on a future date at a price agreed at that time of entering futures it is not traded on any stock exchanges they are generally traded only over the counter.
  • Futures: A futures contract is an agreement between two parties to buy or sell an asset or an instrument at a certain time in the future at a certain price. Future contracts are traded on stock exchanges. The value of future contracts is marked to market every day.
  • Options: In options, it refers to the right but not the obligation to buy or sell a security or other assets during a given time for a specified price. The specified price is called the strike price. Once the option is offered the option writer must fulfill the contract. if one party has the option the other party has an obligation. If the buyer or writer does not exercise the option within the specified. The option will get expired.
  • Swaps: Swaps are derivative contracts in which two parties exchange their financial obligations. The cash flows are based on a national principal amount agreed between both parties without exchanging the principal amount. the amount of cash flows is based on a rate of interest. One cash flow is generally fixed and the other is variable. For example, the floating rate of interest may be exchanged with the loan with a fixed rate of interest. Swaps are not traded on stock exchanges. They are traded on a counter market.

Based on underlying assets

The derivatives are traded based on underlying assets they can, be broadly classified into two commodity derivatives and financial derivatives

  • Commodity derivatives: In the case of commodity derivatives are the underlying asset traders’ commodities. The commodities may be agricultural products such as rice-wheat, cotton, oil, soya, rubber, etc., and metals such as copper, tin, gold, silver, etc.
  • financial derivatives: In financial derivatives, the underlying assets are financial instruments or products. The financial derivatives derive their value from financial assets suggest foreign exchange shares or security interest rates etc.

Based on a trading mechanism

If the derivative instruments are traded based on a trade mechanism that can be classified into exchange-traded derivatives and over the counter derivatives

  • Exchange-traded derivatives: These are traded on organized or regulated exchanges. the buyer and seller need not know each other the exchange is the counterparty for both the buyer and seller. This means that the derivative Exchange Act is an intermediary to all transactions. Exchange-traded derivatives are standard products.
  • Over-the-counter derivatives: These are contracts that are traded outside the exchanges. . these are traded between two traders that know each other personally. They are also traded through an intermediary usually a large bank. these contracts are specific to the parties involved.

We can choose any type of derivatives according to the condition of the different types of derivatives and our interests.






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