Functions of Capital Market:
What are derivatives? Derivatives are financial contracts whose value is dependent on an underlying asset or group of assets. The commonly used assets are stocks, bonds, currencies, commodities and market indices. The value of the underlying assets keeps changing according to market conditions. The basic principle behind entering into derivative contracts is to earn profits by speculating on the value of the underlying asset in future. Imagine that the market price of an equity share may go up or down.
You may suffer a loss owing to a fall in the stock value. In this situation, you may the options market is subdivided into a derivative contract either to make gains by placing accurate bet.
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- Market exposure refers to the dollar amount of funds or percentage of a broader portfolio that is invested in a particular type of security, market sector, or industry.
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Or simply cushion yourself from the losses in the spot market where the stock is being traded. Why do investors enter derivative contracts? Apart from making profits, there are various other reasons behind the use of derivative contracts. Some of them are as follows: Arbitrage advantage Arbitrage trading involves buying a commodity or security at a low price in one market and selling it at a high price in the other market.
In this way, you are benefited by the differences in prices of the commodity in the two different markets. Protection against market volatility A price fluctuation of asset may increase your probability of losses. You can look for products in the derivative market which will help you to shield against a reduction in the price of stocks that you own. Additionally, you may buy products to safeguard the options market is subdivided into a price rise in case of stocks that you are planning to buy.
Park surplus funds Some individuals use derivatives as a means of transferring risk. However, others use it for speculation and making profits. Here, you can take advantage of the price fluctuations without actually selling the underlying shares.
Who participates in derivatives market? You can divide them into following categories based on their trading motives: Hedgers These are risk-averse traders in stock markets. They aim at derivative markets to secure their investment portfolio against the market risk and price movements.
Market Exposure Definition
They do this by assuming an opposite position in the derivatives market. In this manner, they transfer the risk of loss to those others who are ready to take it. Imagine that you hold shares of XYZ company which are currently priced at Rs. Your aim is to sell these shares after three months. In this situation, you can buy a put option by paying a nominal premium that will take care of both the above requirements.
Speculators These are risk-takers of the derivative market. They want to embrace risk in order to earn profits. They have a completely opposite point of view as compared to the hedgers.
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This difference of opinion helps them to make huge profits if the bets turn correct. In the above example, you bought a put option to secure yourself from a fall in the stock prices. Your counterparty i.
Hence, the speculator keeps the premium and makes a profit. Margin traders A margin refers to the minimum amount that you need to deposit with the broker to participate in the derivative market. It is used to reflect your losses and gains on a daily basis as per market movements.
It enables to get a leverage in derivative trades and maintain a large outstanding position.
Types of Market Segmentation
Imagine that with a sum of Rs. However, in the derivative market you can own a three times bigger position i. Rs 6 lakh with the same amount. Arbitrageurs These utilize the low-risk market imperfections to make profits.
They simultaneously buy low-priced securities in one market and sell them at higher price in another market. This can happen options pool call when the same security is quoted at different prices in different markets.
Suppose an equity share is quoted at Rs in stock market and at Rs in the futures market. An arbitrageur would buy the stock at Rs in the stock market and sell it at Rs in the futures market. The four major types of derivative contracts are options, forwards, futures and swaps. The buyer is not under any obligation to exercise the option.
Types of Capital Market
The option seller is known as the option writer. The specified price is known as strike price. You can exercise American options at any time before the expiry of the option period. European options, however, can be exercised only on the date of expiration date. The parties to the future contract are under an obligation to perform the contract.
These contracts are traded on the stock exchange.
The value of future contracts are marked-to-market everyday. It means that the contract value is adjusted according to market movements till the expiration date. Forwards Forwards are like futures contracts wherein the holder is under an obligation to perform the contract. But forwards are unstandardised and not traded on stock exchanges.
These are available over-the-counter and are not marked-to-market.
These can be customised to suit the requirements of the parties to the contract. Swaps Swaps are derivative contracts wherein two parties exchange their financial obligations. The cash flows are based on a notional principal amount agreed between both the parties without exchange of principal.
The Importance of Market Segmentation
The amount of cash flows is based on a rate of interest. One cash flow is generally fixed and the other changes on the basis of a benchmark interest rate.
Interest rate swaps are the most commonly used category. Swaps are not traded on stock exchanges and are over-the-counter contracts between businesses or financial institutions. You need to understand the functioning of derivative markets before trading.
The strategies applicable in derivatives are completely different from that of the stock market. Derivative market requires you to deposit margin amount before starting trading.
The margin amount cannot be withdrawn until the trade is settled.
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- The Importance of Market Segmentation Market segmentation can help you to define and better understand your target audiences and ideal customers.
Moreover, you need to replenish the amount when it falls below the minimum level. You should have an active trading account which permits derivative trading.
If you are using services of a broker, then you can place orders online or the options market is subdivided into the phone.