Derivative Contracts

Derivative contracts are financial instruments whose value is derived from an underlying asset such as stocks, commodities, currencies, or interest rates. These contracts represent an agreement between two parties to buy or sell the asset at a predetermined price on a future date.

Key Features

Derived Value – Value depends on the price of the underlying asset

Contractual Agreement – Involves two or more parties

Future Settlement – Executed at a future date or based on price movement

Leverage – Small investment can control large exposure

Risk Transfer – Helps shift risk from one party to another

Types of Derivatives

✔️Futures – Standardized contracts traded on exchanges
✔️Options – Provide right but not obligation to buy/sell
✔️Forwards – Customized agreements traded over-the-counter (OTC)
✔️Swaps – Exchange of financial obligations (e.g., interest rates)

Uses

✔️Hedging – Protect against price fluctuations (e.g., farmers, exporters)
✔️Speculation – Earn profits from price changes
✔️Arbitrage – Take advantage of price differences in markets

Example

✔️A farmer enters a contract to sell wheat at a fixed price after 3 months.
✔️If market price falls → farmer is protected
✔️If price rises → buyer benefits

Q1. Which authority regulates currency derivative contracts in India?

(a) SEBI
(b) RBI
(c) Both RBI and SEBI
(d) Ministry of Finance

Q3. A Indian exporter expecting dollar receipts after 3 months fears rupee appreciation. Which instrument best hedges this risk?

(a) Buy a USD Call option
(b) Sell a USD Forward contract
(c) Buy a USD Future
(d) Enter an interest rate swap

Little difficult but if you know the concept it becomes easy

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(c) Both RBI and SEBI

RBI — regulates under FEMA; governs who can participate, position limits, eligible currencies
SEBI — regulates exchange platform (NSE/BSE); trading rules, margins, surveillance
Both jointly issued the 2023 circular tightening currency derivative norms (proof of underlying exposure required).

(b) Sell a USD Forward contract

Logic:
Exporter will receive USD in 3 months → wants to convert to INR
Fears rupee appreciation = USD will be worth less in INR terms
So he locks in today's exchange rate by selling USD forward
Why others wrong:
(a) USD Call → right to buy USD → importer's hedge
(c) USD Future → buying = expecting USD to rise, opposite of need
(d) Interest rate swap → hedges interest rate risk, not currency risk
Rule: Exporter = future USD seller → sell forward. Importer = future USD buyer → buy forward.

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