International Monetary Fund (IMF) defines derivatives as ‘financial instruments that are linked to a specific financial instrument and indicator or commodity and through which specific financial risks can be traded in financial markets in their own right. The value of a fiancial derivative derives from the price of an underlying item, such as an asset or index. Unlike debt securities, no principal is advanced to be repaid and no investment income accrues".
Derivative instruments are defined by the Indian Securities Contracts (Regulation) Act, 1956 to include (1) a security derived from a debt instrument, share, secured/unsecured loan, risk instrument or contract for differences, or any other form of security and (2) a contract that derives its value from the prices/index of prices of underlying securities.
Thus, derivatives are financial instruments/contracts the value of which depends upon the value of an underlying. Since their value is essentially derived out of an underlying. they are financial abstractions whose value is derived mathematically from the changes in the value of the underlying.
In recent years, derivatives have become increasingly important in the field of finance. While futures and options are now actively traded on many exchanges, forward contracts are popular on the over-the-counter (OTC) market.
This book explains at length the various concepts of financial derivatives, reasons for their popularity, risks involved and their emergence in the Indian capital market.
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