Questions and Answers
What are derivatives primarily based on?
Which of the following is NOT a commonly used derivative contract?
What is the primary advantage of using margin money in derivative trading?
What happens if the market moves against an investor using derivatives?
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Which statement accurately describes futures contracts?
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What is the implication of leverage in futures trading?
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Under which act are derivatives defined?
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What is the result of an investor going long on a futures contract for gold if prices increase?
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What is a common mistake investors make regarding margin money?
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What is the role of the National Securities Clearing Corporation (NSCCL) regarding futures and options?
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What does the Standard Portfolio Analysis of Risk (SPAN) system do?
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Who is eligible to participate in the derivatives market?
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Study Notes
Market for Derivatives
- Derivatives are financial instruments with values derived from underlying assets like equities, forex, or indices.
- Transactions involve contracts where parties agree to pay each other based on asset values at a specific time.
- Regulatory definition includes securities derived from debt instruments, contracts for differences, and others.
- Common types of derivatives include futures, forwards, options, and swaps.
How Derivatives Work
- Investors utilize margin money, a fraction of the asset's total value, to take leveraged positions in derivatives.
- Margin amounts are set by stock exchanges and can fluctuate over time.
- If the underlying asset's price increases, investors profit; if it decreases, they risk losing the entire margin or more.
- Example: Buying a gold futures contract valued at Rs. 11 lac requires only a 4% margin (Rs. 44,000), instead of the full amount, highlighting potential for both profit and loss.
- Misunderstanding of risk often leads investors to over-leverage, resulting in significant losses when prices drop.
Margin System
- The National Securities Clearing Corporation (NSCCL) manages risk through an online monitoring and margining system.
- The Standard Portfolio Analysis of Risk (SPAN) system is employed for margin calculations.
- Position monitoring occurs intraday, ensuring timely assessment of risks across portfolios.
Risks Involved in Derivatives
- Participation in the derivatives market necessitates a clear understanding of the risks, as losses can exceed initial investments.
- Derivatives should not be treated as investments since they are not considered an asset class.
- Investors retain liability for the remaining value of the underlying asset at contract expiration, leading to substantial profits or losses with sharp market movements.
Participation in Derivatives
- Individuals, brokers, and corporations can engage in the derivatives market, provided they have a tolerance for risk.
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Description
Explore the intricacies of the derivatives market, where financial instruments derive their value from underlying assets. This quiz covers the key concepts, contracts, and risks associated with derivatives, making it essential for anyone looking to understand this complex financial arena.
