Tuesday, April 27, 2010

The World of Derivatives

Derivatives are specialized contracts which marks an agreement or an option to buy or sell its underlying's up to pre-choreographed time in the future at a prearranged price,which is know as the exercise price. The word “derivatives” originated from mathematics and signify the variables, these variables are derived from another variable-they have no value of their own and they derive their value from the value of some other asset, that’s commonly known as underlying.
Not in modern sense,though the history of derivatives is surprisingly longer and could be traced back since the age of Mahabharata,albeit advent of modern day’s derivatives contracts can be attributed to the need for farmers to protect themselves from any decline in the price of their corps due to delayed monsoon or over production.

The first “futures” contracts can be traced to the “Yadoya” rice market in Osaka {Japan} around 1650-those were the explicitly standardized contracts which resembled very close to today’s futures contracts. The Chicago Board of Trade {CBOT}, the largest derivative exchange in the world was established in 1848 where forward contracts on various commodities were standardized around 1865-aftetwards, futures {contracts}have remained more or less in the same form, as we know them in modern understanding.
In Indian case too-derivatives have a long standing presence; the commodity derivative market has been operationalizing in India since the nineteenth century with organized trading in cotton through the establishment of Cotton Trade Association in 1875, since than contracts on various other commodities have been introduced as well.

Indian market is in growing phase with seven-eight years of operation in exchange traded financial derivatives, those were introduced in India in June 2000 at the two major stock exchanges-NSE and BSE.Further National Commodity &Derivatives Exchange Limited {NCDEX} started its operation in December 2003, to provide a platform for commodities trading-with slew of measures, the derivatives market in India has grown exponentially over the years, especially at NSE.
Stock futures are the highest traded contracts on NSE accounting for around 55% of the total turnover in derivatives trade at NSE, as on April13, 2005. Broadly derivatives can be categorized in three orders-I. Simple derivatives {plane Vanilla products}, II.Complex derivatives {exotic products} and III.Very complex products designed and suitable to particular client only.

Indian banks remains mostly untouched with the last two products as RBI doesn’t permit too much open positions on foreign exchange; many Indian banks did the deals and in turn entered into back to back understanding with the foreign banks-it was so because Indian banks didn’t have those exotic products, they bought it from foreign banks and sold them to corporates.Thanks to our regulators, who never believed in “greed is good” principle like the protagonist of 1987 released Hollywood blockbuster {Wall Street} or its real executioner{bankers} at Wall Street…we also can’t ignore the wise saying of grand old man of investment, Mr. Warren Buffet, who in aggrieved state pronounced on the wake of deep recession in 2008, derivatives as “Financial Weapons of Mass Destruction”.
Indeed he wasn’t wrong as longer as he saw its bad outcome by the acts of its maligners {greedy bankers from Wall Street} otherwise, a financial product even derivative can’t stand so destructively on their own foot-these potential outside push is the real threat behind the entire web of derivative trading.

A single derivative product known Credit Default Swaps {CDS} has alone fuelled the matter for more than six dozens bank failure, alone in U.S.A since the break out of recession in 2007-wrong doings are still far from being over as another giant from Wall Street {Goldman Sachs}is badly tapped in its wave of unethical handling.Derivatives as a financial product is very useful until its bounded with an ethical conscience and incentive for mass enrapture otherwise its repercussions can be easily ransack the entire order…proper regulatory execution and shared vision of institutions involved in this field can lead to a sustainable way-out.
Atul Kumar Thakur
April24th 2010, Saturday, New Delhi

1 comment:

  1. A Good piece!, message is there with perspective.