Type of Securities

Table of Contents

Type of Securities

This article deals with ‘Type of Securities.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Security Market

  • Segment of financial market of an economy from where long term capital is raised via security instruments such as Debt, Equity and Derivatives .
  • There are different ways to classify Security Markets.

Classification 1 : Type of Security being traded

Type of Securities

Classification 2 : By Tenure of Securities

Type of Securities

Classification 3 : By Freshness of Security

Type of Securities

Classification 4 : By Settlement of Security

Type of Securities

Type of Securities

Securities are fungible and tradable financial instruments that are used to raise capital from public and private markets. 

There are three type of Securities i.e. (1) Debt , (2) Equity and (3) Derivatives .

Type of Securities

Different instruments to raise money from market

  • Consider a hypothetical situation – I have ₹5 Lakh & to start a business I need ₹10 Lakh. Now question arises that , how can I arrange rest  5 Lakhs ? Answer – I can approach Security Market to raise capital via  Debt or Equity.
  • In general, if anybody wants to start a business , he/she will need 4 factors of  production
Entrepreneurship Land
Capital Labour

And to arrange these factors of production, one need truckload of money which can be raised via Debt or Equity. Both these instruments have their own advantages and disadvantages which we will discuss in detail in the chapter.

Different instruments to raise money from market

Debt Instruments

  • Self explanatory –  you borrow money from someone & say that I will give you 10% annual interest for 5 years & at end will pay you principle (minimum period more than 1 year) .
  • This is a  type of security paper.
  • Company will have to pay debt owner whether company is making profit or not.
  • Examples : Bonds, Debentures , External Commercial Borrowing, T Bills , Commercial papers, Certificate of deposit etc.
  • If you buy such instrument , you will be called Creditor of the Company (not owner) .
  • Benefits of becoming Creditor
    1. Fixed Income whether company is making profit or loss .
    2. First claim during liquidity .

Short and Long Term Debt Instruments

Short and Long Term Debt Instruments

#1 : Short Term Debt Instruments

  • They have maturity period of   less than 1 year.
  • Market where they are sold is called Money Market .
  • They are highly liquid as they can be sold and resold very easily.
  • These are sold at discount to face value and then bought at face value after fixed number of days (all Short Term Debt instruments that are mentioned below are sold and bought in this way)
  • Eg : T-Bill which is for period upto 14 days and issued by government .
Short Term Debt Instruments

Short Term Debt Instruments issued by various agencies

1 . Government

T-Bill Treasury Bills
Maturity Period of  upto 14 , 91, 182 or 364 days    .
– Note : State Governments don’t issue T-Bills (till 2001, they used to issue but RBI stopped this in 2001) (2018 Prelims question)
CMB Cash Management Bills
They can have maturity period of upto 90 days .
Ways & Means Advances Mechanism through which RBI lends money to Government, for temporary short term needs when there is mismatch in receipt and expenditure of Government.

2 . Companies

  • Commercial Papers
  • Promissory Notes

Both work same as T-Bills but are issued by Companies .

3 . Banks

  • Certificate of Deposits : Work same as T-Bills.
  • Call Money : Banks inter borrow among themselves for 1 day for CRR Adjustment.
  • Notice Money : Same as Call Money but for period between 2 to 14 days .
  • Repo Agreements : Already studied in Monetary Policy (Bank lends from RBI for period upto 14 days).

4 . Merchant

  • Commercial Bill : Merchant sells his unpaid invoice to bank at discount and then again buys invoice at face value when recovery date of invoice arrives .

5 . MSMEs

  • Trade Receivables Electronic Discounting System (Treds): An electronic system in which MSME owner pledges his unpaid invoice made to Corporates to bank or NBFC at discount and then again buys invoice at face value when recovery date of invoice arrives .

Before reading about Long Term Debt Instruments , we need to have knowledge of Credit Rating and Bond Yield.

Side Topic : Credit Rating

  • Credit Rating is the process to access the credit worthiness( credit record, integrity, capability) of a prospective borrower to meet the future debt obligations.
  • Credit Rating can be given to individual companies & even countries .
  • SEBI Rule : Credit Rating of Company is required if it wants to raise Debt Instrument having maturity period greater than 18 months .
  • Usually equity share is not rated here.
  • Interest rate paid on Bonds is not fixed  & depend on the credit rating  :-
    1. Companies and Countries having high credit ratings are least to default on their loans and rate of interest on Bonds issued by them is lowest (Gilt Edged) .
    2. Companies and Countries having low credit ratings are most likely to default on their loans and to attract buyers they have to offer high rate of interest.
  • Companies which do the work of Credit Rating are known as Credit Rating  Companies . These include  CRISIL, S&P, Moody’s etc. and they give rating like   AAA,A,BBB,BB,C,D etc.
Credit Ratings

Side Note : Gilt Edged vs Junk Bond

Junk Bond – Also known as High Yield Bond .
If company having low rating like C& D issue bonds , nobody would invest in them because they are insecure .
To seduce investors they offer high interest rate like 15-17% .  
Gilt Edged Bond Companies high in Credit rating & government of country also issue bond.
These are highly secure  .
They offer very low interest like 4% .  

Side Topic : Bond Yield

  • Bond Yield is the  profit percentage that investor is earning from the given bond. It is calculated by dividing Interest earned by the investor  with Par Value of Bond for that investor 
Bond Yield

Bond Yield increases in two cases

  • During Boom Period : In this period , investor is interested to invest his money in companies likely to grow faster and sell his existing Bonds at lesser value to invest his money in growing companies .
  • When economy of country is about to collapse , investor will think that it is better to sell sovereign bonds at very less value and get whatever he can . Implication is – When government will issue new shares government has to offer very high interest (greater than Bond Yield of earlier floating bonds) to attract investors toward new bonds.

#2 : Long Term Debt Instruments

  • When period of maturity is greater than 1 year   .
  • Market where it is sold is called Capital Market .


Long Term Debt Instruments

2.1 Long Term Debt Instruments issued by Governments

2.1.1  Coupon Bonds

  • In this, Government will issue Bond with Coupons attached to it. Person who has bought the Coupon Bond can get interest each year by tearing the coupon from bond and giving it to designated authority  . At the maturity period , he will get his initial amount back by giving back Coupon Bond.
Coupon Bonds

2.1.2 Bearer Bonds

  • They are regular bonds but they don’t have holders name on them .
  • Nobody can keep record of them because no name is written on them. Hence, it can be easily used in money laundering and to carry illegal activities.

Why Governments  issue bearer bonds?

  • When Government is in dire need of money like at time of war , they cant go in lengthy procedure of checking the credentials .

Note : Currency is Zero Interest Bearer Bond .

Bearer Bonds

2.1.3 Inflation Index Bonds

  • If interest offered by Bond is less than the inflation, person who has invested in these bonds will loose the purchasing power of his money. Hence, in these type of situations , people start to invest in Gold in order to preserve the purchasing power of their hard earned cash , thereby increasing the Current Account Deficit and weakening the rupee further.
Inflation Index Bonds
  • To deal with such situations, Government of India came up with Inflation Index Bonds in 1997, 2013 and 2018 to provide positive real interest rate to household, thereby reducing the Gold consumption  .
  • Inflation indexed bonds provide returns that are always in excess of inflation, ensuring that price rise does not erode the value of savings.
  • In Inflation Index Bonds, Interest Rate is relative to the inflation in the economy. Eg : CPI + 1.5% or WPI + 2.0% .

2.1.4 Sovereign Gold Bond

  • These are issued by RBI on behalf of government to deal with problem of gold imports in India .
  • These bonds are denominated in Gold Grams and apart from that interest of 2.5 to 2.75% is also given. At the end of tenure of bond, person gets amount equivalent to prevailing gold prices at that time along with interest .
Sovereign Gold Bond

2.1.5 Municipal Bond

  • Bonds issued by Municipal Corporations .
  • In India , Bangalore Municipal Corporation was the first to launch Municipal Bond in 1997 .
  • Municipalities are permitted to raise upto ₹10,000 crore via Municipal Bonds.

Need of Municipal Bonds

  • Smart Cities & Municipal Bonds : For building smart cities we need huge amount of capital . This capital can be raised via Municipal Bonds.
  • Committee on urban infrastructure headed by Isher Judge Ahluwalia (2011) had estimated that Indian cities would need to invest around 40 trillion at constant prices in the two decades till 2031 in urban infrastructure. 
  • 14th Finance Commission & Niti Aayog’s 3 Year Agenda also recognise the role to be played by Municipal Bonds in building Urban Infrastructure .
  • Financial Crunch of Urban Local Bodies (ULBs) : ULBs need to gather huge funds from all available sources to improve conditions of urban infrastructure . Municipal bonds are good option.


  • Municipal Bonds are not time tested and it will be difficult to attract investors  .
  • It can also be a source of inequalities because the better rated municipal corporations would corner most of the investment, crowding out the investment for the already infrastructurally backward cities. 
  • PFRDA classifies municipal bonds as Class C instruments instead of Class G (Government securities) making them to compete with other Class C instruments having higher yields thus making municipal bonds unattractive.
  • Most of the Municipalities under Smart City Projects are below BBB- ratings on S&P which means below investment grade.
  • It will be challenge to use the capital earned via Municipal Bonds. ULBs don’t have capacity to absorb huge funds.

Way forward : Denmark has agency to protect bond-holders in case one city in the pool defaults  . Indian government can look into feasibility of this to instill confidence in minds of investors .

2.2 Long Term Debt Instruments issued by Companies

They are of various types

Redeemable Bonds Company will pay regular interest and will return principal on maturity.  
Irredeemable Bonds  Company will pay only interest but no principal is returned.  
Partially Convertible Debenture Company will pay interest but at the time of maturity, some of the Bonds will be converted to Shares and on rest , principal will be repaid. Eg : 70% Debenture + 30% Share .  
Fully Convertible Company will pay interest but at the time of maturity, Bonds will be converted to Shares (and principal is not payed).  
Optionally Fully Convertible Debentures Company will pay interest but at the time of maturity company can give option  that investor can convert his bonds/ debentures to shares (just an option which investor can accept or reject). But the ‘rate’, will be decided by the company (i.e., how many shares against how many debentures).

2.3 Long Term Debt Instruments issued by World Bank

2.3.1 Masala and Maharaja Bonds

  • World Bank has 5 Bodies –  one of them is International Finance Corporation (IFC) & they help in raising  offshore capital via various types of Offshore Bonds called Panda Bonds (for China) , Kangaroo Bonds (for Australia) and Masala & Maharaja Bonds (for India) .

Masala Bond

  • These are offshore ₹ denominated bond  
    1. Known as Masala Bonds because India is famous for Spices ( Formosa Bonds for  Taiwan, Samba Bonds for Brazil, Samurai Bond for Japan)
    2. Called ‘Offshore’ because they are floated in London and other foreign Exchanges
    3. ₹ denominated’ because they are sold & bought in ₹ (& not $s )
  • Benefits of Masala Bond
    1. They help in fighting local currency volatility . Currency volatility in Masala Bonds is to be borne by investor because they buy these bonds in Rupee and later gets back their principal and interest in Rupee.
    2. Interest Rate is also low because they are issued by World Bank (IFC) and not company itself . Hence, they are very secure (Aaa rated) because in case company refuses to pay, World Bank will pay on it’s behalf.
  • The move to permit Masala bonds is an attempt to increase the international status of ₹ and is also a step toward full currency convertibility .
Masala Bond

Recent activities in Masala Bonds

  • NHAI raised capital via Masala Bonds to fund their highway projects
  • Kerala Government’s Kerala Infrastructure Investment Fund Board raised capital via Masala Bonds, becoming first state to do so.

Maharaja Bonds

  • Rupee Denominated Bond issued in India by World Bank’s IFC.
  • Same as Masala Bond but issued in India .
  • They also are ‘Aaa’ rated and hence interest rates are very low.
Maharaja Bonds

2.4  Miscellaneous Type of Long Debt Instruments

2.4.1 Social Impact Bond

  • These bonds are offered to High Net worth Individuals (HNI) who are interested in doing philanthropic works like Bill Gates, Premji, Ratan Tata etc . Although interest offered on these Bonds are lower than general bonds but their aim is to do social welfare.
  • Eg :
    1. NGO named Educate Girls issued Social Development Bonds to raise money to educate girls in India.
    2. Women’s Livelihood Bonds  issued by SIDBI to invest in projects targeted at improving livelihood of women by generating employment opportunities.
Social Impact Bond

2.4.2 Green Bonds

  • Green bond is a type of long term bond but  issuer of a green bond publicly states that capital is being raised to fund ‘green’ (environment friendly) projects, like renewable energy, clean transportation etc . There is no standard definition of green bonds as of now.
  • Examples of Green Bonds
    1. World’s first Green Bond was launched by World Bank (2007).
    2. India’s first Green Bond was launched by Yes Bank (2015).
    3. Indian Renewable Energy Development Agency (IREDA) launched India’s first Masala Green Bond at London Stock Exchange (2018).
    1. CLP India (Wind Energy Company) was the first Indian company to tap this route .
  • India has become the seventh largest green bond market in the world in 2017.

Side Topic : Blue Bonds

  • Same concept as Green Bonds.
  • In this, issuer publicly states that capital is being raised to fund climate resilient water conservation or marine protection projects.
  • Seychelles (small island nation in Indian Ocean) issued world first Blue Bond in 2018 for marine protection and sustainable fishery projects.

2.4.3 Catastrophe Bond

  • Catastrophe Bonds are  high-yield bonds issued by Insurance Companies . Their interest can be as high as 18% but in case natural disaster happens, then principal will not be returned (although if natural disaster doesn’t happen within the tenure of bond, principal will be returned) .
  • Frequently issued in developed western countries .
  • Suggestion : Indian Insurance Companies can also use this.


  • You  borrow money from someone &   in return you offer partnership  .
  • Equity holders are called  owners/ proprietors of the company.
  • Equity holders are given dividend in case company earns profit.
  • But they have last claim during liquidation of the company.

Types of Equity /Shares 

There are two types of shares

1 . Ordinary  shares

  • They are most common type of Shares.
  • Ordinary share-holders have voting power in the meetings of shareholders and they have last claim during liquidation.

2 . Preference shares

  • Generally issued to banks by companies although retail investors are also eligible.
  • Preference is given to them in following things
    1. In term of dividend payment ,they are given dividends even if equity shareholders are not.
    2. When company is to be closed, preference share holders are given money first from the proceeds of sales of assets of the company.
    3. They may have enhanced voting rights such as ability to veto mergers or acquisitions or right to first refusal when new shares are issued.

Order of Claim

Bond(Debenture) > Preferential share > Ordinary Share

Terminology in Shares

Value = 
Rs. 50 
Rs So 
Snu.•es ALLOP ERH 
= 20 
But this share is selling in 
share-market at Rs 70 
Investor paid Rs 20 more 
than face value
Face Value Value of Share written on Share itself .
It can be any integer – 1, 2, 3 ___25, 50, 100 (But can’t be decimal like 1.50) .
Condition : When IPO is issued, Company cant sell Share below Face Value.  
Par Value – Market determined Value of  (single) Share .
When IPO is launched, Par Value can’t be lower than Face Value. After that, Par value is decided by the market forces. It can be lower or greater than face value.  
Premium  If company is doing well, person can think that he can get big dividend when dividend will be announced. So he can buy those shares from Share Market at greater price than it’s Face Value.
Value above Face Value is called its Premium. Eg : if above share having face value of ₹50 is selling at ₹ 70 , then its Premium will be ₹ 20 .  

Digital Shares

Digital Shares

Problems with Paper Shares

  • Delivery Problem
  • Fear of Theft
  • Transfer delays leading to speculations

Demat Account

  • Dematerialised Account .
  • System was started  in mid 90s .
  • Earlier when you buy shares , you get certificate .
  • But now Shares  are electronically transferred to your account known as Demat account.


  • It is like a bank locker where securities are held in physical form.
  • In India there are two depositories
    1. National Securities Depository limited (NSDL)
    2. Central Depository Service Limited (CDSL)

Depository Participant(DP)

  • Depository Participants are Agents of  Depositories and act as intermediary between the depository and the investors.
  • Customer must open a “Demat” account in a depository-partner (DP) which can be a bank or an NBFC.
  • Eg ICICI, HDFC, SBI etc.

IPO (Initial Public Offer)

IPO (Initial Public Offer)
  • When company sell  share for the first time to the public , it is called IPO

Red Herring Prospectus

  • Before company  launches it’s IPO to get some capital via equity finance ,  company has to give Red Herring Prospectus  mentioning all the information like who are their promoters, their track record, their business plan, address etc. (all details except on which date IPO would be launched & what would be price of IPO) .
  • Only when SEBI approves this, then they have permission of going ahead  .


  • These are companies who do lengthy legal work & accounting paper work before launching IPO that require CA, Corporate Lawyers etc  . They charge commission for providing these services .
  • Eg : Mahindra, ICICI etc.

How price of IPO would be fixed

Two methods

Fixed Pricing Method

  • Company announces face value and premium in advance. Eg
    1. Face value = ₹ 10
    2. Premium = ₹15
    3. Final Price = ₹25
    4.  1 lakh such shares will be issued
  • Hence, Newspaper headline will  be ₹25 Lakh IPO will be launched in the market.

Book Building Method

  • Application for 1 Lakh shares invited (hypothetical number) .
  • And investors are asked to send application at which price they want to get these share. Eg
Quoted price of share Number of Applications received
₹ 500 X 10,000
₹200 X 50,000
₹ 125 X 40,000
₹100X 500
And so on  
  • In above example,  at ₹125  all 1 Lakh shares have been booked . Hence, face value of each share will be fixed at  ₹125 and all shares will be sold at Rs 125 per share.
  • Hence, all the shares are sold at face value in this case .

From Economic Survey (2020)

Number of IPOs issued in India have been steadily declining . This shows that

  • There is slow-down in the economy and entrepreneurs are delaying their decision to issue IPOs of their start-ups.
  • Investors too are un-enthusiastic about investing in share-markets due to lower dividend expectations.
Number of IPOs issued in India

Follow-up Public Offer (FPO)

  • If company has already issued shares previously, and now issuing more shares to obtain more capital, it is called Follow-up Public Offer .
  • It is obligatory for the company that it can offer FPO only to the existing shareholders of the company , known as Rights issue of share .
  • If company don’t want rights issue of share , company will have to hold general meeting of shareholders & pass resolution about it.

American Depository Receipts(ADR) & Bharat Depository Receipts

American Depository Receipts(ADR)

  • If Indian Company wants to issue their shares in America, they cant do it directly as they will have to register there and there are lot of other complications.
  • What Indian Company can do is ,sell those shares to American Intermediary (eg Bank of America) . Bank will issue equivalent amount of American Depository Receipts which can be bought by Americans from US Stock Exchanges.
  • When Indian Company will issue dividend, they will give that to American Intermediary and American Intermediary will distribute it to ADR Holders.
American Depository Receipts(ADR)

Global Depository Receipts

  • Same as ADR for European Union countries

Bharat  Depository Receipts 

  • Opposite to ADR .
  • It is used when foreign companies want to issue shares in India .
Bharat  Depository Receipts

Other Terms associated with Shares

1 . Share Buyback

  • Process when corporations repurchase the stock it has issued .
  • It reduces the number of shares outstanding ,giving each of remaining shareholder larger% ownership of company.
  • Buyback prices are more than market prices.
  • Companies can buyback with reserves but cant borrow to buyback.
  • It is allowed in India since 1998.
  • Reasons for buyback
    1. When Companies have large retained earnings, they don’t issue big dividend because in this process large amount of money will get wasted in tax. They generally use that money to buyback shares. 
    1. When companies management is optimistic about future & believe that current share price is undervalued  .
    2. Putting unused cash into use.
    3. Raising earnings per share .
    4. Reducing number of shareholders to reduce the cost of servicing them.

2 . Employee Stock Option Plan (ESOP)

  • Company give shares to employees at discounted rate so that employees become more committed to success of company (if company make more profit you make more profit).
  • Economic Survey (2020) has suggested government to give ESOP to employees of Public Sector Banks to improve their performance.

3 . Sweet Equity

  • If Company sell its shares to directors, employees etc. at discount for their value addition like IPR & know how.

4 . Penny Stocks and Blue Chip Stocks

Penny Stock Shares whose market price remain excessively low compared to its face value. Such pathetic companies give zero or little dividend.
Blue Chip Stock Shares of a nationally recognized, well-established and financially sound company with a history of generating good dividend whose market price is very high than it’s face value.

5. Share Pledging

When company raises loan from the Bank or NBFC by pledging it’s shares as collateral.

6. Bull and Bear Investors

There are two type of investors

Bull Investors Optimistic speculator who hopes share prices will rise, so purchases shares (to sell them later at much higher price).
Bear Investors A pessimistic speculator who fears prices will fall , so he sells his shares .

6. Rajiv Gandhi Equity Savings Scheme (RGESS)

  • RGESS  provides 50% deduction of the amount invested from taxable income for that year to new investors in securities market who invest up to Rs. 50,000 and whose annual income is below Rs. 10 lakh. The tax deduction allowed is over and above the Rs. 1 lakh limit under Section 80 C of the Income Tax Act.
  • This is to promote the habit of investment in securities in the Indians.

Equity funding for Start-ups

1 . Venture  Capitalist

  • Venture capitalist is a company that is willing to invest in the projects that are risky but have a promising future prospect. Venture Capital bridges the gap where traditional sources of funds actively cannot participate in funding new ventures.
  • They deal only with big things, big projects & big investments.
  • Venture capitalist companies arrange this money either by borrowing from companies like mutual funds, pension funds or they may issue their own bonds.
  • They demand part in company and seats in company’s Board of directors. Hence along with capital, Venture Capitalists  also bring in smart advice, hand on management support and other skills .
  • Venture capital industry in India is still at a nascent stage. With a view to promote innovation, enterprise and conversion of scientific technology and knowledge based ideas into commercial production, it is very important to promote venture capital activity in India.
  • For decades, venture capitalists have nurtured the growth of America’s high technology and entrepreneurial communities . Companies such as Compaq, Sun Microsystems, Intel, Microsoft, and Genentech are famous examples of companies that received venture capital early in their development. Now, venture capitalists in India have a chance to do the same to Indian firms.

2 . Angel Investors

  • These are rich gentlemen who  provides financial backing to entrepreneurs for ‘starting their business’. Angel investors are usually found among an entrepreneur’s family and friends but they may be from outside also.They can give debt or equity but mostly they play in equity .
  • They are focused on helping the business succeed, rather than reaping a huge profit from their investment.
  • What is need of Angel Investors?
    • You can take capital from Banks , IPO or venture capitalist if your business project is likely to make success based on previous experience.
    • But if your idea is untested & new , nobody would be interested  in financing you. Eg: Steve Jobs was funded by Angel Investor when he started Apple.
  • In India, examples of Angel Investors include Ratan Tata who has invested in Urban Ladder and TVM Pai who has invested in ZoomCar.
  • Angel investor can be recognised as Category I Alternate Investment Fund (AIF).

Side Topic : Angel Tax Issue

Angel Tax

  • Under Income Tax (IT) Act’s Section 56(2) , Government of India can impose Angel Tax .  
  • First time, it was introduced in 2012 to stop money laundering via this route (Person with lot of money can give his money to company to convert it into white).

How it is calculated ?

  • Let’s assume, I am an investor and I feel that valuation of company (Fair Market Valuation (FMV)) is ₹1 crore . Based on this valuation, if I invest ₹50 lakh in the startup, I will get 50% ownership.
  • But if Tax Authorities say that FMV of Company is not 1 Crore but ₹50 Lakh. Hence, 50% ownership will just cost ₹25 lakh. Tax Authorities will regard rest 25 lakhs as other incomes under IT Act and tax it at rate of 30.9%  .


  • Valuation Methodologies are very subjective .
  • Government is forcing Startups to pay Angel Tax even before they have generated any revenue .
  • Angel Investors are going away from investments and Startups are finding it difficult to raise capital as Banks are already in stress and aren’t ready to invest in such risky ventures .

Budget 2019 solved this issue : If Start-ups and their investors provide the required declarations and information, then IT dept. will settle the matter, and will do no further scrutiny.

3 . Crowd Funding 

  • Crowd Funding is the practice of funding a project or venture by raising money from large number of people , typically via internet. 
  • Various platforms like Grex, LetsVenture etc. are providing this service in India .
  • This funding can be of various types
    • Equity Based
    • Debt Based
    • Cause Based
    • Reward Based
  • Large number of Startups, Software developers, film-makers (eg Kannada movie Lucia) , music festivals (eg Control ALT Delete) etc. have raised funds via this platform .


There is other type of security as well , known as Derivatives . We will have just an overview of this as it is not that important from examination point of view .

Type of 
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Question : What is derivative ?

  • Financial instrument that  derive their price from some  underlying asset are known as Derivatives.
  • The price of derivatives are directly dependent upon underlying asset in present & projected future trends which can be equity, foreign exchange, commodity or mortgaged Backed securities etc.
  • Eg : For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the ‘underlying asset’.

There are four types of Derivative contracts

1 . Forward

  • A Forward is a contract between two parties to buy or sell an asset at a specified future time at a price agreed on in the contract.

2 . Future

  • Future is a legally binding contract that obligate the parties to transact an asset at predetermined future date and price. Here, the buyer must purchase or seller must sell the underlying asset at the set price , regardless of the current market price .
  • Future and forward are almost similar . But forward distinguishes itself from a future as it is traded between two parties directly without using an exchange.

3 . Option

  • If person buys an options , it grants him the right, but not the obligation to buy or sell an underlying asset at a set price

4 . Swap

  • Swap refers to  exchange of one financial instrument for another between the transacting parties concerned at a predetermined time.

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