INTRODUCTION
The emergence of the market for derivative products, most notably forwards, futures and options can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices.
Financial markets are, by nature, extremely volatile and hence, the risk factor is an important concern for financial agents. To reduce the risk, the concept of derivatives comes into picture.
DERIVATION OF DERIVATIVES
Derivatives in the form of forwards and options have been around as long as there has been commerce because all commerce involves business risk. The history of derivatives can be traced far back to renaissance period (15th Century) where the Venetian spice traders waiting a cargo on high seas would enter into a forward contract.Forward contracts are also traced in Japanese and American markets for hundreds of years ago. The Futures trading on the commodities first started in Chicago way back in 1874. But the explosion of derivative markets in the form we see today can be attributed to volatility in the foreign exchange rates created due to collapse of Breton Woods system. (A system whereby all the exchange rates were pegged to US$ whereas there was fixed parity between US$ and Gold). It led to the introduction of the forward contracts in the foreign currency by 1972. The equity options were introduced in 1973. The early 80s’ also led to the introduction of few more derivative products viz. currency swaps, interest rate swaps, index futures and options, etc.
In India, the L.C.Gupta Committee was appointed in 1996 to develop appropriate regulatory framework for the equity-based derivatives trading. It submitted its report in 1998, which was later approved by SEBI. It has suggested introducing derivative products in a phased manner starting with Index Futures followed by Index Options and Options on shares. Pursuant to the same, Index Futures were introduced in India in June 2000 at Bombay Stock Exchange and National Stock Exchange, Delhi Stock Exchange has indicated to join them shortly.
Financial Derivatives have been in existence in the markets for over 150 years – in fact the first reference to some form of the modern day. Financial Derivative is found in the Futures markets that were function in Chicago in the 1850’s. Over the years a more formalized structure came into place – the most significant fillip in this regard was the seminal work of Fisher Black and Myron Scholes in 1973. Since then, the development of Financial Derivatives and its extensive use in the financial sector has been synonymous with the stupendous growth in the financial sector itself. The 1980’s and the 1990’s saw tremendous growth in the Financial Sector and a lot of it was directly fuelled by the growth and development of the use of derivatives in this area.
The liberalization in the Indian Financial Sector started more than a decade back. But it is only now that the Reserve Bank of India is looking at allowing the use of derivatives in the market in a wide scale. Though derivatives in the equity market were permitted in 2001, the currency and the interest rate sectors of the financial sector in India were kept immune for the use of derivatives. The only derivative that was allowed in the money market segment of the financial sector was Swaps and with a case-by-case approval from RBI some back-to-back foreign currency option deals. However, RBI is now keen to open up the segment and allow for options on both currency (the Indian Rupee) as well as the interest rate applicable in the Indian markets. In view of this, the traders of banks and financial institutions as well as corporate need to be aware of these techniques for both investment as well as risk management functions; especially given the highly volatile nature of the industry.