Derivative Market in India

CHAPTER I: DEFINITION AND USES OF DERIVATIVES
Derivative is defined as a security which is a financial contract. Its value is derived from the value of some other thing such as - commodity price, stock price, exchange rate, interest rate, an index of prices, etc. Some simple kinds of derivatives are –
  * Forwards
  * Futures
  * Options
  * Swaps.

Derivatives are traded for different reasons. Derivatives enable traders in hedging an already existing risk by taking position in the markets to offset potential losses. Chiefly, the derivative users are referred to as hedgers in India. Further, as per Indian laws, derivatives ought to be used only for the purposes of hedging. Derivative trading is also done under speculation where traders take positions to make profit from the anticipated variations in prices. However, it is practically difficult to distinguish as to whether a particular trade was done for the purposes of hedging or for speculation.
There is another type of trader called the arbitrageurs who seek to profit from the discrepancies in the derivative and spot prices. Arbitraging has been found to exist in India between two different exchanges intra-city and inter-city.
An analysis of 2002 of Indian equity derivatives markets reflects Indian markets as being inefficient. It is argued that impediments such as market frictions, lack of knowledge, regulatory impediments, etc have been responsible for the low levels of capital employed in trading in arbitrage in India.

CHAPTER II: EXCHANGE TRADED AND OVER THE COUNTER (OTC) DERIVATIVE INSTRUMENTS
Over-the-counter or OTC contracts like swaps and forwards are negotiated on a bilateral basis between the parties. Terms of OTC contracts are characterized as usually flexible and may be customized to suit the requirements of particular user/users. OTC contracts carry considerable credit risk that the counterparty who owes money could make defaults on his obligation to pay. Generally, OTC derivatives...