Synetic College Logo
Unit 3 of 4 · MBA Sem 4

Unit 3: Derivatives

International Finance and Financial Derivatives notes · PTU syllabus (MBA 915-18)

3 min read9 topics10 exam questions
On this page
  1. Unit summary
  2. Meaning, types and importance of derivatives
  3. Regulatory framework of derivatives in India
  4. Forwards and futures compared
  5. Pricing futures and mark-to-market
  6. Speculation, hedging and arbitrage
  7. Option contracts
  8. The Black–Scholes model
  9. Put–call parity
  10. Option trading strategies
  11. Key terms
  12. Quick revision
  13. Important questions

Unit summary

Derivatives let firms and investors transfer risk — or take it on. This unit covers the meaning, types, importance and regulatory framework of derivatives in India, forwards vs futures, pricing and mark-to-market, speculation, hedging and arbitrage, option contracts, the Black–Scholes model, put–call parity and option trading strategies.

After this unit you can

  • Explain the meaning, types, importance and regulation of derivatives
  • Compare forwards and futures and explain pricing and mark-to-market
  • Explain hedging, speculation and arbitrage
  • Price options and apply put–call parity and option strategies

PTU syllabus topics

  • Meaning
  • types
  • importance and regulatory framework of derivatives in India
  • forward vs futures contracts
  • pricing and mark-to-market
  • speculation/hedging/arbitrage
  • option contracts
  • Black-Scholes model
  • put-call parity
  • option trading strategies
Key formulasOption pricing essentials

  • Put-call parity

    C + K e^(−rT) = P + S

  • Black-Scholes call

    C = S N(d1) − K e^(−rT) N(d2)

  • d1

    [ln(S/K) + (r + σ²/2) T] / (σ √T)

  • d2

    d1 − σ √T

1

Topic 1

Meaning, types and importance of derivatives

  • Derivative: a contract whose value depends on an underlying asset — shares, indices, currencies, interest rates, commodities, credit.
ClassificationTypes of derivatives
Derivatives

  • Forwards

    Customised OTC agreements

  • Futures

    Standardised exchange-traded contracts

  • Options

    Right without obligation

  • Swaps

    Exchange of cash flow streams

  • Others

    Warrants, credit derivatives, exotic options

  • Importance: risk management (hedging), price discovery, market efficiency and liquidity, lower transaction costs, completing markets.
  • Risks: leverage, counterparty risk (OTC), speculation and losses by retail traders — SEBI studies show most individual F&O traders lose money.
2

Topic 2

Regulatory framework of derivatives in India

  • Securities Contracts (Regulation) Act, 1956 recognises derivatives as securities; L.C. Gupta Committee (1998) recommended exchange-traded derivatives; index futures launched in June 2000, options in 2001.
  • SEBI regulates equity, currency and commodity derivatives on exchanges (NSE, BSE, MCX); RBI regulates interest rate and OTC forex derivatives.
  • Risk controls: SPAN-based initial margins, mark-to-market, position limits, clearing corporation guarantee; 2024 measures for index derivatives — larger contract sizes, fewer weekly expiries, upfront option premium collection.
3

Topic 3

Forwards and futures compared

ComparisonForward vs futures contracts
Forward
Futures

Trading

Over the counter, private

On an exchange

Terms

Customised

Standardised lot size and expiry

Counterparty risk

High

Eliminated by the clearing corporation

Settlement

At maturity

Daily mark-to-market

Margin

Usually none

Initial and maintenance margins

Liquidity

Low

High

Example

A trader buys one Nifty futures lot (say 75 units — exchanges revise lot sizes periodically) at 24,000. If Nifty settles at 24,300, profit = 300 × 75 = ₹22,500 (before costs); the gain is credited through daily mark-to-market.

4

Topic 4

Pricing futures and mark-to-market

Key formulasCost-of-carry pricing

  • Futures price

    F = S × e^(rt) (continuous) or S × (1 + r)^t

  • With dividends

    F = (S − PV of dividends) × (1 + r)^t

  • Currency futures

    F = S × (1 + ih) ÷ (1 + if)

Example

Spot ₹1,000, interest 8% a year, 3 months to expiry: F ≈ 1,000 × (1.08)^0.25 ≈ ₹1,019.4.

  • Mark-to-market: gains and losses are settled daily; if the margin account falls below the maintenance margin, a margin call requires top-up.
  • Basis: spot − futures; converges to zero at expiry.
5

Topic 5

Speculation, hedging and arbitrage

ComparisonParticipants in derivatives
Purpose
Example

Hedger

Reduce existing risk

Exporter sells dollar futures to lock the rupee value of receipts

Speculator

Profit from expected price moves; adds liquidity

Buys Nifty futures expecting a rise

Arbitrageur

Riskless profit from mispricing

Buys spot and sells futures when futures are overpriced (cash-and-carry)

6

Topic 6

Option contracts

  • Call gives the right to buy; put the right to sell at the strike price; the buyer pays a premium; European vs American exercise.
  • Option value = intrinsic value + time value.
ClassificationDeterminants of option premium
Option value

  • Spot price

    Higher spot raises calls, lowers puts

  • Strike price

    Higher strike lowers calls, raises puts

  • Time to expiry

    More time raises value

  • Volatility

    Higher volatility raises both

  • Interest rate

    Raises calls, lowers puts

  • Dividends

    Lower calls, raise puts

7

Topic 7

The Black–Scholes model

Key formulasBlack–Scholes (European, non-dividend)

  • Call

    C = S N(d1) − K e^(−rT) N(d2)

  • Put

    P = K e^(−rT) N(−d2) − S N(−d1)

  • d1

    [ln(S ÷ K) + (r + σ² ÷ 2) T] ÷ (σ √T)

  • d2

    d1 − σ √T

  • Assumptions: lognormal prices, constant volatility and interest rate, no transaction costs or dividends, European exercise, continuous trading.
  • Greeks: delta, gamma, theta, vega, rho — sensitivities used for hedging.
  • Binomial model: values options step by step and handles American options.
8

Topic 8

Put–call parity

Key formulasPut–call parity

  • Relationship

    C + K e^(−rT) = P + S

  • Discrete form

    C + K ÷ (1 + r)^T = P + S

Example

S = ₹100, K = ₹100, r = 10% a year, T = 1 year, call = ₹12. Put = 12 + 100 ÷ 1.10 − 100 = ₹2.91. If the put trades at ₹5, buy the call and bond, sell the put and share — riskless profit.

9

Topic 9

Option trading strategies

ClassificationDerivatives and uses
Derivatives

  • Forwards

    OTC; lock future exchange rate

  • Futures

    Exchange-traded; margins; currency futures on NSE/BSE

  • Options

    Call (right to buy), put (right to sell); premium

  • Swaps

    Currency swaps (exchange principal and interest in two currencies); interest rate swaps (fixed vs floating)

ProcessBasic option strategies
  1. 1Protective put

    Own asset + buy put — insurance against fall

  2. 2Covered call

    Own asset + sell call — earn premium, cap upside

  3. 3Straddle

    Buy call + put at same strike — profit from big move either way

  4. 4Strangle

    Buy out-of-the-money call and put — cheaper volatility bet

  5. 5Spreads

    Bull and bear spreads limit risk and reward

Example

An exporter expecting US$ 1 million in 3 months buys a put option at ₹83 with a premium of ₹0.50. If the rupee strengthens to ₹81, the exporter exercises at ₹83 (net ₹82.50); if it weakens to ₹85, the exporter lets the option lapse and sells at ₹85 (net ₹84.50).

Key terms

Derivative
Contract whose value depends on an underlying asset
Cost of carry
Interest and storage cost of holding the underlying
Basis
Spot price minus futures price
Put–call parity
Arbitrage relation between call, put, stock and bond
Delta
Change in option price for a unit change in the underlying

Quick revision

  • Types and importance; Indian regulation (SCRA, SEBI, RBI); L.C. Gupta Committee.
  • Forwards vs futures; cost-of-carry pricing; margins and MTM; basis.
  • Hedgers, speculators, arbitrageurs.
  • Option premium determinants; Black–Scholes; Greeks; binomial.
  • Put–call parity; protective put, covered call, straddle, strangle, spreads.

Important exam questions

Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).

Short-answer questions

  1. Q1.Define a derivative.
  2. Q2.Who regulates currency and interest rate derivatives in India?
  3. Q3.State the cost-of-carry formula.
  4. Q4.What is mark-to-market?
  5. Q5.State put–call parity.
  6. Q6.What is a straddle?

Long-answer questions

  1. Q1.Explain the meaning, types, importance and regulatory framework of derivatives in India.
  2. Q2.Compare forwards and futures and explain futures pricing.
  3. Q3.Explain the Black–Scholes model and the determinants of option prices.
  4. Q4.Explain put–call parity and option trading strategies with examples.

Stuck on this unit?

Message SBS on WhatsApp for help with International Finance and Financial Derivatives, or to ask about studying MBA at Synetic.

WhatsApp us