Features of Derivatives – Standardization, Margin, Zero Net Investment
What makes a Derivative different from buying a Share? It's the Leverage.
1. Key Features
A. Zero Net Investment (Leverage)
- You don't need to pay the full value of the asset. You only pay a small deposit called Margin.
- Example: To buy ₹10 Lakh worth of Nifty Futures, you only pay ₹1 Lakh Margin.
- Effect: Small money controls big value (Leverage).
B. Future Settlement
- The contract is agreed today, but settlement happens in the future (e.g., Expiry Date).
C. Secondary Market Trading
- Most derivatives (Futures/Options) are traded on Exchanges (NSE/BSE), making them highly liquid.
D. No Physical Delivery (mostly)
- Most financial derivatives are Cash Settled. You don't get the actual barrel of Oil; you just get the profit/loss difference.
2. Diagram: The Leverage Effect
Investment"Trader pays ₹10,000 Margin."
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Exposure"Controls assets worth ₹1,00,000."
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Profit"If asset rises 10%, Profit is ₹10,000 (100% Return on Margin)."
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Risk"If asset falls 10%, Loss is ₹10,000 (100% Wipeout)."
3. Exam Notes: Writing the Answer
Question: "Discuss the salient features of Financial Derivatives." (5 Marks)
Answering Strategy:
- List: Bullet points are best.
- Keywords: Use terms like "Derived Value", "Future Date", "Leverage", "Hedging Tool".
- Explain Margin: Give the example of paying only 10% to control 100%.
Summary
- Double Edged Sword: Leverage makes you rich fast, or poor fast.
- Contract: It is a legal contract, not an asset itself.
Quiz Time! 🎯
Test Your Knowledge
Question 1 of 4
1. Derivatives are characterized by: