From BSE to NSE: Understanding the concept of Derivates Market in 2022
Do you have a genuine knack for the financial market? Is your interest in the concepts of derivatives growing day by day? If your answer is yes to both these questions then a career in investment banking might be just the right fit for you. Before you jump into your search for the best investment banking courses on the internet, let us briefly revisit the basic concepts of the derivatives market, its benefits, and uses, and how you as an aspiring investment banker can play an active role in this money market.
Table of Contents
- 1 Derivatives Market Explained
- 2 Types of Derivatives
- 3 Benefits of Derivatives
- 4 Role of Investment Banker in Derivatives Market
- 5 Skills Required by an Investment Banker
Derivatives Market Explained
A derivative is a type of financial contract between two individuals/parties or more. The underlying basis of this contract is a mutually agreed-upon financial or commodity asset (for example security) or a group of assets (referred to as an index). The most commonly used financial instruments used to forge a derivative contract are commodities, currencies, bonds, market indexes, interest rates, and stocks.
In a derivatives market, you are likely to come across these three kinds of participants:
Hedgers are traders who engage in self-protectionism from the risk that arises out of price movements. They will cover or hedge their position by getting into a trade policy of the opposite nature and attempt to pass on the risk to those who are comfortable bearing it. In this way, they protect themselves from the risk or uncertainty associated with a particular price.
Speculators have an appetite for high risk and can predict the future price movement to make gains quickly and largely. Speculators try to garner the maximum output out of price volatility. They absorb excess risk and provide liquidity in the market where other investors would not like to get involved.
Arbitrage involves low-risk trading and the arbitrageurs buy securities in one market and parallel sell in the other. This happens when the same kind of securities are being sold in two different types of markets simultaneously at different prices.
Types of Derivatives
To understand the derivatives market better, you also need to have an idea of the four sub-types:
Customized agreement between two parties wherein they mutually agree to trade on a particular asset or commodity at an agreed-upon price and a fixed date in the future. They are under a contract basis to bear the respective loss or profit should things go/not go in their favor. These contracts are traded privately over the counter.
The standardized alternative of the forward contract type. Two parties agree to trade on a particular contract at a specified date and time and a fixed price. Unlike forwarding contracts, they can be traded on the exchange.
A mutual agreement between the seller and the buyer wherein the buyer is given the right to either buy or sell a particular commodity or asset at a later date in the future at a fixed price. However, the buyer is not obliged to do so.
Under this type of derivative contract, two individuals or parties exchange the liabilities or cash flows from two financial instruments separate from each other. The swaps are based on a notional principal amount such as a bond or loan.
Benefits of Derivatives
If you are wondering why the derivatives market is so lucrative to traders and investors, here are some of the benefits of its uses:
Hedging Risk Exposure
A derivatives financial contract helps to hedge or bypass a possible risk underlying an asset
Underlying Asset Price Determination
Helps to determine or predict the price of an underlying asset
Derivatives can aid you to get quick access to assets that are otherwise not available
Derivatives contracts help to duplicate the asset payoff. Thus, they increase the efficiency of the financial market.
Role of Investment Banker in Derivatives Market
When it comes to the derivatives market, investment banks have a huge role to play as their interests are involved in this market from across the world. Needless to say, this is where the part of an investment banker gains prominence:
Advice to Clients
When it comes to global investment banking, investment bankers offer advice to their clients to sometimes restructure finance to navigate away from possible bankruptcy, they can advise about mergers and acquisitions. To do these things, investment banks obtain access to books that help them analyze the risks involved and where they should hedge.
Investment bankers sometimes liquidate their positions before maturity and act as market makers. The market-making ends up utilizing a lot of capital from the trading desk of the bank involved and offers an exit route to the investors.
Structured Products Creation
When the needs of the client cannot be solved with futures and swaps, the global investment banking firm will call in ‘quants. These are highly specialized professionals to analyze risks and club the products together to generate a new financial product which is known as a structured product.
Marketing Structured Products
Once the quants have created the new structured products, the investment bankers will now need to find parties who are willing to buy them. This is a very difficult task that requires a lot of skill as the newly created products are perceived to be very risky in the financial market.
Act as Middlemen
When investment bankers are unable to find counterparties to sell their newly created products to, they hire risk analysts to evaluate the risk involved if they are to trade it on their books.
Skills Required by an Investment Banker
If you feel intrigued about the derivatives market after going through this article and wish to enroll in a course, you should know what basic investment banking skills to become successful after training:
- Strong intellect
- Self-discipline and diligence
- An academic inclination for subjects like linguistics, sociology, and anthropology
- Communication skills
If you want to buy and sell derivatives or just want to help organizations or parties to buy or sell their product you should enroll certified investment banking operations professional course from any reputed institution which will train you intensively to become an expert investment banker in the future.