Derivatives are assets that determine their value for an underlying asset. These assets can be of any type — equity, bonds, commodities or any other security. The spot prices of these underlying assets determine the prices f the derivatives. In the developed financial markets, derivatives are very popular and are death with almost every time. But in the developing markets like India, derivatives are still not considered the right option and are still questioned. The debate for derivatives to be included in the market and whether or not it is right choice, has been going on for quite some time now. The following are some of the benefits and disadvantages of derivatives:
Benefits of NSE derivatives:
1. Hedging: Derivatives help in hedging. They can hedge the future price and the risk that come with it. For instance, if a person doesn’t know the future price for his products at the time of its manufacturing, he can sell it in the future market and lock the price. If the spot price is more, he will only have to bear a marginal loss which will still be better than the lock in price
2. Risk Management: The future rates and the uncertainty helps the investors to manage the risks which help increase their portfolio in the market.
3. Price: The future discovery of the price becomes more certain and reliable. This makes any unnecessary opportunities that affect the working, to disappear and leads to more certainty.
4. Raise funds: With currency and interest tares swaps, there will be more influx of foreign exchange in the financial market. This will help gain ad raise foreign funds in the Indian market.
Disadvantages of NSE derivatives:
1. Liquidity: Liquidity means having enough ease and leisure to get in and out of the market anytime. Many think that Indian market doesn’t have enough liquid power to do so and hence, derivatives is not suitable for the Indian financial market.
2. Efficiency: Derivatives require a strong and mature financial market. Some fear that Indian financial market is not cut out for derivatives because they lack maturity and sound functioning and hence, it will affect the efficiency of the market.
3. Speculation: Because of the certainty and the hedging, there can also be speculations created in the market unnecessarily. This will affect the market a lot and can have worse consequences than one can imagine.
4. Volatile: Because of the above two i.e. the efficiency and the speculation, introduction of derivatives in the market will cause even more volatility.
5. Counter risk: There is always a counter risk in trading with derivatives as not all the transactions are backed by exchange trade. This shows that a party can declare itself bankrupt at any time and such counter risk will have to be dealt with.
Derivatives are a great way to measure and manage risks. It strengthens the position of a firms’ standing in the financial market and it gives them the freedom to deal various investment opportunities. The Indian market has a long way to go when it comes to derivatives.