Derivative and Risk Management: A New Dimension of Indian Financial Market

Starting from the Modigliani-Miller(MM) approach that “ One bird in the hand and two birds in the bush” to a local saying that “ Higher a monkey climbs the tree, the more it exposes its back”, everywhere you will find the element of risk, when someone goes for an additional benefit or return. Forget about additional returns, many times investors worry about what would be his actual return on his investment. Given two options in hand, an investor would be happier, if his investment is protected with a minimal return in comparison to high additional returns at a cost of further risk. In the first option you are completely risk averse. In the second option, it would be more interesting to take the challenge, if there were some mechanism available to freeze the quantum of risk so that one can compare it with the additional return and if the additional return is more than the risk, he will venture into, and otherwise he will abstain. The first option squeezes or seals all opportunities to earn more. The second one explores ample returns, but is subject to uncertainties. In the present high finance economies investors including corporate bodies competing to grab any possible opportunities which may arise. In result this has foster the way for financial engineering to develop sophisticated financial instruments to hedge against these unforeseen aberrations and uncertainties. Derivatives are nothing but the beautiful outcomes of these financial engineering processes. In general, derivatives are financial instruments in the form of futures, options, forwards, swaps, etc. which help investors and corporates manage their risk. With the advent of globalization, the Indian economy with the regime of strict control, is now opened up and exposed to price volatility in relation to assets and commodities and more particularly assets of financial nature. Though this volatility was witnessed earlier also, but with the globalization of business and free movement of financial assets, price risk management has become inevitable in India like other developed and developing countries. This scenario has given birth to several financially reengineered instruments known as derivatives. This article throws light on the recent development in Indian derivative market in terms of available derivative instruments, related market for their dealings and participants in the market.