A transaction is the actions of legal entities or individuals used to change, establish and complete certain rights and obligations.
Any transaction is characterized by the following features:
- she is a conscious act of will;
- conducting transactions is lawful and legal;
- parties involved in the transaction enter into civil relations, which can subsequently be terminated or changed.
There are many types of transactions, among which urgent ones can be distinguished. This type of transaction is used when concluding agreements with a deferred settlement date.
Description
A derivatives transaction is an agreement of two parties in relation to an underlying asset with a distribution of rights and obligations and a predetermined date on which the performance of obligations is due. The delay should be at least 2 working days from the date of conclusion of the agreement. The terms of such an agreement are either directly specified in the agreement itself, or depend on the rules determined by the trade organizer.
In other words, a derivatives transaction is an agreement with a predetermined beginning of the execution of the transaction and the date of its completion, which accounts for the fulfillment of obligations.
A basic (or basic) asset is an object whose value is used as the main settlement base used to execute a futures contract. These assets include various goods, futures, securities, including stocks.
Derivatives are often used for hedging - insurance that minimizes financial risks. As a result, possible future losses are compensated due to price or other indicators. As a hedged item, both assets and liabilities, as well as cash associated with them, can be used.
Essence
To simplify the understanding of the futures contract, we can assume that the futures transaction is an operation where the object is not the goods, but the actual obligations and rights in relation to the issued standard agreements.
Derivatives contracts are only implemented subject to cash settlement. The quantity and quality of assets delivered in the future are agreed in advance.
The main goal of derivatives transactions is to eliminate financial risks. This is due to the fixing of asset prices during the execution of the contract. Parties to the transaction receive certain guarantees of the execution of the agreement. The seller minimizes price losses, the buyer receives rights to acquired assets with a fixed price in order to obtain further profit.
Derivatives Example: option, interest rate swap, warrant, convertible bond, agreement on future interest rate, etc. Let us consider the types in more detail.
Types of derivatives transactions
Among futures deals, there are various contracts defined as futures by special government agencies, including forward, option, futures, and other agreements. Each of these contracts quite fully reveals the concept of a derivative financial instrument, the scope of which is somewhat narrower than that of other transactions of this kind.
The conditions and prices of the derivative (derivative financial instrument) are based on the use of the underlying asset parameters.
The underlying asset, which acts as the basis for the forwards, is a real product that has a deferred delivery date. Futures are used in the conclusion of standard agreements for the supply of exchange goods. Options allow you to assign rights to the subsequent transfer of rights and obligations in relation to the contract or exchange goods.
Sometimes participants can conduct opposite transactions on the same day with the same amounts. Such transactions are called swaps and are divided into several types: currency, commodity and interest-bearing derivatives contracts.
Forward contract
In the forward obligations on the purchase / sale of the object are prescribed at a predetermined value after a set period of time. Counterparties participate directly in the transaction, and dealers act as intermediaries, so the forward belongs to the over-the-counter category.
There are forwards in which the estimated date of execution of the agreement is not indicated. They are called open date forwards.
Forwards are divided into delivery and settlement. The delivery is completed after the delivery of the underlying asset and the full payment. Another forward contract – settlement - executed without delivery of the asset.
Advantages and disadvantages
Among the advantages of forward contracts are:
- the OTC nature of the transaction, providing a certain freedom of action, in particular in setting the price of the underlying asset and in writing down the terms of the agreement;
- hedging of risks taking into account the interests of participants;
- lack of additional transaction processing costs.
The disadvantages of forward transactions include:
- high probability of default by agreement of one of the parties;
- difficulties in finding another party to the transaction and the corresponding low liquidity of the forward transaction due to the lack of a secondary market;
- the impossibility of changing the terms of the transaction after the conclusion of the contract.
Futures contract
Futures is an agreement between the parties involved in the sale / purchase of assets at a predetermined date at the cost determined at the time of conclusion of the contract (futures value). The packaging, labeling, quality and quantity, as well as other parameters of the assets can be specified in the contract in advance.
In their structure, futures are very similar to forwards. The only difference is that futures are executed through the exchange. The participants in the transaction agree on the value of the assets and the number of contracts created, the remaining points are determined by the exchange platform, including delivery times, volume of assets, quality of the tools used.
Like forwards, futures transactions are settlement and delivery. Settlement futures contract involves cash settlements in the form of the difference between the price fixed in the contract and the value of the asset at the time of execution of the agreement. It is used to hedge financial risks or for profit.
Deliverable futures are executed after the asset is delivered to the buyer during the period specified in the agreement. If the seller does not fulfill its obligations on time, the exchange imposes a fine on it.
Advantages and disadvantages
The following positive aspects of concluding a futures transaction are highlighted:
- hedging of risks;
- high liquidity;
- low cost of the operation compared to the amounts appearing in the contract;
- the presence of certain guarantees from the clearing house;
- the availability of a transaction for all participants in the exchange.
The negative aspects of futures contracts include:
- lower income from financial resources on a brokerage deposit account presented in the form of insurance premiums;
- the inability to minimize risks in long-term operations in the execution of short-term futures contracts;
- incomplete compliance of standard conditions with the requests of the parties to the agreement.
Option contract
The option gives the right (but not obligation) to acquire the asset at a predetermined price upon the date specified in the contract. Responsibility for fulfilling the terms of the contract lies solely with the seller.
When concluding an option, the buyer pays a certain part of the amount of money - the so-called option premium. It acts as a fee for the right to conclude transactions in the future. The amount of the premium depends on the supply and demand in the options market and the current value of the underlying asset.
Options transactions are exchange and over-the-counter. In favor of the exchange option, a high level of liquidity and standardization of executed agreements indicate, in favor of the OTC - flexibility in determining the terms of the contract.
Advantages and disadvantages of options
Common advantages of option contracts include:
- making a profit without buying an exchange instrument;
- risk limitation by option price;
- hedging the current price to protect against future fluctuations;
- significantly lower option cost compared to the underlying asset.
Like any other type of fixed-term contract, the option has several disadvantages:
- inflated transaction value;
- difficulty in handling;
- high sensitivity to time, because of which part of the contracts may remain unfulfilled.
Currency transactions
The agreement of the parties on the delivery of a fixed amount of foreign currency after a certain period of time at the rate that was established at the time the contract was concluded is called an urgent currency transaction. Currency transactions can be either futures or forward.
Currency conversion - the exchange of monetary units of various states - is often carried out in the implementation of foreign exchange transactions. Depending on the exchange rate, interest rate and inflation, this transaction may be profitable or result in certain losses.
Currency transactions, due to their specific nature, have several features:
- Establishment of a specific time interval from the date of execution of the contract to the date of its execution. The currency delivery time is set upon completion of the period established by the agreement (from several weeks to several months).
- Fixing the exchange rate on the date of the transaction regardless of the date of its execution.
Currency transactions pursue the following objectives:
- Currency conversion is performed with hedging of currency risk;
- exchange rate differences may provide future profit;
- insurance of investments in foreign capital against possible losses associated with a temporary depreciation of the exchange rate is carried out.
Financial instrument concept
The underlying asset is the basis of a derivative financial instrument (or derivative), the price of which is directly dependent on the underlying asset. A derivative can be issued as a fixed-term contract or derivative security.
Bilateral agreements, the price of which depends on the base price and is a derivative of market quotes, are financial instruments of derivatives transactions. Subsequently, the established amount of money will have to pay one of the parties to the contract.
Thus, the market value of the derivative depends on the price of the underlying asset and on the likelihood of meeting the obligations specified in the agreement.Derivatives help to share risk.
According to Article 301 of the Tax Code of the Russian Federation, derivatives are derivatives transactions, the terms of which do not provide for the delivery of an underlying asset. The agreement shall indicate the procedure for mutual settlements of participants in a transaction on a certain date, taking into account price fluctuations or changes in another indicator in comparison with that established during the execution of the agreement.
In some cases, a derivative can also be considered as a derivative security, which is created on the basis of transactions conducted with the securities included in them.
The essence of the financial instrument
A derivative as an agreement on derivatives transactions in financial markets must fulfill the following conditions (only in this case it can be considered circulating):
- the procedure for concluding an agreement and its execution is determined by the trade organizer;
- the moment of fulfillment of all duties and rights prescribed in the agreement being concluded is the date the transaction with a financial instrument is completed;
- data on the prices of financial instruments are freely available and openly published in the media.
A transaction with a derivative is deemed executed if:
- Underlying asset delivered
- final settlement was made;
- An operation was performed with a financial instrument, completely opposite to the previous one.
Conclusion
In general, a derivatives transaction is an agreement aimed at fulfilling obligations after a certain period of time. It is used to minimize risks associated with fluctuations in prices and other indicators of underlying assets.
The execution of derivatives transactions provides certain advantages to both the seller and the buyer. The seller gains the ability to hedge his assets, the buyer - the likely profit in the future.
Depending on the objectives pursued, it is possible to conclude fixed-term contracts through the exchange or outside it. The exchange provides certain guarantees for the transaction and high liquidity of assets. The conclusion of over-the-counter contracts allows you to save on the preparation of the contract and provides greater freedom of action to the parties to the agreement.
