The significance of derivatives:
Derivatives market serves following specific functions:
1. Derivatives market helps in improving price discovery based on actual valuations and expectations.
2. It helps in transferring risk from those who have low risk appetite to participants with high rish appetite.
For example, hedgers want to give away the risk where as traders are willing to take risk.
3. It shifts speculative trades from an unorganized market to an organized market. Risk management mechanism and surveillance of activities of various participants in the organized space provide stability to the financial system.
Risks faced by participants in derivatives:
Derivatives, being leveraged products, have the following risks:
- counterparty risk(default by counterparty)
- price risk(loss on position because of price move)
- liquidity risk(inability to exit from a position)
- legal or regulatory risk(enforceability of contracts)
- operational risk(fraud, inadequate documentation, improper execution etc.)
Market participants who trade in derivatives are advised to carefully read the Model Risk Disclosure Document, handed over to him by the broker at the time of signing the document.
Model Risk disclosure document:
-it is issued by the member of Exchanges
-it contains important information on trading in equities and F&O segments of exchanges