History of Derivatives Market: In the early days forward contracts in the United States were meant to take care of the interests of the merchants and dealers by making sure that there were enough buyers and sellers for different commodities like grains, pulses, metals etc. However, with the forward contracts “credit risk” remained a very serious problem. In order to counter this problem of credit risk, a group of visionary businessmen from Chicago formed the Chicago Board of Trade (CBOT), way back in the year 1848. The most important motive of the CBOT was to provide a centralized platform or location that is known to the traders way in advance so that the buyers and sellers could negotiate forward contracts to fulfill their respective interests. In the year 1865, the CBOT put its best foot forward in order to list the first “exchange traded” derivatives contract in the US. On that occasion, the world’s first standardized and exchange traded derivative instrument was born. This inovative derivative instrument was called  “Future Contract”. In the year 1919, another organization known as the Chicago Butter and Egg Board, a sister concern of the CBOT, was allowed to trade future contracts. This was the world's second derivatives market in the organized sector. Later its name was changed to Chicago Mercantile Exchange (CME) from Chicago Butter and Egg Board. Even to the present day, the CBOT and the CME remain the two largest organized futures exchanges in the world. As a matter of fact these two are the largest “financial” exchanges of any kind in the whole of the world to the present day. The very first stock index futures contract was traded at an exchange in the United States popularly known as Kansas City Board of Trade (KBOT). In today's date, the most popular stock index futures contract in the world is based on S&P 500 index. The S&P 500 index is traded on Chicago Mercantile Exchange and is its benchmark index. During the mid eighties, financial future contracts became the most popular derivative instruments generating extremely huge sales volumes that are many times higher than the commodity future contracts. Stock exchange Index futures, futures on Treasury-bills and Euro-currency futures are the three most popular future contract types traded in the present day. Other popular international derivatives exchanges that trade futures and options are London International Financial Futures and Options Exchange (LIFFE) in England, Deutsche Termin Boerse (DTB) in Germany, Singapore Exchange Limited (SGX) in Singapore, Tokyo International Financial Futures Exchange Inc. (TIFFE) in Japan, Marché à Terme International de France (MATIF) in France, Europe's Global Financial Marketplace (EUREX) of the European Union etc.

Financial Derivatives Market in India:
In today's date, both in terms of trading volumes and sales turnover, the National Stock Exchange of India (NSE) is the largest derivatives exchange in India. The average sales turnover for a day at the NSE currently crosses Rs 50,000 crores. The derivatives trading on the National Stock Exchange (NSE) started with S&P CNX NIFTY index futures on June 12, in the year 2000. S&P CNX NIFTY is the benchmark index of the National Stock Excfhange. The trading in index options at the NSE started on June 4, in the year 2001 and trading in options on individual stocks started on July 2, the same year. Individual securities future contracts were launched on November 9, that year. As to the present date, the derivative contracts at the National Stock Exchange have a maximum of 3 – month expiration cycle. At any given point of time, three derivative contracts are available for trading with respect to the expiration cycle. They are of 1 – month, 2 – month and 3 – month time period for expiry. A new contract is introduced on the next trading day which is Friday. The near month contract expires on Thursday. 

Traders in Derivative Markets:
The following three broad categories of participants – hedgers, speculators and arbitrageurs trade in the derivative market. There is always some risk factor associated with the price of an asset. The hedgers use derivative instruments like futures and options to reduce or eliminate this risk. The hedgers are generally risk averse in nature. A hedger will take a position in the futures market that is opposite to a risk to which he/she is exposed. The speculators wish to bet on future movements in the price of an asset. They forecast the future price and accordingly take long or short position. Futures and options contracts are the instruments by which they can increase both the potential gains and potential losses in a speculative transaction. The arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. When arbitrageurs see a discrepancy between the futures price of an asset and its cash price, they will take offsetting positions in the two markets to lock in a profit. The spreaders are also risk averse in nature. They want to take less risk and are satisfied with less returns. They take offsetting future position which minimizes the risk and thereby minimizes the return as well.

Use of Derivative Instruments:
In the contemporary market situation, there are many advantages of derivative instruments which makes them increasingly popular among the investor community all over the world. Following are the main ways in which derivatives are used.
1- The most important use of derivatives is to control, avoid, shift and manage different types of risks through strategies like hedging, arbitraging, spreading etc.
2- Derivatives serve as measuring tools of the future price trends by spreading different information regarding the futures markets trading of various securities thereby assisting the investors appropriate and superior allocation of resources.
3- In case of derivatives trading, no immediate full amount of the transaction is required, as a result large number of traders, speculators and arbitrageurs are able to operate in these markets. This increases the liquidity and decreases the transaction costs.
4- With the help of derivative products, invertors, traders and fund managers can formulate strategies for proper asset allocation and high returns thereby achieving their investment objectives.
5- Derivative instruments help in balancing price fluctuations, reduce the price spread, integrate the price structure with respect to time and remove shortages in the markets.
6- Derivative products promote competitive trading among different market operators like hedgers, speculators, arbitrageurs etc. This results in increase in the trading volumes and growth of financial markets.
7- Derivative trading develops the market towards “complete” and “efficient” markets. In a complete market, no particular investor is at a better position than the other as all of them share the same market information and have similar resources at their disposal. In an efficient market, there is no scope for any abnormal gain in a financial transaction whatsoever.

Grounds on which derivative instruments have been criticized: Despite the advantages of derivative instruments, some industry experts have raised doubts over their rapid growth and have criticized them on the following grounds.
1- Speculative and gambling motives: One of the strongest arguments against derivatives is that they promote speculative activities in the market. The world over, the volume of derivative trading has increased in multiples of the value of the underlying assets while a mere one or two percent of the transactions are settled by actual delivery. The rest of the trading is done with speculative and gambling motives.
2- Increase in risk: Derivatives are supposed to be a risk management instrument. However, it has been argued that it is not the complete truth. Derivative instruments that are traded off-exchange or the OTC market carry more risk factor. They expose the trading parties to operational risk, counter-party risk and legal risk.
3- Instability of the financial system: It has been argued that derivatives have increased the risk factor not only for the trading parties but also the entire financial system. The rapid growth in the trading volumes of derivative instruments have given rise to the fear of  micro and macro financial crisis. The speculative and gambling motives of the market participants have made the financial system unstable.
4- Price instability: It has been said that derivative instruments help in balancing price fluctuations, reduce the price spread, integrate the price structure with respect to time and remove shortages in the markets. However, the critics have doubt about this. They argue that derivatives have caused price fluctuations and increased the price spread thereby resulting in price instability.
5- Displacement effect: Another doubt over their rapid growth of the derivative market is that it will affect the business volumes in the primary market or the new issue market. When majority of the investors move towards the derivatives market, raising fresh capital in the primary market will get difficult. This will give rise to the phenomenon called displacement effect.
6- Increased regulatory burden: As already pointed out, derivatives have increased the risk factor which has made the financial system unstable. The speculative and gambling motives of the market participants have increased the burden on the government and the regulatory authorities to exercise control, supervision and monitoring of the market movements so that frauds, scams and situations of crisis can be avoided.


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