Saturday, September 26, 2009

A derivative is a financial instrument:
(a) whose value changes in response to the change in a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or similar variable (sometimes called the 'underlying');
(b) that requires no initial net investment or little initial net investment relative to other types of contracts that have a similar response to changes in market conditions; and
(c) that is settled at a future date.
In India, different derivatives instruments are permitted and regulated by various regulators, like Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI) and Forward Markets Commission (FMC). Broadly, RBI is empowered to regulate the interest rate derivatives, foreign currency derivatives and credit derivatives. For regulatory purposes, derivatives have been defined in the Reserve Bank of India Act, as follows:
"Derivative" means an instrument, to be settled at a future date, whose value is derived from change in interest rate, foreign exchange rate, credit rating or credit index, price of securities (also called "underlying"), or a combination of more than one of them and includes interest rate swaps, forward rate agreements, foreign currency swaps, foreign currency-rupee swaps, foreign currency options, foreign currency-rupee options or such other instruments as may be specified by the Bank from time to time.
The term derivative indicates that it has no independent value, i.e., its value is entirely derived from the value of the underlying asset. The underlying asset can be commodities, securities, bullion, currency, livestock or anything else. In other words, derivatives means forward, futures, option or any other value of a specified real or financial asset or to an index of securities. The securities contracts (regulation) act 1956 defines derivative as under;
Derivatives include
1. Security derived from a debt instrument, share, loan whether secure or unsecured, risk instrument or contract for differences or any other form of security.
2. A contract which derives its value from the prices, or index of prices of underlying securities.

A derivative instrument is a financial derivative or other contract with all three of the following characteristics:

It has

1. One or more underlying, and
2. One or more notional amount or payments provisions or both.
Those terms determine the amount o the settlement or settlements.

It requires no initial net investment or an initial net investment is that smaller than would be required for other types of contract that would be expected to have a similar response to changes in market factors.

Its terms require or permit net settlement. It can be readily settled net by a means outside the contract or it provides for delivery of an asset that puts the recipients in apposition not substantially different from net settlement.

In general, from the aforementioned, derivatives refer to securities or to contracts that derive from another-whose value depends on another contract or assets. As such the financial derivatives are financial instruments whose prices or values re derived from the prices of other underlying financial instruments or financial assets. The underlying instruments may be a equity share, stock, bond, debenture, treasury bill, foreign currency or even another derivative asset. The price of the derivative is not the price of the financial derivative. For example, the value of a treasury bill of future contracts or foreign currency forward contract will depend upon the price or value of the underlying assets, such as Treasury bill or foreign currency. Due to this reason, transactions in derivative markets are used to offset the risk price changes in the underlying assets. In fact, the derivatives can be formed on almost any variable, for example, from the price of hogs to the among of snow falling at a certain ski resort.

The term financial derivative relates with a variety of financial instruments which include stocks, bonds, treasury bills, interest rate, foreign currencies and other hybrid securities. Financial derivatives include futures, forwards, and options, swaps etc. future contracts are the most important form a combination of cash market instruments or other financial derivate instruments. In fact, most of the financial derivatives are not revolutionary new instruments rather they are merely combinations of older generation derivatives and/or standard cash instruments.

The financial derivatives were also known as off-balance sheet instruments because no asset or liability underlying the contract was put on the balance sheet as such. Since the values of such derivatives depend upon the movement of market prices of the underlying assets, hence, they were recorded on the balance sheet. However, it is a matter of considerable debate whether off-balance sheet instruments should be considered for derivative is a debatable issue.

In brief, the term financial market derivative can be defined as a treasury or capital market instrument, which is derived from, or bears a close relation to a cash instrument or another derivative instrument. Hence, financial derivatives are financial instruments whose prices are derived from the prices of other financial instruments.

Features of financial derivative:

The basic features of the derivative instrument can be drawn from the general definition of a derivative irrespective of its type. Derivatives or derivative securities are future contracts which are written between two parties (counter parties) and whose value are derived from the value of underlying ideally held and easily marketable assets such as agricultural and other physical (tangible) commodities, or short term and long term financial instruments, or intangible things like weather, commodities price index to such contracts are those other than the original issuer (holder) of the underlying asset. From this definition, the basic features of a derivative may be stated as follows

1. A derivative instrument relates to the future contract between two parties. It means there must be a contract binding on the underlying parties and the same to be fulfilled in future. The future period may be short or long depending upon the nature of contract, for example, short-term interest rate futures and long-term interest rate futures contract.

2. Normally, the derivative instruments have the value which derived from the values of other underlying assets, such as agricultural commodities, metals, financial assets, intangible assets, etc. value of derivatives depends upon the value of the underlying instrument and which changes as per the changes as per the changes in the underlying assets, and sometimes, it may be nil or zero. Hence, they are closely related.

3. In general, the counter parties have specified obligation under the derivative contract. Obviously, the nature of the obligation would be different as per the type of the instrument of a derivative. For example, the obligation of the counter parties, under the different derivatives, such as forward contract, future contract, option contract and swap contract would be different.

4. The derivatives contracts can be undertaken directly between the two parties or through the particular exchange like financial future contracts. The exchange – traded derivatives are quite liquid and have low transactional costs in comparison to tailor-made contracts.

5. In general, the financial derivatives are carried off-balance sheet. The size of the derivative contract depends upon its notional amount. The notional amount is the amount used to calculate the pay off. For instance, in the option contract, the potential loss and potential payoff, both may be different from the value of underlying shares, because the payoff of derivative products differs from the payoff that their notional amount might suggest.

6. Usually, in derivatives trading, the taking or making of delivery of underlying assets is not involved; rather underlying transactions are mostly settled by taking offsetting positions in the derivatives themselves. There is, therefore, no effective limit on the quantity of claims, which can be traded respect of underlying assets.

7. Derivatives are also known as deferred delivery or deferred payment instrument. It means that it is easier to take short or long position in derivatives in comparison to other assets or securities. Further, it is possible to combine them to match specific, i.e., they are more easily amenable to financial engineering.

8. Derivatives are most secondary market instruments and have little usefulness in mobilizing fresh capital by the corporate world; however, warrants and convertibles are exception in this respect.

9. Although in the market, the standardized, general and exchange-traded derivatives are being increasingly evolved, however, still there are so many privately negotiated customized, over the counter (OTC) traded derivatives are in existence. They expose the trading parties to operational risk, counter-party risk and legal risk. Further, there may also be uncertainty about the regulatory status of such derivatives.

10. Finally, the derivative instruments, sometimes, because of their off-balance sheet nature, can be used to clear up the balance sheet. For example, a fund manager who is restricted from taking particular currency can buy a structured note whose coupon is tied to the performance of a particular currency pair.

Wednesday, August 5, 2009


There are about 100 million Debit Cards and 35 million Credit Cards currently in circulation in India.
Cash Withdrawal and Deposit at ATMs.
Top up prepaid cell phones.
Utility Payments like Phone Bills/Electricity Bills and Card Payments.
Pay LIC premiums and other insurance premiums.(Corporation Bank has enabled this feature in all of the ATMs.
Making donations to temples/charities.
Booking of Air and Rail Tickets.
Transfer of money to debit card account with another debit card.
Transfer of money to account holders within the same bank or to the account holders of other banks below 50,000.00.
A host of other usages of the card are in the offing.
Ignore calls purportedly from your bank whereby you are required to furnish details of your card including security codes/account details. Please keep in mind that a banker never calls a customer for these information since they already have these information. You could be taken for a ride.

Skimming is a process of swiping your card through a card swiping machine with a skimmer attached, which we are not aware. The skimmer captures all the confidential features of your card. The information is used by fraudsters to clone the cards. IF THE USAGE OF A DEBIT CARD IS IMPERATIVE, INSIST THAT THE CARD IS SWIPED IN YOUR PRESENCE.
Never use a Debit Card to do your shopping if you can help it. Please bear in mind that there is no grace time for Debit Cards. Use your Credit Card since there is an option for your to contest a fraudulent transaction.

Insist on debit cards with PIN usage every time you use it since it is more safer. Debit cards which does not require PINs are more dangerous.

Surveys have shown that merchants, airline staff, petrol station attendants, and restaurant cashiers never checked signatures and 75% of the cases test purchases made by males using credit cards issued to females went unnoticed.

When misuse is noticed, complain to the bank issuing the card. If the same is not resolved, complain to the Banking Ombudsman within 30 days.

Fraudulent/phishing emails seeking debit card details not be answered.

Shop/book using credit cards since you have option to contest in case of fraudulent usage. Never use debit cards while shopping through the net/web.

Check/track the bank accounts. Statements to be scrutinized periodically.
Complete transactions in ATM before leaving. Scope of card left and used for withdrawal by the next user. Readiness of ATM to be ensured. Wait till the welcome screen appears on the ATM.

Guard ATM statements. Destroy before putting in the waste basket lest account/card details would be given away inadvertently.

Monday, August 3, 2009



All deposits (SB/CA/RD/FDs) upto Rs.1.00 lakh in a commercial bank or co-operative bank in India are insured by the DICGCI. The insurance cover is extended by collecting premium from banks, at half yearly intervals at the rate of 10 paise per annum per Rs.100/- . Te coverage is free to the depositors. Rs 1.00 lakh is inclusive of interest also. Deposits in different banks are separately insured with each deposit eligible for Rs.1.00 lakh cover. The banks covered are all commercial banks including branches of foreign banks functioning in India, lcal area banks and RRBs. All co-operative banks other than those in states like Meghalaya, UT of Chandigarh, Lakhshadeep and Nagar Haveli are also covered. Primary co-operative societies are not covered under the scheme.


How to identify Micro Small and Medium Enterprises?
MICRO ENTERPRISES : Units with investment in Plant & Machinery not exceeding Rs.25.00 lakhs in the manufacturing sector and Rs.10.00 lakhs in the services sector.

SMALL ENTERPRISES: Units with investment in Plant & Machinery between Rs.25.00 lakhs and Rs.5.00 crores in the manufacturing sector and between Rs.10.00 lakhs and Rs.2.00 crores in the service sector.
MEDIUM ENTERPRISES: Units with investment in Plant & Machinery between 5.00 crores and 10.00 crores in the manufacturing sector and Rs.2.00 crores and 5.00 crores in the service sector.


What is Cheque Truncation?

Truncation is the process of stopping the flow of physical cheques issued by the drawer to the drawee bank/branch. The physical instrument is truncated at some point en-route to the drawee bank and the electronic image of the cheque is sent to the drawee branch along with the relevant information such as MICR fields, date of presentment and so on. The need to move the physical instruments across branches is done away with thereby reducing the time required for payment of the cheques, the associated cost of transit and the delay in processing etc leading the speedy collection and realization of cheques. Advantage of CTS are:

Speeds up collection of cheques and thereby enhances customer satisfaction.
Reduces scope for clearing related frauds.
Minimises cost of collection of cheques.
Reduces reconciliation problems.
Eliminates logistical problems.


So far there has been no unanimity on the factors responsible for the crisis. There have been two different, but mutually exclusive view points on what is behind the crisis.

According to one view, the financial sector debacle has its origin in the “Global Imbalance” – the phenomenon of large current account surpluses in China and few other countries co-existing with USA with a large deficit. The global imbalance is reflected in the large mismatches in the current account positions of some countries and their mirror image in the form of domestic savings – investment mismatches.

The US has been running huge deficits. Countries such as China and Japan needed an outlet to deploy their surpluses. It was mutual convenience, as it were, for the savings of Asian Countries to find a haven in the U.S which needed money because it saved very little. The money from the Asian surplus countries flooded the US market that kept the interest rates low, inflated the prices of real estates, shares and other assets. When the bubble burst, the financial sector crisis surfaced. Hence, an orderly unwinding of the imbalance alone would help mitigate the crisis. If this is so, macro economic policies of countries need fine tuning.
The US Govt’s unsuccessful effort to persuade China to revalue the yuan to make their exports less competitive points to the belief that the global imbalances to be the primary reason for the global economic crisis.
However as per the totally different view expressed by the IMF in a recent paper, global imbalance is only an indirect cause. The main culprits were the deficient financial regulation and the failure of market discipline resulting in a systematic flouting of rules and regulations by banks.

1. Deficient Financial Regulations.
2. Failure of market discipline leading to systematic flouting of rules and regulation by the banks.

The sub prime crisis showed that almost all the banks used their ingenuity to develop structures and products that were outside the normal regulatory confines of banking in order to satisfy their customers seeking high returns. In the process they created a large number of shadow institutions – Investment Banks, Hedge Funds and the like. These shadow institutions grew over time to be systemically important. Through securitization and other means, the banks convinced themselves that the risks were spread out.

The complex instruments presumed to minimize the risk with the original issuer and guarantee a high return for the investor who bought them. In the end those created them did not comprehend their risks. Hence, IMF prescribes brining shadow banks within the ambit of regulations.

Hence, winding down global imbalance and enhanced regulation will be the key measures that would be agreed upon as a solution to the global economic crisis.