What is a Derivative contract?
A derivative contract is an enforceable agreement whose value is derived from the value of an underlying asset; the underlying asset can be a commodity, precious metal, currency, bond, stock, or, indices of commodities, stocks etc. Four most common examples of derivative instruments are forwards, futures, options and swaps/spreads.
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What is a forward contract?
A forward contract is a legally enforceable agreement for delivery of goods or the underlying asset on a specific date in future at a price agreed on the date of contract. Under Forward Contracts (Regulation) Act, 1952, all the contracts for delivery of goods, which are settled by payment of money difference or where delivery and payment is made after a period of 11 days, are forward contracts.

How are futures prices determined?
Futures prices evolve from the interaction of bids and offers emanating from all over the country - which converge in the trading floor or the trading engine. The bid and offer prices are based on the expectations of prices on the maturity date.

What is long position & short position?
In simple terms, long position is a net bought position. Short position is net sold position.

What is bull spread & bear spread  (futures)?
In most commodities and financial derivatives market, the term refers to buying contracts maturing in nereby month, and selling the deferred month contracts, to profit from the wide spread which is larger than the cost of carry and Bear spread refers to selling the nearby contract month, and buying the distant contract, to profit from saving in the cost of carry.

What is 'Contango'? When is futures contract in 'Contango'?
Contango means a situation, where futures contract prices are higher than the spot price and the futures contracts maturing earlier.
It arises normally when the contract matures during the same cropseason. In an well-integrated market, Contango is equal to the cost of carry viz. Interest rate on investment, loss on account of loss of weight or deterioration in quantity etc.

What is 'Backwardation'? When is futures contract at 'Backwardation'?
When the prices of spot, or contracts maturing earlier are higher than a particular futures contract, it is said to be trading at Backwardation.
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It is usual for a contract maturing in the peak season to be in backwardation during the lean period.

What is 'basis'?
It is normally calculated as cash price minus the futures price. A positive number indicates a futures discount (Backwardation) and a negative number, a futures premium (Contango). Unless otherwise specified, the price of the nearby futures contract month is generally used to calculate the basis.

What is cash settlement?
It is a process for performing a futures contract by payment of money difference rather than by delivering the physical commodity or instrument representing such physical commodity (like, warehouse receipt)

What is offset?
It refers to the liquidation of a futures contract by entering into opposite (purchase or sale, as the case may be) of an identical contract.

What is settlement price?
The settlement price is the price at which all the outstanding trades are settled, i.e, profits or losses, if any, are paid. The method of fixing Settlement price is prescribed in the Byelaws of the exchanges; normally it is a weighted average of prices of transactions both in spot and futures market during specified period.

What is convergence?
This refers to the tendency of difference between spot and futures contract to decline continuously, so as to become zero on the date on maturity.

What is Warehouse Receipt?
It is a document issued by a warehouse indicating ownership of a stored commodity and specifying details in respect of some particulars, like, quality, quantity and, some times, indicating the crop season.

Why do we need speculators in futures market?
Participants in physical markets use futures market for price discovery and price risk management. In fact, in the absence of futures market, they would be compelled to speculate on prices. Futures market helps them to avoid speculation by entering into hedge contracts. It is however extremely unlikely for every hedger to find a hedger counterparty with matching requirements. The hedgers intend to shift price risk, which they can only if there are participants willing to accept the risk. Speculators are such participants who are willing to take risk of hedgers in the expectation of making profit. Speculators provide liquidity to the market, therefore, it is difficult to imagine a futures market functioning without speculators.

What is the difference between a speculator and gambler?
Speculators are not gamblers, since they do not create risk, but merely accept the risk, which already exists in the market. The speculators are the persons who try to assimilate all the possible price-sensitive information, on the basis of which they can expect to make profit. The speculators therefore contribute in improving the efficiency of price discovery function of the futures market.

What is hedging?
Hedging is a mechanism by which the participants in the physical/ cash markets can cover their price risk. Theoretically, the relationship between the futures and cash prices is determined by cost of carry. The two prices therefore move in tandem. This enables the participants in the physical/ cash markets to cover their price risk by taking opposite position in the futures market.

Illustrate hedging by a stockist by using futures market?
To illustrate the concept of hedging, let us assume that, on 1st December, 2002, a stockist purchases, say, 10 tonnes of Castorseed in the physical market @ Rs. 1600/- p.q.. To hedge price-risk, he would simultaneously sell 10 contracts of one tonne each in the futures market at the prevailing price. Assuming the ruling price in May, 2003 contract is Rs.1750/- p.q., the stockist is able to lock in a spread/"badla" of Rs. 150/- p.q., i.e., about 9% for about 6 months. The stockist would, in the first instance, take the decision to purchase stock only if such a spread covers his cost of carry and a reasonable profit of margin. Assuming that the stockist sells his stock in the month of April when the spot price is Rs. 1500/- p.q.. The stockist would incur a loss of Rs. 100/- p.q. on his physical stocks. He would also make a loss of expenses incurred for carrying the stocks. However, since the spot and futures prices move in parity, futures price is also likely to decline, say, from Rs. 1750/- p.q. to, say, Rs. 1625/- p.a. The stockist can liquidate his contract in the futures market by entering into purchase contract @ Rs. 1625/- p.q. He would end up earning a profit of Rs. 125/- in the futures segment. Looking at the gain/loss in the two segments, we find that the stockist is able to hedge his price risk by operating simultaneously in the two markets and taking opposite positions. He gains in the futures market if he loses in the spot market; but he would lose in futures market if he gains in the spot market. Similarly, processors, exporters, and importers can also hedge their price risks.

What is arbitrage?
Arbitrage refers to the simultaneous purchase and sale in two markets so that the selling price is higher than the buying price by more than the transaction cost, so that the arbitrageur makes risk-less profit.

 What kinds of risks do participants face in derivatives markets?
Different kinds of risks faced by participants in derivativesmarkets are: a) credit risk b) market risk c) liquidity risk d) legal risk e) operational risk

What is credit risk?
Credit risk on account of default by counter party: This is very low or almost zeros because the Exchange takes on the responsibility for the performance of contracts

 What is market risk?
Market risk is the risk of loss on account of adverse movement of price.

What is liquidity risk?
Liquidity risks is the risk that unwinding of transactions may be difficult, if the market is illiquid

 What is Legal risk?
Legal risk is that legal objections might be raised, regulatory framework might disallow some activities.

What is operational risk?
Operational risk is the risk arising out of some operational difficulties, like, failure of electricity, due to which it becomes difficult to operate in the market.

What is initial/ordinary margin?
It is the amount to be deposited by the market participants in his margin account with clearing house before they can place order to buy or sell a futures contracts. This must be maintained throughout the time their position is open and is returnable at delivery, exercise, expiry or closing out.

What is Mark-to-Market margin ..............?
Mark-to-market margins (MTM or M2M or valan) are payable based on closing prices at the end of each trading day. These margins will be paid by the buyer if the price declines and by the seller if the price rises. This margin is worked out on difference between the closing/clearing rate and the rate of the contract (if it is enterned into on that day) or the previous day's clearing rate. The Exchange collects these margins from buyers if the prices decline and pays to the sellers and vice versa.

What is Foreign Exchange / Forex / FX?
Foreign exchange is the simultaneous purchase of one currency and sale of another – currencies are always traded in pairs. International currencies are traded on floating exchange rates. There is a daily average turnover of about US$1.5 trillion in the foreign exchange markets. The foreign exchange market is known as the "Forex," or "FX" market. It is the largest financial market in the world.

Is there a central location for the Forex Market?
Forex trading is not managed through an exchange. Since transactions are conducted between two counterparts, the FX market is an “inter-bank,” or over the counter (OTC) market

Who participates in the FX market?
Central, commercial and investment banks have traditionally dominated the Forex market. Other market participation is rapidly increasing, and now includes international money managers and brokers, multinational corporations, registered dealers, options and futures traders, and private investors.