Derivatives are investment instruments that consist of a contract

between parties whose value derives from and depends on the value
of an underlying financial asset.

*Importance of derivative markets*

_*1. Risk Sharing:*_ Derivatives are mainly used to hedge risk

associated with the underlying asset to the willing parties to take
risk. The risk comes from several sources and is unavoidable.
Derivatives are mainly intended to reduce the risks through
transferring, spreading, etc. to the third parties who are risk seekers.

_*2. Implementation of Asset allocation Decisions:*_

Derivatives are useful in implementing the asset allocation strategies
on account of their
property of low cost of diversification and leverage.

_*3 Information gathering:*_

Derivative markets affect the information structure of the financial
system. The economic benefit of the information is that the potential
imbalances can be visualized more easily by
the higher implied volatilities.

*Risks involved in derivatives market*

1. if one of the parties involved in a derivatives trade, such as the

buyer, seller or dealer, defaults on the contract. This risk is higher in
over-the-counter, or OTC, markets, which are much less regulated
than ordinary trading exchanges.

2. Agency risk simply means that if there is a principal and an agent,

the agent may not act in the best interest of the principal because
their objectives are different from that of the principal

3. Investors base their decisions on different factors – technical

analysis, fundamental analysis, and assumptions. Some even base it
on luck – which is also a kind of risk. These are some of the few risks
involved in derivatives market
*Role of derivative markets*

_*1. Risk Management:*_

As derivative prices are related to the underlying spot market goods (assets),
they can be used to reduce or increase the risk of owing the spot items.

_*2. Price discovery*_

As derivative prices are related to the underlying spot market goods (assets),
they can be used to reduce or increase the risk of owing the spot items.

_*3. Operational advantages*_

*_4. Market efficiency_*

Role of derivatives market.

1. MANAGEMENT OF RISK:
Risk management is not about the elimination of risk rather it
is about the management of risk. Financial derivatives provide
a powerful tool for limiting risks that individual and
organization face in the ordinary conduct of their businesses.
Effective use of derivatives can save cost and it can increase
return from the organization.

2. EXPLOIT OPPURTUNITIES TO ENHANCE RETURNS:

Derivative securities such as options, forwards and futures, and
swaps can provide firms and investors to exploit opportunities
to enhance returns that might not otherwise be available.

3. 5. PRICE DISCOVERY:
Price discovery means revealing information about future cash
market prices through the future markets. Derivative markets
provide a mechanism by which diverse and scattered opinions
 of future are collected into one really discernible number which
provides which provide a consensus of knowledgeable thinking.

4. 6. PRICE STABILISATION:
Derivative market helps to keep a stabilizing influence on spot
prices by reducing the both term fluctuations. In other words,
derivatives reduces both peak and depths and leads to price
stabilization effect in the cash market underlying assets.

5. 7. EFFICIENCY IN TRADING:
Financial derivatives allow for free trading of risk components
and that leads in improving market efficiency. Traders can use
a position in one or more financial derivatives as a substitute or
position in the underlying instruments. In many instances,
traders find financial derivatives to be more attractive than
the underlying security.

6. 9. HIGHER TRADING VOLUME:

Derivatives due to there inherent nature, are linked to the
underlying cash markets. With the introduction of derivatives,
the underlying markets witnesses higher trading volumes
because of participation by more players who would not
otherwise participate for lack of an arrangement to transfer
risk.

7. 10. CONTROL MARKET ACTIVITIES:

Speculative investors shift a more controlled environment of
derivatives market. In the absence of an organized derivative
marketspeculators trade in the underlying cash markets.
Managing, monitoring and surveillance of the activities of
various participants becomes extremely difficult in these kinds
of mixed markets.
 8. 11. ACTS AS CATALYST:
An important incidental benefit that flows from derivatives
trading is that it acts as catalyst for new entrepreneur activity.
The Derivatives leave a history of attracting many bright, and
well educated people with an entrepreneurial attitude. They
often encourage others to enter into business and create new
products and employment opportunities , the benefit of Which
art immense.

Risk involved in derivatives market are :

Risk 1: Commodity Risk

Risk 2: Stock Market Risk

Risk 3: Interest Rate Risk

Risk 4: Credit Risk