Derivatives and

Risk
Management
ACV Subrahmanyam
Summer Term 2024
Agenda

• Background
• Role of Financial Markets & Instruments
• Role of Derivatives
• Course contents
• Evaluation components

2
 Background – why do we need finance?
• Circular flow of the economy
• Analytical model on income and
expenditure
• What is missing?
• Double coincidence of wants
• Barter to Market – Role of Money
• Eliminates search costs
• Embodies purchasing “power”
• What is Power – Rate of doing work

• Brings in role of Time

• Time is Linear – Exhaustive – Rivalrous
Source:
https://corporatefinanceinstitute.com/resources/economics/circular-flow-model/#:~:text=Th
• Finance enables transformation of Money
e%20circular%20flow%20model%20is,the%20circular%20flow%20of%20income
. 3
Power
Derivatives and Risk Management : ACV Subrahmanyam Wednesday, June 19, 2024
 Real Assets Vs Financial Assets

• Remember in both the cases, the value is realized only in relation to market exchange
• Intrinsic value is important – you cannot eat cash “water diamond paradox”

•Physical Commodities, Plant Machinery, Gold, Land etc.

•Tangible goods which give us some utility
Real Assets
•Need time to be converted into “liquid” money – physical cash

•Denote ownership of money power– equity/ debt / deposits etc.

•Notional categories that technically intangible
Financial Assets
•Require less time to convert into “liquid” money – physical cash

4 Derivatives and Risk Management : ACV Subrahmanyam Wednesday, June 19, 2024
 Types of Financial Assets
Balance sheet is a true and fair representation of an individual or firm’s liabilities and assets
Various financial instruments / products provide investors (savers) with options to choose risks and
rewards
Efficient financial system relies on having instruments and products that cater a vast array of
investment needs

Cash Deposits Financial Assets (Speculative

(Transaction Motive) (Precautionary Motive) Motive)
Fundamental Embodiment of Next best alternative Stock / Bonds / Debt /
Money Power Derivatives
Fulcrum of the financial
Sovereign Monopoly to Create system Bridge gap between savers/
Money (BITCOIN/ USD investors
dominance) Practical embodiment of
money power Drives the Risk and Reward
Reference Unit / Scale​ framework - Inherently
​ Enables transfer effective volatile
Valuation in relation to the transfer of money power
ability to convert into cash Valuation and Ownership
(Liquidity) Risk Transformation concerns

5 Derivatives and Risk Management : ACV Subrahmanyam Wednesday, June 19, 2024
 What are derivatives ?
𝑦 =f (x )
• Class of Financial Asset
“ that derives value from some underlying
variable”
• What is the underlying?
• Started with Commodities – Stocks – Indices
• Basically, any financial asset whose value
changes with respect an event / variable
(Differentiable) – weather derivatives / default
swaps
• Popularity depends on use (liquidity and depth)
• Fundamental Characteristic – enables
exposure without ownership
Source: • Derivatives enables transformation of Risk
https://en.wikipedia.org/wiki/Derivative
6 without losing Money Power
Derivatives and Risk Management : ACV Subrahmanyam Wednesday, June 19, 2024
 The concept of Leverage
• Derivatives are popular because they create
leverage
• Leverage in finance – own money
• Multiplies returns – while preserving value
Financial Instrument Initial Value Final Value Net Gain
Hold Cash 1,00,000 1,00,000 0*
(There is an issue
here)

Bank Deposits SB @ 1,00,000 1,03,000 3000

3%
G-securities @ 6% 1,00,000 1,06,000 6000

• Stocks
Last one@SBIN 1,00,000
years SBIN stock moved 1,40,000
from ₹ 600 to ₹ 840 40,000
• Now let's say you have a SBIN futures contract to buy SBIN at ₹ 800 in
Source: https://www.google.com/url?sa=i&url=https%3A%2F%2Far.inspiredpencil.com one year
%2Fpictures-2023%2Fmechanical-advantage-
lever&psig=AOvVaw0b9cyas0yvTfD7y7KNClqV&ust=1717033929340000&source=im
• 1000 Shares @ 800 and sell @ 840 – Same profit
ages&cd=vfe&opi=89978449&ved=0CBIQjRxqFwoTCLj0t4TgsYYDFQAAAAAdAAA • But initial capital or your own money in the game is only ₹30,000 (5% of
AABAw
7
6,00,000)
Derivatives and Risk Management : ACV Subrahmanyam Wednesday, June 19, 2024
• Options further increase leverage
 Course Handout

Summary
Summer Term
Course Handout (Part-II)
Date: 23-05-2024
In addition to part-I (General Handout for all courses appended to the time table) this portion gives further
specific details regarding the course.

Course No. : FIN F311/ ECON F354

Course Title : Derivatives and Risk Management
Instructor-in-Charge : ACV SUBRAHMANYAM subrahmanyam.acv@hyderabad.bits-pilani.ac.in
Scope and Objective of the Course: Derivatives are class of financial assets that derive value
This course introduces forwards, futures & options as securities for risk management & speculation.
Exposures to equity, currency, interest rate & commodity risk are examined. Pricing derivatives using
analytical & numerical techniques.
from the underlying variable (Commodities/ Stocks/
The objective of this course is to familiarize the students with the various instruments available for risk Indices/ Events)
management. It covers rather simpler instruments such as options, futures, swaps, and credit derivatives.
Besides discussing the pricing of these instruments and hedging principles the course would also aim at
introduction of some complex instruments such as options on futures and swaps etc. The course has three
main objectives:
i) To understand the role of financial risk management as well as the techniques available for its
measurement in financial and non-financial corporations.
Enable transformation of money power without risk of
ii) To review the set of financial instruments available in modern financial markets as well as the
strategies that a firm or and an individual can use to optimize the management of the risks this
losing it
company is faced to, and
iii) To build a framework that will help integrate financial risk management into an overall corporate
strategy.

Textbooks:
1. John C. Hull & Basu Sankarshan, Options, Futures and Other Derivatives, 8th Edition, Pearson
Famous in risk management as they enable leverage
Education.

Reference books & Cases

R1. Understanding Futures Markets by Robert W. Kolb and James A. Overdahl, 6th edition, Blackwell.
R2. International Financial Management by Cheol Eun, and Bruce G. Resnick, 6th edition, McGraw-Hill. Forwards, Futures, Options, Swaps etc.
R3. Derivatives, by Rangarajan Sundaram, Sanjiv Das, McGraw Hill, 1st edition
R4. Risk Management and Financial Institutions, John Hull.
Lecture Notes, available on the CMS
Course Plan:

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Thank you
ACV Subrahmanyam
subrahmanyam.acv@hyderabad.bits-pilani.ac.in
Chamber Consolation #k -232 / Gmeet (for goa
students)
with prior email appointment