Govind Gurnani on LinkedIn: Demystifying A Distinction Between Equity And Derivative In Capital Market (2024)

Financial Derivatives In The Banking SectorDerivatives, are risk management financial instruments, which derive their value from an underlying asset. The underlying asset can be stocks, currencies, commodities, indices, and even interest rates.There are four types of financial derivatives: Forwards, Futures, Options and Swaps. Financial derivatives are used for a number of purposes including risk management, hedging, arbitrage between markets, and speculation.Financial derivatives contracts are usually settled by net payments of cash. This often occurs before maturity for exchange traded contracts such as commodity futures. Cash settlement is a logical consequence of the use of financial derivatives to trade risk independently of ownership of an underlying item.🟦 Forward ContractsForward contracts mean two parties come together and enter into an agreement to buy and sell an underlying asset set at a fixed date and agreed on a price in the future.
In simple words, it is an agreement formed between both parties to sell their asset on an agreed future date.
The forward contracts are customized and have a high tendency of counterparty risk. Since it is a customized and over the counter contract, the size of the agreement entirely depends on the term of the contract.🟦 Future ContractsFuture contracts refer to an agreement made by the two parties to buy or sell an underlying instrument at a fixed price on a future date.The size of future contracts is fixed, and it is regulated by the stock exchange just because it is known as a standardized contract.
Since these contracts are standard and are listed on the stock exchange, they cannot be changed or modified in any possible way.
In simple words, future contracts have pre-decided size, pre-decided expiry period, pre-decided size. In futures contracts, an initial margin is required because settlement and collateral are done daily.🟦 Option ContractsOptions contracts provide the right but not the commitment to buy or sell an underlying instrument. 
Option contracts consist of two options:🔹Call Option🔹Put Option🔷In call option, the buyer has all the right to purchase an underlying asset at a fixed price while entering the contracts. While in put option, the buyer has all the right but not obligation to sell an underlying asset at a fixed price while entering the contract.🟦 Swap ContractsSwap contracts mean the agreement is done privately between both parties. The parties who enter into swap contracts agree to exchange their cash flow in the future as per the pre-determined formula. 
Under swap contracts, the underlying security is the interest rate or currency, as these contracts protect both parties from several major risks.
These contracts are not traded to the stock exchange as investment banker plays the role of a middleman between these contracts.Thanks for reading….

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Risk Assessment Methods In The Banking SectorRisk management is the continuing process to identify, analyse, evaluate, and treat loss exposures and monitor risk control and financial resources to mitigate the adverse effects of loss.Measuring risks in banks is a critical aspect of risk management to ensure the stability and soundness of the financial institution. There are various methods and tools employed to assess and quantify risks in banks. Here are some common approaches:1️⃣ Credit Risk▪️Credit Scoring Models: These models assess the creditworthiness of borrowers based on historical data, financial statements, and other relevant factors.▪️Credit Risk Models: Under this, statistical techniques are used to estimate the probability of default, loss given default, and exposure at default.2️⃣ Market Risk▪️Value at Risk :Estimates the potential loss in market value of a portfolio given a certain level of confidence over a specific time horizon.▪️Sensitivity Analysis: Examines how changes in market variables impact the bank’s portfolio.3️⃣ Operational Risk▪️Loss Data Analysis: Reviews historical data on operational losses to identify patterns and trends.▪️Key Risk Indicators : Monitors predefined indicators that signal potential operational issues.4️⃣ Liquidity Risk▪️Gap Analysis: Assesses the maturity profile of assets and liabilities to identify potential funding gaps.▪️Stress Testing: Simulates adverse scenarios to evaluate the bank’s ability to withstand liquidity shocks.5️⃣ Interest Rate Risk▪️Earnings at Risk : Measures the potential impact of interest rate changes on a bank’s earnings.▪️Duration Analysis: Assesses the sensitivity of the portfolio to changes in interest rates.▪️ Simulation Analysis: Simulation analysis involves using computer models to estimate the potential impact of various interest rate scenarios on a bank’s financial position and performance.6️⃣ Compliance & Legal Risk▪️Regulatory Compliance Audits: Ensures adherence to regulatory requirements.▪️Legal Risk Assessments: Identifies and manages legal risks associated with contracts, litigation, and other legal matters.7️⃣ Reputation Risk▪️Customer Feedback and Surveys :Monitors customer satisfaction and feedback.▪️Media Monitoring: Keeps track of media coverage and public perception.8️⃣ Concentration Risk▪️Portfolio Diversification AnalysisExamines the concentration of risks across various segments.▪️Geographic and Industry Exposure AnalysisAssesses risk concentrations in specific regions or industries.9️⃣ Cybersecurity Risk▪️Vulnerability Assessments: Identifies weaknesses in the bank’s cybersecurity infrastructure.▪️Incident Response Planning: Prepares for and responds to cybersecurity incidents.Thanks for reading…

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Banks & Non-Banks Can Now Issue Pre-Paid Payment Instruments For Payments Across Various Public Transport SystemsRecently, the Reserve Bank of India has amended MD- Prepaid Payment Instruments (PPIs) authorising bank and non-bank PPI issuers to issue PPIs for making payments across various public transport systems.◼️PPIs for Mass Transit Systems (PPI-MTS):▪️Banks / non-banks are permitted to issue such PPIs;▪️Such PPIs shall contain the Automated Fare Collection application related to transit services, toll collection and parking;▪️Such PPIs shall be enabled only for payments across various modes of public transport such as metro, buses, rail, & waterways, tolls and parking;▪️These PPIs can be issued without KYC verification of the holders;▪️These PPI can be reloadable in nature;▪️The amount outstanding, in such PPIs shall not exceed ₹3,000/- at any point of time;▪️These PPIs can have perpetual validity, i.e., the provisions of validity and redemption given in Section 13 of this MD shall not apply to PPI-MTS; and▪️Cash-withdrawal, refund or funds transfer shall not be permitted in such PPIs.Thanks for reading…

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Demystifying A Concept Of “Catastrophe (CAT) Bonds” In A Capital MarketCat bonds are a type of insurance-linked securities. Governments need to set up a special purpose vehicle (SPV) to facilitate the transaction. The SPV invests the money from investors and pay coupons or interests to them. At the end of the term, the SPV will return the investors’ money if a disaster does not happen. However, a payout is made to the issuer upon the occurrence of a specified climate event, which typically involves a parametric trigger, such as a pre-defined hurricane wind speed or earthquake intensity. Thanks for reading…

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Demystifying A Concept Of “Drop Lock Bond” In A Fixed Income Market

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Classification And Measurement Of Financial Assets Under IFRS 9 : SimplifiedIFRS 9 introduces a more principles based approach to the classification of financial assets which must be classified into one of three categories:▪️amortised cost, ▪️fair value through other comprehensive income (FVOCI), and ▪️fair value through profit or loss (FVTPL). A business model refers to how an entity manages its financial assets in order to generate cash flows and is determined at a level that reflects how groups of financial assets are managed. IFRS 9 identifies three types of business models: ‘hold to collect’, ‘hold to collect and sell’ and ‘other’.IFRS 9 identifies two different types of cash flows that might arise from the contractual terms of a financial asset:▪️Those that are solely payments of principal and interest (SPPI) i.e. cash flows that are consistent with a ‘basic lending arrangement’, and▪️All other cash flows.1️⃣ Amortised CostFinancial assets are classified as amortised cost if the following two conditions are met:▪️The financial asset is held within a business model whose objective is to hold assets to collect contractual cash flows.▪️The contractual terms of the financial asset give rise to cash flows that are solely payments of principal and interest on the principal amount outstanding.Amortised cost is calculated using the effective interest rate method. This method recognises interest income based on the effective interest rate of the financial asset over its expected life. For example, if a company has a loan with a fixed interest rate, it would be classified as an amortised cost asset if it meets the above criteria.2️⃣ Fair Value Through Other Comprehensive Income Financial assets are classified as FVOCI if they meet the following conditions:▪️The financial asset is held within a business model whose aim is to both collecting contractual cash flows and selling financial assets.▪️The contractual terms of the financial asset give rise to cash flows that are solely payments of principal and interest on the principal amount outstanding.Under FVOCI classification, gains and losses are recognised in other comprehensive income (OCI) until the financial asset is sold or impaired. For example, if a company holds a bond with a fixed interest rate and plans to hold it until maturity but also has the option to sell it, it would be classified as an FVOCI asset.3️⃣ Fair Value Through Profit or Loss Financial assets that do not meet the above criteria are classified as FVTPL. For example, if a company holds equity securities or derivatives, it would be classified as an FVTPL asset.Under FVTPL classification, gains and losses are recognised in profit or loss, with no option for recognition in OCI. This category is used for financial assets that are held for trading purposes or that do not meet the criteria for amortised cost or FVOCI classification.Thanks for reading…

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कार्य सेवा परिवर्तन का प्रभाव

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A Funny Anecdote By Former RBI Governor Dr Y V Reddy On Relationship Between The Government And Reserve Bank Of India

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A Story Of Greatness Of Former RBI Governor Y V ReddyOnce when Dr Y V Reddy was at the helm of the Reserve Bank of India (2003 to 2008), there was “creative tensions" between him and then finance minister P. Chidambaram. One fine morning, the then Prime Minister Manmohan Singh called Mr Reddy to Delhi to his residence to tell him that Chidambaram was very upset with Reddy and he did not know how to sort this out. On hearing this, Mr Reddy would have resigned in the protest against the Government, but he did not do so and went to the FM’s house and offered him an unconditional apology as he did not want to let down the Prime Minister.Thanks for reading…

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