by Equity and equity derivatives are financial instruments that provide investors with an opportunity to invest in the stock market. Equity represents ownership in a company, while equity derivatives are financial contracts whose value is derived from the price of an underlying equity asset.
Equity:
Equity represents ownership in a company. When an investor purchases equity, they become a shareholder in the company and are entitled to a portion of its profits. Equity is typically represented in the form of stocks, which are traded on stock exchanges. The price of a stock is determined by supply and demand factors, and is affected by various market and company-specific factors.
Benefits of Equity:
- Ownership: Equity provides investors with ownership in a company, which means that they can participate in the company’s profits and have a say in its decision-making.
- Diversification: Investing in equity allows investors to diversify their portfolio by spreading their investment across different companies and sectors.
- Long-term returns: Historically, equity has provided higher returns than other asset classes such as bonds and fixed deposits, making it an attractive long-term investment option.
- Liquidity: Stocks are traded on stock exchanges, which means that they are highly liquid and can be bought and sold quickly.
Example of Equity:
Suppose an investor purchases 100 shares of a company at a price of Rs. 1,000 per share. The total investment in this case would be Rs. 1,00,000. If the price of the stock increases to Rs. 1,200 per share, the value of the investor’s investment would be Rs. 1,20,000, resulting in a profit of Rs. 20,000.
Equity Derivatives:
Equity derivatives are financial contracts whose value is derived from the price of an underlying equity asset. The underlying asset can be a stock or an equity index. Equity derivatives are typically used for hedging and speculation purposes.
There are various types of equity derivatives, including futures, options, and swaps.
Futures:
A futures contract is an agreement to buy or sell an underlying asset at a predetermined price and date in the future. In the case of equity futures, the underlying asset is a stock or an equity index. Futures contracts are typically settled on a daily basis and can be either cash-settled or physically settled.
Benefits of Equity Futures:
- Leverage: Futures contracts allow investors to take a leveraged position in the underlying asset, which means that they can control a large amount of assets with a relatively small investment.
- Hedging: Futures contracts can be used to hedge against price movements in the underlying asset. For example, if an investor holds a portfolio of stocks, they can use futures contracts to hedge against a decline in the value of the portfolio.
- Liquidity: Futures contracts are highly liquid and can be bought and sold quickly.
Example of Equity Futures:
Suppose an investor believes that the price of a stock is going to increase in the future. The investor can buy a futures contract for the stock at the current market price. If the price of the stock increases in the future, the value of the futures contract will also increase, resulting in a profit for the investor.
Options:
An options contract is a financial contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price and date in the future. In the case of equity options, the underlying asset is a stock or an equity index.
Benefits of Equity Options:
- Flexibility: Options contracts provide investors with flexibility in terms of the amount of investment, the time frame of investment, and the level of risk.
- Hedging: Options contracts can be used to hedge against price movements in the underlying asset. For example, an investor who holds a portfolio of stocks can buy put options on the portfolio to hedge against a decline in the value of the portfolio.
- Leverage: Options contracts allow investors to take a leveraged position in the underlying asset, which means that they can control a large amount of assets with a relatively small investment.
Example of Equity Options:
Suppose an investor buys a call option on a stock with a strike price of Rs. 1,000 and an expiration date of one month. If the price of the stock increases to Rs. 1,200, the investor can exercise the option and buy the stock at the strike price of Rs. 1,000, resulting in a profit of Rs. 200 per share.
Swaps:
A swap is a financial contract in which two parties agree to exchange cash flows based on the price of an underlying asset. In the case of equity swaps, the underlying asset is a stock or an equity index.
Benefits of Equity Swaps:
- Customization: Swaps contracts can be customized to meet the specific needs of the parties involved.
- Hedging: Swaps contracts can be used to hedge against price movements in the underlying asset.
Example of Equity Swaps:
Suppose an investor wants to hedge against the price risk of a portfolio of stocks. The investor can enter into an equity swap with another party, where they agree to exchange cash flows based on the price of the portfolio. If the price of the portfolio declines, the investor will receive a cash flow from the other party, which will offset the decline in the value of the portfolio.
Brokers:
Brokers are intermediaries between buyers and sellers in financial markets. In India, there are two types of brokers – full-service brokers and discount brokers.
Full-service Brokers: Full-service brokers offer a wide range of services to their clients, including research and analysis, investment advice, and portfolio management. They charge a higher commission than discount brokers, but provide more value-added services.
Example of Full-service Brokers in India:
- ICICI Securities
- HDFC Securities
- Kotak Securities
- Angel Broking
Discount Brokers: Discount brokers offer a no-frills trading platform and charge lower commissions than full-service brokers. They do not provide investment advice or research and analysis services.
Example of Discount Brokers in India:
- Zerodha
- Upstox
- 5Paisa
- Trade Smart Online
