NISM-Series-VIII: Equity Derivatives · Introduction to Forwards and Futures

Introduction to Derivatives and Their Types

Updated 11 October 2026 · Fact-checked

A derivative is a financial contract whose value is derived from an underlying asset such as a share, index, currency, commodity or interest rate. The main types are forwards, futures, options and swaps. To answer exam questions, identify the underlying, the contract type, and whether the user is hedging, speculating or arbitraging.

Understand Introduction to Derivatives and Types

A derivative is a contract. It has no value of its own. Its value depends on the price of something else, called the underlying. The underlying can be a stock, a stock index like Nifty 50, a commodity, a currency, an interest rate or even another derivative.

Think of a contract to buy 100 shares of a company at ₹500 after one month. You do not own the shares today. The contract gains or loses value as the share price moves. That is a derivative.

There are four main types. A forward is a private agreement to buy or sell an asset at a fixed price on a future date. A future is the same idea, but standardised and traded on an exchange. An option gives the buyer a right, not an obligation, to buy (call) or sell (put) at a fixed price. A swap is an agreement to exchange cash flows over a period, for example fixed interest for floating interest.

Three kinds of participants use derivatives. Hedgers have an existing exposure and want to reduce risk. Speculators take a view on price direction and accept risk for profit. Arbitrageurs exploit price differences between markets to earn a nearly risk-free profit.

In India, equity derivatives traded on exchanges are futures and options on indices and stocks. Forwards and swaps are mainly over-the-counter (OTC) contracts. NISM Series VIII tests these definitions and the roles of participants directly.

Key formulas to remember

Derivative: Value of derivative = f(price of underlying); The contract's value depends on the underlying. The underlying can be financial or commodity-based.
Forward vs future: Forward = OTC, customised | Future = exchange-traded, standardised; Both create an obligation for both parties to transact at a fixed price on a future date.
Option rights: Buyer: right, no obligation | Seller (writer): obligation if buyer exercises; Call = right to buy. Put = right to sell. The buyer pays a premium.
Swap: Swap = exchange of cash flows between two parties; Common examples are interest rate swaps and currency swaps. Usually OTC.
Participant roles: Hedger = reduces risk | Speculator = takes risk for profit | Arbitrageur = locks in price-gap profit; Match the intent in the question to the role.

How to solve Introduction to Derivatives and Types questions

Use this method for any definition, classification or participant question on this topic.

1Read the question and find the keyword: underlying, obligation, right, exchange-traded, customised, cash flows, risk reduction or price difference.
2Identify the underlying asset if one is mentioned.
3Decide the contract type. Right without obligation means option. Exchange-traded and standardised means future. Private and customised means forward. Exchange of cash flows means swap.
4For participant questions, ask: does the person already have exposure (hedger), want to bet on direction (speculator), or exploit a price gap between two markets (arbitrageur)?
5Eliminate options that use absolute words such as 'always' or 'guaranteed' unless the definition truly says so.
6Check the final choice against the exact definition before marking it.

Quickest way: Keyword matching for contract types and participants

When to use it: Use it for one-line definition or 'which of the following' questions where time is short.

Right to buy or sell, premium paid: option.
Customised, private, OTC, settled at end: forward.
Standardised, exchange, margin, daily settlement: future.
Exchange of interest or currency flows: swap.
Reduce existing risk: hedger. View on direction: speculator. Price gap across markets: arbitrageur.

Common mistakes in Introduction to Derivatives and Types

Saying a derivative has its own independent value.
Students treat contracts like shares or bonds.
Fix: Remember that a derivative's value is derived from its underlying and changes when the underlying changes.
Confusing forwards and futures.
Both fix a price for a future date.
Fix: Ask where it trades and who sets the terms. Customised and private is forward. Standardised and on an exchange is future.
Thinking an option buyer has an obligation.
Students mix up futures and options.
Fix: The option buyer has a right. The option seller (writer) has the obligation if the buyer exercises.
Calling any trader who expects a price rise a hedger.
Students focus on the trade, not the purpose.
Fix: A hedger already has an exposure to offset. Taking a view without exposure makes you a speculator.
Calling arbitrage a speculative bet.
Both involve making profit from price moves.
Fix: Arbitrage exploits a price difference for the same or equivalent asset in different markets, aiming for low or no risk.

Worked examples

Example 1

A mutual fund holds a large portfolio of Nifty 50 shares and sells Nifty futures to protect against a market fall. Which participant is the fund acting as, and why?

A. Speculator
B. Hedger
C. Arbitrageur
D. Swap dealer

Show the solution

Find the purpose: the fund wants protection against a fall.
Check exposure: it already holds Nifty shares, so it has existing risk.
Selling futures offsets losses on the shares if the market falls.
Reducing existing risk is the role of a hedger.

Answer: B. Hedger

Example 2

Which contract gives the buyer a right but not an obligation to buy the underlying at a fixed price on or before a specified date?

A. Forward contract
B. Futures contract
C. Call option
D. Interest rate swap

Show the solution

The key phrase is 'right but not an obligation'.
Forwards and futures bind both parties to transact, so A and B are out.
A swap is an exchange of cash flows, not a right to buy, so D is out.
A right to buy at a fixed price is a call option.

Answer: C. Call option

Exam tips

Learn one-line definitions of the four contract types word for word. Questions often reuse them.
Watch for the words 'right' and 'obligation'. They separate options from forwards and futures.
For participant questions, judge the purpose of the trade, not the instrument used.
Remember that forwards and swaps are typically OTC, while futures and exchange-traded options are standardised.
In negative-marking papers, skip only if you cannot eliminate two options. Definition questions usually allow elimination.

Practice questions from Introduction to Forwards and Futures

Introduction to Derivatives and Types: frequently asked questions

What are derivatives in NISM Series VIII?

Derivatives are contracts whose value depends on an underlying asset such as a share, index, currency or commodity. The exam covers their definition, types and uses. Chapter 1 builds this base for later topics on futures and options.

What are the four main types of derivatives?

They are forwards, futures, options and swaps. Forwards are customised OTC contracts, futures are standardised exchange contracts, options give a right without obligation, and swaps exchange cash flows.

What is the difference between hedgers, speculators and arbitrageurs?

A hedger reduces an existing risk. A speculator takes risk on a price view to earn profit. An arbitrageur exploits a price difference between markets to earn a low-risk profit.

Is the NISM Series VIII exam negatively marked?

Yes. It has negative marking of 25% of the marks assigned to a question. The paper has 100 questions, 100 marks and 2 hours, and the pass mark is 60%.