A QUALITATIVE STUDY OF RISK MITIGATION THROUGH DERIVATIVES

Abstract

This research delves into the practical applications of derivatives by market participants in the Indian stock market, specifically focusing on their effectiveness in mitigating various financial risks. Through in-depth interviews with key players like portfolio managers, risk managers, and traders, the study sheds light on how derivatives are utilized. Derivatives like index futures and options offer tools to manage exposure to broader market fluctuations, potentially safeguarding portfolios from significant losses during downturns. Currency futures and options enable businesses and investors to lock in exchange rate, protecting against movements in the USD/INR or other relevant currency pairs. Derivatives like stock futures and options can be used to hedge against specific sectors or individual stocks, providing greater portfolio diversification and risk management flexibility. Key findings from the interviews reveal that derivatives, when strategically employed within the Indian market context, can be highly effective in mitigating financial risks locking in prices or rates using derivatives shields users from the negative consequences of unexpected changes in stock prices, indices, or currency exchange rates. Effective hedging strategies can contribute to more predictable income streams, particularly for businesses with significant exposure to financial markets. Derivatives can enable market participants to confidently enter new sectors or undertake investments that would otherwise be hindered by substantial risk exposure. However, the research also acknowledges the inherent complexities and limitations associated with derivatives. The Indian derivatives market operates under specific regulations set by SEBI, which may impose additional considerations or restrictions compared to other markets. Liquidity for certain derivative contracts, particularly those on less actively traded stocks or indices, can be lower, potentially impacting the ease of execution and potentially increasing transaction costs. In conclusion, this research, informed by the insights of market practitioners within the Indian context, underscores the significant role derivatives play in mitigating diverse financial risks. While complexities and limitations exist, a comprehensive understanding 7 of these instruments, coupled with careful consideration of the Indian regulatory environment and market dynamics, can significantly enhance risk management practices and support informed investment decisions for market participants operating within the Indian stock market.