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Further, as suggested by the Tarapore committee report Introduction of foreign currency-rupee options, rupee and cross currency swaptions, exotic options would further enable Indian forex market participants manage their exposures better and offer liquidity in the market. Although global trade in currency derivatives has been substantial, forex derivatives in India are still dominated by INR/USD forward contracts with RBI stipulations governing entry of players has left problems of term, tenor, depth and liquidity unattended.

Credit Derivatives: An Emerging Prospect

Credit derivatives are contracts seeking to transfer an asset's risk and returns from one counter party to another without transferring the ownership. Credit derivatives trades today are more trading tools (as a proxy tool to allow trading in the general credit of a reference entity, and thereby replicating a cash bond) than hedging tools (to protect against credit risks, default risks inherent in exposures held by banks) these derivatives are traded over-the-counter (OTC) in developed markets.

Credit derivatives like Total Return Swaps, Credit Default Swaps, Credit Spread Options and Credit Linked Notes help Reduce a particular risk concentration in the portfolio, Control credit risks of any debt instrument, and gain exposure to another bank's loan portfolio. The recent bankruptcies in US, for e.g. Enron, WorldCom and Swissair etc. could have completely devastated even the giant economy of US, if the risk was not mitigated and the losses effectively spread from such defaults, with short term leverage to insurance firms, and others, by using CDS.

Though these tools currently have a limited presence in India, their market could see an explosive growth given the needs for the product and thrust from key areas. Most Indian nationalized banks, saddled with NPAs to the tune of 5-6% of their total asset base, and creates an obvious need for credit protection.

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* Contributed by -
Nidhi Sethi,
Batch of 2006,
IMT Ghaziabad.