Derivatives

Derivatives in mutual funds are financial instruments whose value is linked to an underlying asset, instrument, or index and are based on agreements or contracts. They are frequently used to hedge and/or manage risk.

Derivatives can also be used to make speculative investments based on the movement of the value of an underlying asset, to gain exposure to an area that is difficult to invest in directly, or to create optionability by linking the derivative's value to a certain condition or occurrence. In general, derivatives provide leverage.

As a result, a little change in the value of the underlying asset can result in a big difference in the derivative's value, resulting in large profits or losses depending on the direction of the shift.

In mutual funds, derivatives are usually used for hedging, speculation, and arbitrage. Mutual funds are allowed to employ derivatives for hedging purposes by the Securities and Exchange Board of India (SEBI). Derivatives can be used to hedge the mutual fund's equity assets.

In addition, mutual funds use derivatives in their arbitrage strategies.