derivative

(noun)

A financial instrument whose value depends on the valuation of an underlying asset; such as a warrant, an option, etc.

Related Terms

  • fungible
  • maturity
  • financial leverage
  • leverage
  • notional
  • margin
  • capital

Examples of derivative in the following topics:

  • Overview of Derivatives

    • A derivative is a financial instrument whose value is based on one or more underlying assets.
    • Derivatives are broadly categorized by the relationship between the underlying asset and the derivative, the type of underlying asset, the market in which they trade, and their pay-off profile.
    • The most common types of derivatives are forwards, futures, options, and swaps.
    • The OTC derivative market is the largest market for derivatives, and is mostly unregulated with respect to disclosure of information between the parties.
    • Exchange-traded derivative contracts (ETD) are those derivatives instruments that are traded via specialized derivatives exchanges or other exchanges.
  • Forward and Spot Transactions

    • We explain the derivatives market in this chapter.
    • Derivatives are a contract, a piece of paper.
    • Price of derivatives receives or "derives" their value from the underlying assets.
    • Derivatives are contracts, and buyers and sellers exchange the contracts in the derivative markets.
    • Second, derivatives are liquid assets.
  • Uses of Derivatives to Manage Exposure

    • Derivatives allow risk related to the price of underlying assets, such as commodities, to be transferred from one party to another.
    • Derivatives allow risk related to the price of underlying assets, such as commodities, to be transferred from one party to another.
    • Although a third party, called a clearing house, insures a futures contract, not all derivatives are insured against counter-party risk.
    • Derivatives can serve legitimate business purposes, as well.
    • Companies depending on the price of oil for their supply can implement hedging strategies using derivatives to manage this exposure.
  • Managing Marketable Securities

    • These include debt securities, equity securities, and derivatives.
    • Perhaps the most interesting marketable securities (and often the highest risk) are derivatives.
    • As the name implies, derivatives derive their value from the performance of an underlying asset.
    • However, at the business level, derivatives have unique value due to the ability to hedge against various risks.
    • As a clever investor, you purchased derivatives in coffee beans to make sure you would offset this loss with profits in the exchange market.
  • Types of Financial Markets

    • Examples of financial markets include capital markets, derivative markets, money markets, and currency markets.
    • The derivatives market is the financial market for derivatives-- financial instruments like futures contracts or options-- which are derived from other forms of assets.
  • Futures and Forward Contracts

    • First class of derivatives is futures and forward contracts.
    • Derivatives market determines the price of the futures contract.
    • Speculators buy derivatives because the market value of the derivatives could experience wide swings.
    • On the day of delivery, the market value of a derivative must equal the spot price.
    • Exxon gains from the derivatives contract because it pays one million U.S. dollars.
  • Reporting

    • When considering the returns derived from these various investments, organizations and individuals must be aware of the reporting obligations in the country in which those securities are traded.
    • These capital gains are profits derived from the sale of investments, which is to say that existing investments where capital is still tied in the underlying asset it not taxable (though it must be reported on the balance sheet for organizations as assets).
    • When profits from short term investments are derived in a taxation period for an organization, this profit is reported on the income statement and taxed accordingly.
  • Special Derivatives

    • Technically, the derivatives are not tied to a commodity.
    • Issuers of index derivatives could suffer large losses to rapid market changes.
    • Similar to a stock index derivative, the options are not tied to an asset or commodity.
    • Subsequently, investors can buy and sell credit default swaps on the derivatives market.
    • Investors trade CDSs contracts in the derivatives markets.
  • Chapter Questions

    • Can you identify any problems for a finance company to issue derivatives that are not based on a commodity, but on a stock market index?
  • Chapter Questions

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