derivatives

Examples of derivatives 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.

• 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

• Answers to Chapter 18 Questions

  • Derivatives obtain their value from the asset that is specified in the contract.
  • As you guessed, speculators can earn large profits or massive losses from the derivatives market.
  • Problem with the derivatives based on the stock market index or the volatility index is no commodity, or financial instrument is traded.
  • Unfortunately, the company issuing the index derivative could have a massive exposure if the stock market rapidly drops during a financial crisis.