DERIVATIVES
A derivative instrument, broadly, is a financial contract whose payoff structure is determined by the value of an underlying commodity, security, interest rate, share price index, exchange rate, oil price or the like.
Thus a derivative instrument derives its value from some underlying variable.
A derivative instrument by itself does not constitute ownership. It is instead, a promise to convey ownership.
All derivatives are based on some ‘cash’ products.
The underlying asset of a derivative instrument may be any product of the following type
:
• Commodities including grains, coffee beans, etc.
• Precious metals like gold and silver.
• Foreign exchange rate.
• Bonds of different types, including medium to long-term negotiable debt securities issued by governments, companies, etc.
• Short-term debt securities such as T-bills.
• Over-The-Counter (OTC) money market products such as loans or deposits.
However, the most important use of derivatives is in transferring market risk, called Hedging, which is a protection against losses resulting from unforeseen price or volatility changes. Thus, derivatives are a very important tool of risk management.
There are many kinds of derivatives including futures, options, interest rate swaps, and mortgage derivatives.
A derivative instrument, broadly, is a financial contract whose payoff structure is determined by the value of an underlying commodity, security, interest rate, share price index, exchange rate, oil price or the like.
Thus a derivative instrument derives its value from some underlying variable.
A derivative instrument by itself does not constitute ownership. It is instead, a promise to convey ownership.
All derivatives are based on some ‘cash’ products.
The underlying asset of a derivative instrument may be any product of the following type
:
• Commodities including grains, coffee beans, etc.
• Precious metals like gold and silver.
• Foreign exchange rate.
• Bonds of different types, including medium to long-term negotiable debt securities issued by governments, companies, etc.
• Short-term debt securities such as T-bills.
• Over-The-Counter (OTC) money market products such as loans or deposits.
However, the most important use of derivatives is in transferring market risk, called Hedging, which is a protection against losses resulting from unforeseen price or volatility changes. Thus, derivatives are a very important tool of risk management.
There are many kinds of derivatives including futures, options, interest rate swaps, and mortgage derivatives.