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FINANCIAL DERIVATIVES

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Abhijeet S
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FINANCIAL DERIVATIVES - September 3rd, 2010

  • The fundamental argument in theory of futures market presents financial derivatives as an institutional mechanism of risk management.

  • Futures markets can be used by producers and consumers to sell or buy a certain actual physical commodity or other financial assets on a future date at a price that is decided in the present.

  • This mitigates the risk of price change that could create unintended costs for the buyers and sellers.

  • In order to manage the risk of price change, one can hold a futures contract in the futures market to either buy or sell a particular financial asset in the present to be physically sold or bought on a future date.

  • The standard futures contract describes a certain quality and quantity of the commodity or the asset to be delivered on specified date and place, in the future.

  • In financial literature, the process of risk aversion associated with price volatility in a transaction made in the actual physical commodity market is made by making a concomitant opposite transaction in the futures market, where this process is called hedging
  • According to futures market theory, the derivatives traded on the futures market help create an efficient allocation of risk and, therefore, demonstrates sustainable price levels for different commodities and assets that are traded on any exchange.

  • This is based on the effect of a broad and transparent platform for demand and supply which restraints any disproportionate influence on price determination of a particular commodity
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