FINANCIAL DERIVATIVES
Derivatives
We are exposed to many risks in our day-to-day life. nobody
can predict what will happen in the next moment. There may be an accident
calamity theft lost due to some other courses etc. similarly, Business is
exposed to many kinds of risks at all times. Risks may arise due to unexpected changes
in the demand of a product, prices of raw materials may increase labor race
rates may go up, etc. Some type of loss is not insurable. So certain financial
devices or instruments are available in the market to reduce or transfer the
risks. These financial instruments are known as derivatives. Thus the derivatives
are tools that help firms in reducing risk.
What are
Derivatives?
In financial markets and foreign exchange markets, there are
fluctuations. Fluctuations add expose the parties to risk. Hence, parties would
like to hedge their risks for reducing the risk some financial instruments have
been developed recently. These financial instruments are known as the datives. When
the firm reduces its risk exposure by using derivatives it is known as hedging.
Hedging offsets the firm’s risk. The underlying principle behind derivatives is
that a risk-averse individual is willing to pay a price to transfer the risk
and an individual with higher risk-taking is willing to bear the risk for a
price.
According to Robert L. Mconald, “A derivative is simply a financial
instrument (or even more simply an
agreement between two parties) that has a value determined by the price of
something else”.
in normal trading, an
asset is bought and sold. But in derivatives trading, the asset itself is not
traded but the right to buy or sell is traded. Thus a derivative instrument
does not directly result in a trade. It gives a right to a person.
Derivatives are contracts that are written between two p ties
for easily marketable assets. But we do see are also known as before delivery
instruments or deferred payment instruments.
A very simple example of derivatives is curd. It is a derivative
of milk. Milk is the underlying asset. The price of curd depends upon the price
of milk. The price of milk in turn depends upon the demand and supply of milk.
Characteristics
of derivatives
Underlying asset: each derivative product has an
underlying asset
Predefined period: All derivative instruments Harry breathed
armed life at the end of the fix-it video the derivative instruments are closed
out an inward and exchange of payment.
Secondary market instrument: Derivative instruments
are mostly secondary market instruments so that we are not useful in mobilizing
fresh capital by the companies.
Contract fulfillment: Every derivative contract it’s
between two parties. The contract is to be fulfilled in future. T period of the contract is determined by the
nature of the contract.
No independent value: Every derivative instrument
have no independent value. the value of a derivative instrument is dependent
upon the price movement of the underlying asset.
Derivative instruments are good in listing. But it has some
negative sides because it is a secondary market instrument so it is not
suitable for companies. But one of the main advantages of derivatives is it has
a minimum initial investment amount. So it is good for individuals.
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