Introduction to derivatives

picciiiDerivatives are not as well-known as shares or bonds. It seems they get attention only when spectacular losses by some financial institutions or great companies in derivative markets have been made. It might occur that derivatives are new and complex financial instruments. It is true that they might not be as simple to understand at the start as shares but when you do, derivatives provide you a great opportunity to prosper in risk management with your investments.

Financial market comes with a great risk and volatility. Even though the unsystematic risk can be avoided by creating a portfolio there is still the market risk to be taken. When it comes to big money derivatives are usually used to secure investments. Farmers often use them as an “insurance” in the case of a poor harvest. Derivatives  also have their   risks but there is also a chance to gain with really little money. If you go right with your  market development forecast or pricing assets you might see derivatives working as leverage for your investments. Most patient people who just want their savings to be safe, might want to see derivatives just as one way of protection from a market crush.

A derivative itself is a contract the price of which depends on its underlying asset. The contract is usually made by at least two parties who have different views on how market is going to change in the future. Most common underlying assets are based on stocks, market indexes, currencies, commodities or bonds. The  derivative’s value is derived from its underlying assets.

The best known derivative instruments are options, forwards, swaps and futures. Derivatives can be traded in over the counter market (OTC) or in exchange-traded derivative market (ETD). In OTC contracts are made directly between traders and in exchange-traded market derivatives are traded with specialized trading exchanges.

As in any case of spending or investing money for long- or short-time period you need to be rational and understand the consequences of your actions. You might get a glorious profit from using derivatives but you also may be the one who ends up in newspapers with all the money gone.

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