Due to its flexibility and multidimensionality, the derivatives market offers the broadest opportunities for cost reduction and risk insurance, but it can also cause various crisis phenomena. It is precisely in the uncontrollable growth of derivatives that their threatening power lies. Despite such a dubious reputation, these financial instruments have attracted interest for a long time. What is a derivative? What is it "eaten" with?
What does the word derivative mean?
Translated from English, the derivative is “derivative”. And what does this designation mean? A derivative is a derivative financial instrument. In other words, this is an obligation by which to deliver the underlying asset underlying the derivative until a certain time. Also, a derivative is a financial instrument for derivatives transactions, that is, agreements of several parties that pre-determine their obligations and future rights in relation to underlying assets.
What are stock market derivatives?
Financial derivatives are, by definition, futures and forward contracts, over-the-counter and exchange options, exchange derivatives on swaps and the swaps themselves.
What functions do derivatives perform?
A derivative is a security that performs certain functions. For example, an important property is hedging (insurance) of the possibility of future price changes for intangible assets (which include stock indices), for goods, and for the cost of loans. This is the essence of derivatives of financial markets. If we talk about hedging goods, then derivatives are irreplaceable regulatory tools that allow manufacturers of goods to insure themselves against possible future adverse changes in prices for their product.
Why exactly are derivatives?
Despite the apparent complexity, derivatives are securities with fairly simple use. They are called derivatives because the formation of prices for derivatives depends on changes in the value of the underlying asset that underlies them. For example, if the price of gold changes, then the price of the derivative for it will also be different. That is why it is always necessary to say which underlying asset a particular derivative financial instrument belongs to.
What types of derivatives exist?
There are several main types of this financial instrument.
- Derivatives in the foreign exchange and stock markets, which are contracts for the purchase and sale of different currencies. A prerequisite is performance after some time, which depends on the change in the rate of the sold or bought currency, and in the case of the stock market, there is a direct dependence on such a basic asset as a share. Such derivatives can also be classified into three main groups: forwards / futures, swaps and options. The former depend directly on the future price of underlying assets. Swap contracts depend on the current price to future price ratio. Options - from changes in value, however, to a lesser extent than futures and forwards. These groups, in addition to swaps, are called “main derivatives instruments”.
- Interest derivatives. This tool appeared due to periods of destabilization of short-term interest rates. An interest-bearing derivative is a risk hedging instrument ; its use additionally affects the liquidity of the debt capital markets and the possibility of fixing certain profit rates for companies in the future. The most widely used in the international market are interest-rate swaps, options “flora” and “cap”.
- Credit derivatives are OTC structured financial instruments that separate credit risks from assets in order to transfer them to the counterparty in the future. These derivative securities allow the beneficiary to transfer the credit risks of the assets to the side of the guarantor without the necessary sale of the asset.