Derivative Securities
We all use derivative contracts implicitly when we give advance for purchase of items, assets, and services. Forward agreements, contracts to sell a commodity at an agreed price at future date are derivative contracts only
Introduction
We all use derivative contracts implicitly when we give advance for purchase of items, assets, and services.
Forward agreements, contracts to sell a commodity at an agreed price at future date are recorded in history.
But exchange traded derivatve securities are a recent innovation. Derivative securities are a part of markets for risk. In markets for risk, risk is bought and sold. A person who has a risk, but not interested to bear it can go to the market and sell the risk. In this role he is called a hedger. Some other person who wants to acquire the risk, sells a contract for a premium, The contract has provision to compensate the seller of risk (buyer of protection) in case of losses suffered by him due to the inherent risk that he sold.
Even though derivatives are declared as securities in laws of various countries, they are better described as contracts. An exchange traded derivative contract can be traded at an exchange, such as the London International Financial Futures Exchange (LIFFE), where the contracts are pre-defined, and traded via screens, fully electronically. A derivative contract can also be agreed directly between two parties, commonly referred to as Over The Counter or OTC.
The OTC derivatives market is indeed one of risk transfer, but has expanded to enable the pricing, and trading of risk on many different underlying factors such as Interest Rates, Equity Prices, Foreign Exchange Rates, Credit worthiness, and Commodity prices.
The OTC derivatives market is self regulated by the International Swaps and Derivatives Association, the global trade body which all OTC users belong to. Much more information can be found at their website www.isda.org including a much longer introduction to the topic.
For derivatives traded on-exchange, information on contracts traded and trading procedures can be acquired by visiting websites of exchanges such as LIFFE, CBOT, NYMEX, ICE and others.
The OTC derivatives market is indeed one of risk transfer, but has expanded to enable the pricing, and trading of risk on many different underlying factors such as Interest Rates, Equity Prices, Foreign Exchange Rates, Credit worthiness, and Commodity prices.
The OTC derivatives market is self regulated by the International Swaps and Derivatives Association, the global trade body which all OTC users belong to. Much more information can be found at their website www.isda.org including a much longer introduction to the topic.
For derivatives traded on-exchange, information on contracts traded and trading procedures can be acquired by visiting websites of exchanges such as LIFFE, CBOT, NYMEX, ICE and others.
Derivative Securities - Various Instruments
Forward Contracts
A contract between two parties, one party willing to sell a commodity or an underlying asset at an agreed price and an agreed party at a future date. The other party willing to take delivery of the asset and make payment at the future date.
Futures Contracts
Futures contracts are standardized contracts traded on exchanges. The contract quantity and delivery dates are standardized. The contract rate or value keeps fluctuating based on the price of the underlying asset.
Options
Option contract give a right to the buyer of the contract but not an obligation to demand fulfilment of the agreement from the seller
Swaps
In swap asset or liability positions of two parties are swapped between them.
Availability of Derivative Contracts for Acquisition and Trading
Futures
Are available on
Commodities
Stocks
Debt Instruments (Interest Rates)
Currencies
Options
are available on
Commodities
Stocks
Debt Instruments (Interest Rates)
Currencies
Comments
Thanks Bill Hodgson
Thank you for contributing to the development of the knol
Narayana Rao - 21 Jan 2009
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