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What is a Derivative?

What is a Derivative?
In the world of business and finance, a derivative refers to a form of security which has a value that depends on a particular asset product. If the value of this particular asset changes with the market conditions, so is the value of the derivative. These assets from which the value of the derivative depends on may be in the form of stocks, market indexes, bonds, commodities, currencies, and interest rates. In this sense, a derivative product is simply a by-product of the original product.

When it comes to investing, derivatives are often used for leverage or gearing purposes. In this case, when there is minimal movement on the value of the original product or asset, it may cause a big difference in the derivative’s value. Many investors also use derivatives in hedging risks on the underlying asset or original product. Some use it to help speculate and earn some profit in cases where the value of the original and underlying asset moves to the expected direction. This happens when a person bets on some underlying asset and hopes that the other party seeking insurance will have the wrong guess in terms of the future value of the asset involved. In this way, the investing person will be able to gain from the transaction.

Derivative contracts maybe classified as OTC or over-the-counter derivatives and ETD or exchange-traded derivatives. OTC derivatives refer to contracts that are entered into between two parties directly and privately. The negotiations involved in this type of contract are also kept private and without any involvement from other exchanges and intermediaries. And since the trading transactions are privately held in this type of derivative contract, much of it is unregulated, especially in terms of divulging information between the parties involved. This makes OTC contracts the largest market for derivatives. Exchange-traded contracts meanwhile are those that are traded with derivative exchanges that serve as intermediaries in all transactions. And since these exchanges are in contact with the parties involved, an initial margin is taken from either side which will serve as some form of guarantee.

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1 Response for “What is a Derivative?”

  1. Craig says:

    MF Global had quite a few of the smartest men in the financial industry managing their assets. They also had access to the ultimate insider info, because their CEO, Jon Corzine, was a Federal Reserve Bankster insider. So, how could so many of the nation’s brightest make such boneheaded decisions?

    Once again I want to emphasize that for every loser in the financial derivatives market, there is an equal and opposite winner, making tons of cash.

    Since 70% of the 1500 trillion dollar derivatives market is bets against interest rates going up or down, one would think that the former Chairman of Goldman Sachs would have some kind of clue on what the banksters were doing with interest rates. Some would argue that the loss of $40 billion dollars was a huge mistake. I would argue that there are no mistakes when it comes to the Satanic Psychopaths!

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Posted by Erwin Z on Sep 8th, 2011 and filed under Finance & Investing. You can follow any responses to this entry through the RSS 2.0. You can leave a response via following comment form or trackback to this entry from your site