What are Derivative Instruments?

Derivatives are another type of contract that corresponds to the spot market contract. The holder of the contract has the obligation or option to buy or sell certain assets in the future. The price of the contract is derived from the underlying assets, such as certain agricultural and mineral products, and financial indexes or interest rates. The value of the contract is derived from the underlying asset. The most basic derivatives are futures contracts and options contracts. The purpose of inventing derivatives is to provide a tool for hedging risks for traders of the underlying products. With the increase of market participants, the use of derivatives is not only a hedging, but a large amount of investment and speculative transactions. Derivative product features: (1) intertemporal, that is, trading at an agreed time in the future; (2) leverage, that is, using the margin system to magnify transactions; (3) correlation, the price of derivative instruments changes fundamentally It depends on the price change of the underlying asset, but in most cases it is a non-linear correlation. (4) Complex risk. Since the price of the derivative product and the price of the underlying asset are not linear, the risk is difficult to determine. ^[1]

Derivatives

This book is the authority on financial derivatives in the United States,

Robert E. Professor Robert E. Whaley

Derivatives are a collective term for financial instruments that are traded in a special category. The return on this sale is derived from the performance of some other financial elements. Such as assets (commodities, stocks or bonds), interest rates, exchange rates, or various indexes (stock index, consumer price index, and weather index). The performance of these elements will determine the rate of return and time of return for a derivative. The main types of derivatives are futures, options, warrants, forward contracts, swaps, etc. The biggest difference between financial derivatives and stocks is that the stock market will swell. Everyone will benefit if it appreciates, and no one will be spared if it declines. The purchase of financial derivatives is a zero-sum game. Someone who makes money like gambling must lose money.

Derivative Features

1. Intertemporal transactions. Derivatives are contracts created in order to avoid or prevent future risks of changes in prices, interest rates, and exchange rates. The actual delivery, settlement or settlement of the contract's subject matter is agreed to take place at a future time. Intertemporal can be immediate and long-term intertemporal, or long-term and long-term intertemporal.
2. Leverage effect. Derivatives have the authority to trade a certain number of contractual objects in the future with a small amount of energy, with a margin of less than 5% -10% of the market value of the contracted object, or by paying a certain percentage of equity fees. Whether it is margin or equity, compared with the value of the underlying object of the contract, it is a small amount. Derivative transactions are equivalent to buying commodities or financial assets at a discount of 0.5-1, and have a 10-20 times transaction amplification effect.
3. High risk. Derivative price changes have significant uncertainty, and the risks to derivatives traders are also very high. Both buyers and sellers must bear the risks caused by future price, interest rate, and exchange rate fluctuations.
4. The short-term nature of the contract. Derivative contracts have a duration, and the period from signing to expiry is the duration of the derivative. The duration of the derivative generally does not exceed one year.

Derivative Functions

1. Hedging. It is the most important function provided by derivatives for traders, and it is also the driving force for derivatives. The earliest derivative instrument, the forward contract, was created to meet the needs of both parties to the transaction of agricultural products in order to avoid the risk of future price fluctuations.

2. Price discovery. It is often difficult to predict the future, but derivatives have the function of predicting prices.

3. Speculative arbitrage. As long as there are price fluctuations in commodities or assets, there is room for speculation and arbitrage.

Dictionary definition

The Commercial Press's "English-Chinese Dictionary of Securities and Investment" explains: Derivatives in English are: derivatives; financial derivative instruments; derivative instruments; derivative products; financial derivatives. name. Common plurals . Abbreviation for derivative financial instruments. The value of these instruments comes from options and futures contracts that correspond to the value of financial assets. The financial assets traded include stocks, stock indexes, fixed-rate bonds, commodities, currencies, etc. Trading products offered by options exchanges such as index futures and interest rate futures are typical derivatives.