Derivative

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    sebkuhnert
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    Derivatives are financial instruments that are based on one or more underlying assets. This means that not the underlying asset is traded, but a financial instrument, whose price is calculated from the values/prices of the underlying assets.

    The most common types of derivatives are:

    The most common underlying assets include:

    Derivatives are broadly categorized by aspects such as:

    • … the relationship between the underlying asset and the derivative (such as forward, option or swap).
    • … the type of underlying asset (such as equity derivatives, foreign exchange derivatives, interest rate derivatives, commodity derivatives, or credit derivatives).
    • … the market in which they trade (such as exchange-traded or over-the-counter).

    Derivatives can be used for speculation (“bets”) or to hedge (“insurance”).

    For example, a speculator may use them to exert short selling, expecting a stock price to fall significantly – but exposing himself to potentially unlimited losses. That is also why proper risk and money management is crucial especially when trading certain derivatives:

    Money management

    In forex trading, companies often buy currency forwards in order to limit losses due to fluctuations in the exchange rate of two currencies. This is also an example for risks that companies sell to the markets – one of the opportunities why traders can earn money at trading.

    Third parties can use publicly available derivative prices as educated predictions of uncertain future outcomes. For example, the likelihood that a corporation or a country will default on its debts.