The derivative is an indispensable market tool

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Due to its flexibility and multidimensionality, the derivatives market offers the greatest opportunities to reduce costs, insure risks, but it can also cause various crisis phenomena. It is in the uncontrollability of the growth of derivatives volumes that their threatening strength lies. Despite such a dubious reputation, these financial instruments have been attracting interest for a long time. Derivative - what is this? What do they “eat” with?

What does derivative mean?

In translation from English, a derivative is a “derivative”. What does this notation mean? A derivative is a derivative financial instrument. In other words, this is an obligation under which you need to deliver the underlying asset underlying the derivative until a certain time. Also, a derivative is a financial instrument for futures transactions, that is, agreements between several parties that preliminarily determine their obligations and rights for the future in relation to the underlyingassets.

What are stock market derivatives?

Financial derivatives are, by definition, futures and forwards, over-the-counter and exchange-traded options, exchange-traded swap derivatives, and swaps themselves.

What are the functions of derivatives?

A derivative is a security that performs certain functions. For example, an important feature is hedging (insurance) the possibility of future price changes for intangible assets (which include stock indices), for goods, for the cost of loans. This is the whole point of financial market derivatives. When it comes to hedging goods, derivatives are indispensable regulatory tools that allow producers of goods to hedge against possible future adverse price changes for their product.

Why exactly “derivatives”?

For all its apparent complexity, derivatives are securities with a fairly simple use. They are called derivatives because the formation of prices for derivatives depends on the change 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 to which underlying asset this or that derivative financial instrument belongs.

What types of derivatives are there?

There are several main types of this financial instrument.

1. Derivatives in the currency and stock markets,which are contracts for the purchase and sale of different currencies. A prerequisite is execution after some time, which depends on the change in the exchange rate of the currency being sold or bought, and in the case of the stock market, there is a direct dependence on such an underlying 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 the underlying assets. Swap contracts depend on the ratio of the price at the moment to the price in the future. Options - from changes in value, but to a slightly lesser extent than futures and forwards. These groups, other than swaps, are referred to as "major term instruments".



2. Interest-bearing derivatives. This tool appeared due to periods of destabilization of short-term interest rates. The interest rate derivative is a risk hedging tool, its use additionally affects the liquidity of the debt capital markets and the possibility of fixing certain rates of profit for companies in the future. The most widely used in the international market are interest rate swaps, floor and cap options.
3. Credit derivatives are over-the-counter structured financial instruments that separate credit exposures from assets in order to transfer them to a counterparty in the future. These derivatives allow the beneficiary to transfer the credit risk of the asset to the guarantor without having to sell the asset.