A derivative financial instrument is generally a special type of contract under which one party to the transaction undertakes to deliver to another participant a certain underlying asset at an agreed price and within a specified period.
Derivatives are financial instruments based on liabilities in respect of a commodity or other investment asset. Another name for this type of instrument is derivatives. In fact, a derivative financial instrument is often a security for some other security, that is, it is secondary in relation to another asset.
The most common types of derivatives are:
- futures;
- option;
- swap;
- swaption;
- forward contract;
- contract for difference.
Derivative financial instruments are usually divided into types in accordance with the assets that form their basis.
Financial derivative securities, as a rule, include contracts based on rates on long-term and short-term bonds of Great Britain, the USA and a number of other countries.
Currency derivative securities refer to contracts based on the rates of major world currencies.
Index derivatives are contracts entered into on indices of securities.
Commodity derivatives include contracts for energy resources, for precious and some non-ferrous metals, and agricultural products. However, the actual delivery of assets underlying financial derivatives is carried out only in a small number of forward transactions. Usually, the regulation of the transaction is carried out through mutual settlements, which are carried out in cash.
Derivative financial instruments are often used to hedge market risks (hedges). For example, a grain producer can protect himself from a collapse in prices for his products in the future, when he expects to harvest. Or, for example, an automobile company, through derivatives, can insure against a sharp rise in prices for non-ferrous metals.
Another area in the use of derivative financial instruments is speculative transactions. One of the most significant advantages of a derivative is that its acquisition requires significantly less financial resources than other financial instruments. To buy a 100,000 euro futures against the US dollar, you will need only a few thousand dollars of collateral. The financial speculator has the ability to gain substantial leverage that raises the rate of return. But the high potential profit is directly related to the possibility of loss of invested funds: transactions with derivatives are among the most risky.
The price of a financial derivative is directly related to the value of the underlying asset, although there is no complete coincidence in prices. With fluctuations in ratings, credit indices, the value of a physical good or security, the value of a derivative also changes. Therefore, when playing on the difference in the market value of derivative financial instruments, you need to carefully monitor the factors that in one way or another may affect the value of the primary (underlying) asset.
The vast derivatives market is currently considered one of the fastest growing segments of the financial world.
