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What are Derivatives?

by Bhakti

Derivatives are financial securities that depend on or derive from the underlying asset or asset group (benchmark). The value of the underlying asset will continue to change depending on market conditions. The basic principle of derivative contracts is to speculate on the value of future underlying assets to make a profit.

Imagine that the market price of a stock can go up and down. You may incur losses due to falling stock prices. In this situation, you can enter into a derivative contract to make an accurate bet and make a profit or just protect yourself from losses in the spot markets.

What are the types of Derivatives contract?

The four main types of Derivatives contracts are options, forwards, futures, and swaps

  1. Option: An option may be a derivative contract that provides the customer the proper to shop for or sell the underlying asset at a specified price during a selected period. Option sellers are known as option writer. The peculiar price is under stable because it is the strike price. You can exercise your American option at any time before the option period expires.
  2. Futures:  The parties to the futures contract are bind to fulfil the contract. The value of futures contracts is assess daily. This means that the contract amount is adjustable according to the movement of the market until the maturity date.
  3. Forwards: These are like futures contracts where the holder is bind to fulfil the contract. However, futures are not standardized and are not traded on the stock exchange. These are available over-the-counter and are not of market value. These can be personalize to the requirements of the parties to the contract.
  4. Swap: Lastly, a swap is a derivative contract in which two parties exchange financial obligations. Cash flows are based on the notional amount agreed between the parties without the exchange of principal. The amount of cash flow is based on interest rates. One cash flow is usually fix and the other cash flow changes on basis of the benchmark interest rate. Interest rate swaps are the foremost commonly applicable in this category.

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