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What are Derivatives?

by Team Goseeko

Derivatives are financial contracts whose value is linked to the worth of the underlying asset. These are complex financial instruments that are used for a variety of purposes, including hedging and access to additional assets and markets.

Most derivatives are traded over-the-counter (OTC).  The largest derivative exchanges include CME Group (Chicago Mercantile Exchange and Chicago Board of Trade), Korea Exchange and Eureka’s.

Derivative Types

1. Futures

These are financial contracts that require the purchaser of the contract to purchase the asset at a pre-agreed price on a specified future date. Both futures and futures are essentially the same property. However, forward contracts are more flexible because the parties can customize the original product, the quantity of the product, and the trading date.

2. Option

The option gives the purchaser of the contract the right to buy or sell the underlying asset at a given price, but no obligation. Based on the type of option, the buyer may exercise the option on a maturity date (European option) or any date before maturity (American option).

Swaps are derivative contracts that allow the exchange of money flows between two parties. Swaps usually involve exchanging fixed cash flows for variable cash flows. The most popular sorts of swaps are rate of interest swaps, commodity swaps, and currency swaps.

3. Swap

Derivatives accounting is a balance sheet item in which the derivatives held by a company appear in the financial statements in a manner approved by GAAP, IAAB, or both.

Under current international accounting standards and Ind AS 109, companies must measure derivative products at fair value or market value. All fair value gains or losses are recognized in profit or loss unless the derivative is eligible as a hedging instrument for cash flow hedging or net investment hedging.

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