Derivatives

FIN 3040

Derivatives

My paper is going to be on chapter nine about the Derivatives Markets. Derivatives refer to securities with payoffs that depend on the prices of other securities or assets; derivatives can be used to reduce risk, allowing firms and individuals to enter into agreements that they otherwise wouldn't be willing to accept. A derivative is a financial instrument that derives or gets it value from some real good or stock. Common examples of underlying assets are stocks,

bonds, corn, pork, wheat, rainfall, etc. Some examples of derivatives are stock options, forward, futures, and swaps. Why are derivatives important and why do they exist?

Derivatives transaction relies one party’s loss is always another party’s gain. “The main purpose of derivatives is to transfer risk from one person or firm to another, that is, to provide insurance”; for example, if a mechanic before working on a customer car can guarantee a certain price he will receive, he is more likely to work on the car. In many aspects, derivatives improve overall performance of the economy. Hedging and speculative are the two main purposes that derivatives are used. Most businesses often use derivatives to hedge. Hedge funds are open to wealthy or institutional investors and are not subject to many SEC regulations; speculative sought to profit from risk unlike hedging which seeks to transfer risk.

A forward contract is an agreement between a buyer and a seller to exchange a commodity or financial instrument for cash on a prearranged future date for a specified price. “No money changes hands when the agreement is made. “ These are “price-fixing” agreements that saddle the buyer with the same price risks as actually owning the asset. In a forward, the parties lock in a price and are subject to symmetric along with offsetting payment obligations. The long position in forward contract would be the party that agrees to buy the asset in the future; short position would be...