Derivative
Term of the Day - 30 January 2024
Today’s Term is “Derivative”.
In finance, a derivative is a financial contract or instrument whose value is derived from the performance of an underlying asset, index, rate, or other financial benchmark. Derivatives serve various purposes, including hedging against price fluctuations, speculating on market movements, and achieving portfolio diversification. There are several types of derivatives:
Futures Contracts: These obligate the buyer to purchase, and the seller to sell, a specific quantity of an underlying asset at a predetermined future date and price.
Options: These provide the buyer with the right, but not the obligation, to buy (call option) or sell (put option) the underlying asset at a predetermined price within a specified period.
Swaps: These involve the exchange of cash flows or other financial instruments between two parties. Common types include interest rate swaps and currency swaps.
Forwards: Similar to futures contracts, forwards are agreements between two parties to buy or sell an asset at a future date for a specified price. However, forwards are traded over-the-counter (OTC) and are customizable, unlike standardized futures contracts.
Derivatives are essential in risk management and play a significant role in financial markets, providing liquidity, enabling price discovery, and facilitating efficient allocation of capital.
