Glossary > Finance > Financial Markets > Derivatives Markets

Derivatives

Derivatives are financial instruments that derive their value from an underlying asset, index, or rate. They are contracts between two parties based on the future price of the underlying asset.

Example #1

An example of a derivative is a futures contract on gold. The contract specifies a future date and price at which the buyer and seller agree to exchange gold at that price, regardless of the actual market price at that future date.

Example #2

Another example is an options contract on a stock. The holder of the option has the right, but not the obligation, to buy or sell the stock at a predetermined price within a specific period.

Misuse

One common misuse of derivatives is excessive speculation, where investors may take on very high risks in the hope of high rewards. This can lead to financial instability and market manipulation, putting consumer investments at risk. It's crucial to regulate and monitor derivatives trading to prevent excessive speculation that can harm consumers and the market.

Benefits

Derivatives can also be beneficial when used properly. For example, they can help investors manage risk by providing a way to hedge against price fluctuations in the market. Hedging with derivatives can protect investors from potential losses, ensuring a more stable and secure investment portfolio.

Conclusion

Understanding derivatives is essential for consumers and employees in the financial markets to make informed decisions about their investments. While derivatives can be risky if misused, they also offer valuable risk management tools when used responsibly.

Related Terms

AssetRiskHedging