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A derivative is a financial instrument derived from an underlying asset,
eg a stock, stock index, currency etc. Derivatives allow holders to speculate
on price movements of the underlying asset without actually owning the
Derivatives are traded for two main reasons:
1) to allow holders to hedge a position, ie to reduce the risk inherent
in their basic position;
2) to allow speculators to profit from correctly anticipating price movements.
Speculator profits essentially come from the premium paid by hedgers
for reducing their risks.
Demystified: A Step-by-Step Guide to Forwards, Futures, Swaps and
Options by Andrew M. Chisholm. A step-by-step guide
to derivative products. By distilling the complex mathematics and
theory that underlie the subject, Chisholm explains derivative products
in straightforward terms, focusing on applications and intuitive
explanations wherever possible. Case studies and examples of how
the products are used to solve real-world problems, as well as an
extensive glossary and material on the latest derivative products
make this book a must have for anyone working with derivative products.
Derivatives are usually highly geared, with a small percentage change
in the price of the underlying asset producing a much larger change in
the derivative price. This gearing is further increased traders trading
on margin, ie depositing only a fraction of the value traded (the margin)
with their broker. It follows that derivatives offer a much higher potential
for profit - and also loss - than direct investments.
The main types of derivatives are:
- Options - the right to buy/sell an asset at a particular price some
time in the future.
- Futures - the oblgation to buy/sell an asset at a particular price
some time in the future.
- SWAPS - two parties agree to swap financial arrangements with each
other to mutual benefit, eg an institution with a fixed interest debt
that believes interest rates will fall would swap its arrangement with
another institution with variable interest rate debt that believes rates
About Derivatives by Michael Durbin. Financial derivatives,
from standard put and call options to more complex strategies and
combinations, are among the most versatile, powerful, and valuable
tools available to investors. All About Derivatives introduces you
to the many different types of derivatives, providing simple explanations
and easy-to-follow methods for using each. This straightforward,
up-to-date examination covers all aspects of derivative contracts,
explains techniques for pricing and trading them, shows how to use
each to hedge risk or increase profits, and more. Avoiding complicated
formulas and theories to focus on the information you need, it shows
anyone--from individual investors to corporate risk managers--how
derivatives work, how they fit into the larger world of investing,
and why they can be the ideal trading vehicle for improving the
financial performance of yourself or your organization.