Derivative instrument

Derivative What it is:

Derivative instrument

A derivative is a contract between two or more parties whose value is based on Derivative instrument agreed-upon underlying financial asset like a security or set of assets like an index. Common underlying instruments include bonds, commodities, currencies, interest rates, market indexes and stocks.

Futures contracts, forward contracts, optionsswapsand warrants are common derivatives. A futures contractfor example, is a derivative because its value is affected by the performance of the underlying contract.

Similarly, a stock option is a derivative because its value is "derived" from that of the underlying stock. While a derivative's value is based on an asset, ownership of a derivative doesn't mean ownership of the asset.

Generally belonging to the realm of advanced or technical investing, derivatives are used for speculating and hedging purposes. Speculators seek to profit from changing prices in the underlying assetindex or security.

Derivative instrument

For example, a trader may Derivative instrument to profit from an anticipated drop in an index's price by selling or going "short " the related futures contract.

Derivatives used as a hedge allow the risks associated with the underlying asset's price to be transferred between the parties involved in the contract. Derivatives Between Two Parties For example, commodity derivatives are used by farmers and millers to provide a degree of "insurance.

Although both the farmer and the miller have reduced risk by hedging, both remain exposed to the risks that prices will change.

For example, while the farmer is assured of a specified price for the commodity, prices could rise due to, for instance, a shortage because of weather-related events and the farmer will end up losing any additional income that could have been earned. Likewise, prices for the commodity could drop, and the miller will have to pay more for the commodity than he otherwise would have.

Some derivatives are traded on national securities exchanges and are regulated by the U.

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Other derivatives are traded over-the-counter OTC ; these derivatives represent individually negotiated agreements between parties. How Derivatives Benefit Buyers and Sellers Let's use the story of a fictional farm to explore the mechanics of several varieties of derivatives.

Gail, the owner of Healthy Hen Farms, is worried about the volatility of the chicken market, with all the sporadic reports of bird flu coming out of the east. Gail wants to protect her business against another spell of bad news.

So she meets with an investor who enters into a futures contract with her. By hedging with a futures contract, Gail is able to focus on her business and limit her worry about price fluctuations. She has already acquired all the smaller farms near her and wants to open her own processing plant.

She tries to get more financing, but the lenderLenny, rejects her. Lenny's reason for denying financing is that Gail financed her takeovers of the other farms through a massive variable-rate loan, and Lenny is worried that if interest rates rise, she won't be able to pay her debts.

Derivative instrument

Unfortunately, her other lenders refuse to change her current loan terms because they are hoping interest rates will increase, too.

Gail gets a lucky break when she meets Sam, the owner of a chain of restaurants. Sam has a fixed-rate loan about the same size as Gail's and he wants to convert it to a variable-rate loan because he hopes interest rates will decline in the future.Derivative instruments: read the definition of Derivative instruments and 8,+ other financial and investing terms in the timberdesignmag.com Financial Glossary.

Illustration of Derivative Financial Instrument To illustrate the measurement and reporting of a derivative financial instrument, we examine a derivative whose value is related to the market price of Laredo Inc. common stock. Instead of purchasing the stock, Hale could realize a gain from the increase in the.

A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, index or security. An equity derivative is a trading instrument which.

Derivatives Between Two Parties

The effect of embedding a derivative instrument in another type of contract (“the host contract”) is that some or all of the cash flows or other exchanges that otherwise would be required by the contract, whether unconditional or contingent upon the.

A derivative is a financial security with a value that is reliant upon or derived from an underlying asset or group of assets. The derivative itself is a contract between two or more parties based.

Derivative instruments – instruments which derive their value from the value and characteristics of one or more underlying entities such as an asset, The gain or loss on a financial instrument is as follows: Instrument Type Categories Measurement Gains and losses Assets Loans and receivables.

Derivative Instrument - timberdesignmag.com