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Derivatives
Derivatives are financial instrument that derives its value from the value of underlying entities such as an asset, index, or interest rate–it has no intrinsic value in itself. Derivative transactions include a variety of financial contracts, including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards, and various combinations of these.
Type of Derivatives
The types depend on the types of underlying assets. It may be based on physical commodities such as agriculture products, metals, etc. In India, future contracts in commodities are available at different commodities exchange.
1. Commodity Derivative: Commodity derivatives are investment tools that allow investors to profit from certain items without possessing them. This type of investing dates back to 1848 when the Chicago Board of Trade was established. Initially, the idea behind commodity derivatives was to provide a means of risk protection for farmers. They could promise to sell crops in the future for a pre-arranged price.
2. Financial Derivatives: Financial derivatives are financial instruments that are linked to a specific financial instrument or indicator or commodity, and through which specific financial risks can be traded in financial markets in their own right. Transactions in this should be treated as separate transactions rather than as integral parts of the value of underlying transactions to which they may be linked. The value of a financial derivative derives from the price of an underlying item, such as an asset or index. Unlike debt instruments, no principal amount is advanced to be repaid and no investment income accrues. Financial derivatives are used for a number of purposes including risk management, hedging, arbitrage between markets, and speculation.
