Uses of Derivatives- Derivatives are financial instruments that have values derived from other assets like stocks, bonds, or foreign exchange. Derivatives are sometimes used to hedge a position (protecting against the risk of an adverse move in an asset) or to speculate on future moves in the underlying instrument. Hedging is a form of risk management that is common in the stock market, where investors use derivatives called put options to protect shares or even entire portfolios.
The growth in financial markets, globalization of the major stock exchanges, increase in the number of players in the markets and the creation of new financial opportunities led to the creation of a wide array of instruments tailor-made to manage the evolving risk-return profile.
For risk management, banks take the help of derivatives to hedge against uncertainties. Derivatives are used by banks to hedge against
- changes in interest rates
- changes in foreign exchange rates
- fluctuations in commodities prices
Mutual funds and pension funds use them to protect their,
- stock and bond investments
- asset allocation
- yield enhancement
- to avail arbitrage opportunities
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