Characteristics of Derivatives

Characteristics of Derivatives

Here are some of the key characteristics of derivatives in the Treasury market:

Derivatives are contracts that derive their value from an underlying asset: In the case of Treasury derivatives, the underlying asset is usually a Treasury security, such as a Treasury bond or note.

Derivatives have a fixed expiration date: Futures and options contracts have a fixed expiration date, which is the date on which the contract must be settled. Swaps, on the other hand, can have longer maturities and may not have a fixed expiration date.

Derivatives can be used for hedging or speculation: Investors can use derivatives to hedge against price or interest rate movements in the underlying asset, or they can use them to speculate on future movements.

Derivatives can be traded on exchanges or over-the-counter (OTC): Exchange-traded derivatives are standardized contracts that are traded on organized exchanges, while OTC derivatives are customized contracts that are traded directly between two parties.

Derivatives can be complex and involve significant risks: Derivatives can be complex financial instruments that require a high degree of knowledge and expertise to trade effectively. They can also involve significant risks, including the risk of losing more than the initial investment.

Derivatives can provide leverage: Because derivatives allow investors to control a large amount of underlying assets with a relatively small investment, they can provide significant leverage. This can increase the potential return on investment, but it also increases the potential risk.

Derivatives are subject to margin requirements: Investors who trade derivatives are often required to post margin, which is a deposit of funds that serves as collateral against potential losses. Margin requirements vary depending on the type of derivative and the exchange or broker through which it is traded.

• There is no limit on number of units transacted in the derivative market because there are not physical assets to be transacted.
• The derivative markets are usually screen-based computerized exchanges as against the trading market for physical assets.
• Derivatives are only secondary market securities and cannot help in raising funds as against the trading markets for physical assets.
• Derivatives are only secondary market securities and cannot help in raising funds to a firm. I fact, derivatives arise only when the shares and debentures are already issued by the companies.
• The derivative market is quite liquid and transaction can be effected easily.
• The derivatives provide a hedging of price risk of financial transactions over a certain period.

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