Derivatives Flashcards
what is a derivative
a financial product whose value depends on the value of something else
what is the name for what the value of the derivative is dependent on
the underlying
examples of the underlying
interest rate
equity price
commodities
bonds
why use derivatives
transfer of risk from those who want to avoid to those who want to take it on
transfer of risk that would not be possible with financial products (underlying is unattainable eg sunshine)
what is the problem associated with derivatives
when risk is transferred to someone who does not fully understand the risk they are taking on
how are most derivatives exchanged
over the counter
how are derivatives like power tools
extremely useful when used by someone trained to use them but dangerous in the hands of an inexperienced user
are derivatives long term investments
no
most are shorter term like a few years or months
what position will you take if you believe prices will rise
long
what position will you take if you believe prices will fall
short
what does it mean to hedge your risk
protect yourself against it
seek protection from price movements
what is a long hedge
protect against a rise in price
(the investor will lose money if there is a rise in price)
what is a short hedge
protect against a fall in price (the investor will lose money if there is a fall in price)
two general uses of derivatives
hedging
speculating
types of vanilla derivative contracts
forwards
futures
options
swaps
