Deriviative Instruments

Question 1

What are derivative instruments

Answer 1

Stock market products which obtain value from something else

Derivative market compromised of financial instruments (legally binding) which prices are based on price of underlying asset

Examples - futures, options, warrants, interest rate swaps

• Leveraged products (own price movement is greater in % terms)

Question 2

Categories of derivatives instruments

Answer 2

Financial - equities, indices, gilts, interest rates, currency

Commodities - sub categorised into hard; metals, gold, platinum & soft; coffee, oil, sugar

Question 3

Users of derivatives

Answer 3

Those that trade can make large profits but must be mindful of risks involved and understand losses could be multiples of initial outlay

Hedgers - mitigate risks/ take counter balancing actions

Speculators - make profits from price volatility (gamble on fluctuating price movements)

Investors obtain same degree of exposure to asset as direct ownership provides, however but for smaller initial outlay & payments may be delayed to final settlement date (If brought outright in spot market payment and delivery occurs immediately)

Question 4

Development of derivatives

Answer 4

Originally to protect farmers from all in prices received for crops/ how much received to justify harvesting

Futures provided protection so farmers could sell crops at locked in prices at future date (certainty)