Element 6- Derivatives

Question 1

What are the use and application of derivatives?

Answer 1

Derivative is a financial instrument whose price is based on the price of something else, typically an underlying asset.

The asset could be a financial instrument such as bond or a share, or a commodity like oil, gold, silver, corn or wheat.

There are 3 forms of Derivatives:
Forwards
Futures
Options

The use of derivatives are Hedging and Speculation.

Question 2

What’s the definition and function of a future?

Answer 2

A future is a legally binding agreement between a buyer and a seller. The buyer agrees to pay a pre-specified amount for the delivery of a particular pre-specified quantity of an asset at a pre-specified future date. The seller agrees to deliver the asset at the future date, in exchange for the pre-specified amount of money.

Futures contracts have two distinct features:
They are exchange-traded.
They are dealt on standardised terms.