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How Derivatives Work
Category :- General

Author :- Nick Fillmore 
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Posted on January 15, 2014, 8:42 pm
(4 Ratings)

How Derivatives Work

A derivative is a security that derives its value from some other asset. Traditional derivatives include "put" and "call" options, that give holders the right to sell or buy a certain asset at a certain price; futures contracts, that bind a seller and buyer to close a transaction at a determined price on some future date, are another type.

The main advantage or lure of derivatives is that they provide a hedge against the future, and also a way to bet on it for enormous profit. An importer expecting a shipment can use them to "lock in" a foreign currency at a certain exchange rate. But exotic forms with names like the “snowball”, “inverse floater” and “power reverse dual currency note,” can quickly hang billions of dollars in nominal value on mere quivers in the value of the underlying asset.

If we were to have a global financial crisis, a collapse in real underlying assets would put $228.72-trillion worth of derivatives -- about three times the value of the world economy -- at risk at the nine largest banks alone.

Source: http://nickfillmore.blogspot.ca/p/how-derivatives-work-derivative-is.html

Notes  : About the author: an award-winning investigative reporter and a founder of the Canadian Association of Journalists (CAJ), Nick was a news editor and producer with the Canadian Broadcasting Corporation for more than 20 years.
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