What are Derivatives?
A Brief Explanation of Derivatives | Definition
A derivate is a financial instrument derives its value from the value of a separate underlying asset. The derivate itself has no inherent value other than the contract it represents. Types of derivatives include debt obligations, swaps, futures, option, and forwards. Derivates, which are contracts between two parties, have their value tied to a wide range of assets, ideas, and instruments ranging from the nominal price of a stock to complex shorts on foreign currencies. The value of the derivative changes as the value of the underlying asset to which the derivate is tied fluctuates. The values between the derivatives contracts and the underlying assets may be inversely or directly related.
The derivatives market has been estimated to be valued at $700 trillion. However, economists believe the risk associated with the market to be much lower. Derivatives are most commonly used as a method to hedge and protect against risk. Currency speculators use futures to protect against an exchange rate risk. Similarly, options can hedge against a falling share price of a company.
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