Derivatives

1. Definition

Derivatives are financial contracts whose value is derived from the performance of an underlying entity, known as the Underlying Asset (e.g., stocks, bonds, currencies, commodities, or interest rates).

2. Key Types

2.1. Forwards

A customized contract between two parties to buy or sell an asset at a specified price on a future date. Traded Over-the-Counter (OTC).

2.2. Futures

A standardized version of a forward contract, traded on an organized exchange. It involves margin requirements and daily settlement.

2.3. Options

Contracts that give the buyer the right, but not the obligation, to buy (Call) or sell (Put) the underlying asset at a specific price.

2.4. Swaps

Agreements to exchange cash flows or other financial variables between two parties (e.g., Interest Rate Swaps, Currency Swaps).

3. Purpose

1. Hedging: To mitigate or offset the risk of adverse price movements in the underlying asset.
2. Speculation: To bet on the future direction of prices using leverage for potentially higher returns.
3. Arbitrage: To profit from price discrepancies of the same asset in different markets.