Welcome to the Investors Trading Academy talking
glossary of financial terms and events.
Our word of the day is “Derivative”.
A Derivative is a financial instrument whose
characteristics and value depend upon the
characteristics and value of an underlier,
typically a commodity, bond, equity or currency.
Examples of derivatives include futures and
options.
Advanced investors sometimes purchase or sell
derivatives to manage the risk associated
with the underlying security, to protect against
fluctuations in value, or to profit from periods
of inactivity or decline.
These techniques can be quite complicated
and quite risky.
The derivative itself is merely a contract
between two or more parties.
Its value is determined by fluctuations in
the underlying asset.
The most common underlying assets include
stocks, bonds, commodities, currencies, interest
rates and market indexes.
Most derivatives are characterized by high
leverage.
Derivatives are generally used as an instrument
to hedge risk, but can also be used for speculative
purposes.
For example, a European investor purchasing
shares of an American company off of an American
exchange would be exposed to exchange-rate
risk while holding that stock.
To hedge this risk, the investor could purchase
currency futures to lock in a specified exchange
rate for the future stock sale and currency
conversion back into Euros.
