Monday, 31 August 2015

What are Derivatives?

A derivative is anything that 'derives' its value from an underlying. In the Financial Terminology, a derivative is a contract, in the form of a 'future' or an 'option' deriving value from the 'spot price' or the 'underlying.'

For example, let's take the example of Nifty, an index at the National Stock Exchange of India. 


Consider Nifty as an underlying for deriving value of the 'futures' contract of Nifty, i.e. Nifty Future. In other words, a 'Nifty Futures' contract shall derive its value from Nifty. The price movement of this Nifty Future contract will be in accordance with the Nifty spot price. 

Similarly, futures contracts are available for different underlying(s) like the above mentioned Index, equities, commodities, currencies, etc.

The world over, derivatives are a key part of the financial system. they provide liquidity in the financial markets, clubbed with several other uses like hedging tools, leverage etc.

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