What is a derivative? It is a contract whose value depends on an underlying asset. This means that a derivative does not have an independent value. It gains more value as the underlying asset gathers value.
What is an underlying asset? The underlying asset is the subject matter of derivative. Such an asset may be an equity share, a currency, a commodity, a fixed rate debt instrument or a loan (credit).
Derivatives can be broadly classified into financial derivatives and commodity derivatives.
In addition to classification based on type of underlying asset as above, we may classify derivatives in the following ways also:
1) Relationship between the underlying asset and the derivative: Forwards / Futures, Options and Swaps.
2) Market: Exchange-traded derivatives and Over the Counter (OTC) derivatives.
3) Purpose: Speculative, Hedge and Arbitrage
4) Payoff profile: In the Money (ITM), Out of Money (OTM) and At the Money (ATM) derivatives.
5) Payoff profile II: Linear and Non-linear derivatives.
Objective: Derivatives are normally considered as tools for Risk Management. When they are misused, knowingly or unknowingly, they have the potential to become what Warren Buffett calls as 'Financial Weapons of Mass Destruction'. Examples: 1) Nick Leeson of Barings Bank (1995), 2) Jerome Kerviel of SocGen (January, 2008), 3) Kweku Adoboli of UBS (Sept., 2011)
To get the detailed overview on Derivatives Learno going to organize a webinar. This webinar helps you to get the complete overview of derivatives, types of derivatives, the role of derivative in the financial market, and more.
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