Derivative – What is a Derivative?

What is a Derivative?

Definition of Derivative: It is defined as a contract whose cost moderates with the cost movements of an underlying or related security or physical instrument. Commodities, currency and stocks are generally regarded as “underlying”. There are several types of derivatives among which some of the popular ones are futures, options and swaps. Moreover, as it can be linked to any type of security, the possibilities of the derivatives is endless. Therefore, a derivative can also be described as a contract between two different parties which are dependant on the future result of the fundamental. Different derivatives like futures, options and swaps having a theoretical value are calculated by utilizing the formulas like Black Scholes cost model. All of them are traded frequently in the open markets prior to their expiry date. The only danger associated with the utilization of the derivatives is that it can result in huge losses due to the utilization of borrowing or leverage. Derivatives, mainly in the Forex trading markets permit the investors to earn huge returns. Moreover, the investors can lose huge amounts if the cost of the underlying is against them. The requirement to capitalize the insurer named as American International Group, also known as AIG with nearly $85 billion debt offered by the Federal Government of U.S.A was because of the losses acquired by a subsidiary of AIG on the Default Swaps.