Web Trader MT5
Derivative is a financial contract whose value depends on another underlying asset, rate, or index. The asset is not the derivative per se. It is a contract that references the asset’s performance.
The underlying may be a stock, a bond, a currency, a commodity, an interest rate, or a market index. What the two parties are doing is agreeing on terms today, which will play out in what the underlying will do in the future.
The uses of derivatives can vary widely depending on the person using them. It is through derivatives that a corporation hedging its currency exposure on its overseas revenues reduces its risk. A leveraged position on oil prices, taken by a speculative fund, is being used to exacerbate the move.
Even instruments such as futures, options, swaps, and forwards are neutral. The risk profile will solely rely on the use of the products. The notional values in international derivatives markets are a frightening concept, as they run into the hundreds of trillions, yet notional exposure and actual risk are very different.
Example: A UK pension fund has a large gilt holding and is concerned that rising rates will erode its value. Instead of selling the gilts, it enters into an interest rate swap – paying fixed, receiving floating – hedging the rate risk without selling the underlying gilts.
