A Basic Guide To Financial Derivatives

Derivatives are complex financial contracts based on the value of an underlying asset, group of assets or benchmark. These underlying assets can include stocks, bonds, commodities, currencies, interest rates, market indexes or evenInvestors enter into derivative contracts that clearly state terms for how they and another party will respond to future changes in value of the underlying asset.

Notably, futures are standardized, exchange-traded investments, meaning everyday investors can buy them about as easily as they can stocks, even if you personally don’t need a particular good or service at a particular price. Gains and losses are settled daily, meaning you can easily speculate on short-term price movements and aren’t tied to seeing out the full length of a futures contract.

American options, meanwhile, can be enacted at any point leading up to their expiration date. They are similarly non-binding and can go unused. The exact way swaps play out depends on the financial asset being exchanged. For the sake of simplicity, let’s say a company enters into a contract to exchange a variable rate loan for a fixed-rate loan with another company. The company getting rid of its variable rate loan is hoping to protect itself from the risk that rates rise exponentially.

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