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Financial contracts whose value depends on an underlying price, rate, asset or other reference.
Save conceptA derivative is a contract whose value or payments depend on an underlying price, rate, asset or other reference. Futures, options and swaps are common examples. They can help businesses manage exposures or allow traders to take positions without purchasing the underlying asset outright. The contract creates particular rights and obligations; it is not simply a synonym for a risky investment.
Its terms specify the reference, amount, dates and payment rules. A forward can fix a future purchase price; an option gives a right under stated conditions; a swap exchanges specified payment streams. Prices move as the reference and expectations change. and arrangements matter because an apparently profitable contract is useful only if the promised payment or delivery is made.
Suppose an importer agrees to buy US$100,000 in three months for J$155 per US dollar. The agreed payment is J$15.5 million. If the spot rate then reaches J$165, buying at the prevailing rate would cost J$16.5 million. The forward has protected the specified exchange price, but if the spot rate falls to J$145 the importer still owes the contracted J$15.5 million.
Hedging reduces a chosen exposure; it does not guarantee the best outcome after the fact or eliminate every business risk. A derivative's notional amount is the reference used in calculations, not automatically the cash invested or loss at default. Distinguish the product's payment rules, market exposure, leverage and risk before interpreting a large headline notional value.
ECB survey finds easier wholesale credit terms, with financing costs mixed