Derivatives

Derivatives are financial products which derive their value from the price of another financial product, called the underlying. The underlying security can be shares, bonds, but also interest rates, inflation rates, commodity prices, and even weather conditions or other derivatives.

Forwards

A forward contract is an obligation to either buy or sell a certain product at a certain date in the future at a price agreed upon today. Forward contracts are traded on the over-the-counter (OTC) market. The actual delivery and money transfer only takes place at maturity.

Futures

A futures contract is also an obligation to buy or sell a certain product at a certain date in the future at a price agreed upon today. It differs from a forward contract in the way that price differences are settled. In the case of a futures contract, the daily profit or loss is settled every day. In addition, futures contracts are standardised, whereas forward contracts are not. This allows futures contracts to be easily traded on public exchanges.

Swaps

Swaps are contracts in which an investor agrees to exchange payments periodically over a certain time interval at a rate determined today or at certain points in the future. The payments that are exchanged can for example be monthly exchanges of USD against EUR, fixed interest rates against a floating interest rates,…

Options

Options are contracts in which the buyer has the right, but not the obligation, to buy or sell a certain asset at a price determined today during some time in the future.

CFD

CFD stands for contract for difference which is a OTC-market traded derivative. They are popular among retail investors due to their ease in taking leverage.

Summary

Derivatives are complex products whose value depends on other financial securities. Forward contracts, futures contracts, swaps and options can both be used for hedging purposes or for speculation.

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